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Monday Morning Interest Rate Update (May 28, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

Government of Canada (GoC) bond yields plummeted last week as rising fear about the contagion effects of a Greek exit from the euro zone stoked investor demand for the relative safety of GoC bonds.

Between now and the next round of Greek elections on June 17^th the markets will focus on little else. But when the should-we-stay-or-should-we-go-now Greek question is finally answered  there will still be plenty of fear to go around, and if you’re in the market for a Canadian mortgage that fear should help keep borrowing rates low for the foreseeable future (with a catch, that I will close with).

Here’s a sample of what’s next in the worry department once the Grexit stops hogging the headlines:

The Pain in Spain

When it comes to contagion risks, Greece and Portugal are grenades and Spain is a hydrogen bomb. Spain’s economy is about five times larger than the economies of Greece or Portugal and Spain’s ten-year government bond yield closed last week at 6.3% - well above the 6% threshold that many experts refer to as the point-of-no-return. If Greece is the canary in the euro zone’s economic coal mine, then  Spain is the bull in its proverbial china shop.

The Looming Beltway Stand-off  

It seems like a long time ago when global markets quivered at the prospect of a U.S. debt default during last year’s debt ceiling showdown. The final compromise was to form a bi-partisan committee to figure out how to get the deficit under control and if it failed to do so (which it subsequently did) then an automatic spending-cut trigger called “sequestration” would take effect in January of 2013.

Last week the U.S. Congressional Budget Office estimated that the coming combination of the sequestration’s spending cuts and tax increases, along with the expiration of other tax cuts, would drain about 4% from U.S. GDP and tip the country into recession. While this ‘fiscal cliff’ can be avoided if Democrats and Republicans manage to work out a compromise, don’t expect much to happen before the presidential and congressional elections in November.

The world has little appetite for another round of U.S. debt ceiling drama and the U.S. federal government doesn’t have much dry powder left to repair the economic damage that would be caused by a drawn-out fight. That said, expect the partisans to be partisan.

China’s Not-so-soft Landing

While not everyone has noticed, China’s economy has been the main engine driving world economic momentum for several years. That momentum is now on the wane; China’s GDP has slowed from 10.4% in 2010 to 9.2% in 2011 and now to 8.1% in the first quarter of 2012.

The experts I read argue that China’s slowing GDP growth is the beginning of a new era of slower economic growth for the world’s second largest economy. They point to the fact that about half of China’s total GDP is derived from infrastructure investment which has far outpaced the current needs of its citizenry. This has created a surplus of little-used roads, buildings, and even cities and that over-supply significantly reduces the need for future development.

If China starts to build less it will have to compensate for the huge hole that reduced infrastructure spending will create in its GDP while also offsetting reduced export demand from its largest and most well-established trading partners (Europe and the U.S) at the same time. These two factors underpin the risk of hard landing in China.

Five-year GoC bond yields plunged by 9 basis last week, closing at 1.32% on Friday. Lenders reacted by dropping five-year fixed rates across the board and the standard rate is now offered at around 3.19%. A few lenders also launched rate specials that go as low as 2.99% for high-ratio loans (where borrowers have less than 20% equity in their property) and as low as 3.09% for conventional borrowers (who have equity of 20% or more). If that seems backwards, keep in mind that high-ratio borrowers have to pay an additional insurance fee that is between 2 to 3% of their mortgage balance, so while their interest rate is lower, their total cost of borrowing is still higher.

Variable-rate mortgage discounts are being offered in the prime minus .25% range. With the current prime rate  at 3%, if you took a variable-rate mortgage today you would be starting with a rate of 2.75% and it would only take one .25% rate increase by the Bank of Canada to make the five-year variable rate about equivalent to today’s best five-year fixed rates. Given that, I don’t think most borrowers are saving enough to justify taking on variable-rate risk.

The bottom line: While Canadian mortgage borrowers have benefitted from the turmoil beyond our borders thus far, our now miniscule GoC bond yields are a reflection of the growing risk of a near-term systemic shock to the global economy. Such a shock could easily push up bond yields everywhere and if this happens, our mortgage rates could move sharply higher with little warning.

While I expect our borrowing rates to stay low for the foreseeable future, we’re by no means in the clear because that view is based on the assumption that none of the world’s ailing economies will die on the operating table. Fear has been good for our rates, but panic could easily be bad.

David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave

Real Estate Law: The Parrot is Really a Red Herring

Bob Aaron in Legal

Toronto real estate law guru Jeffrey Lem has a knack for making court cases both entertaining and educational at the same time.

His latest effort, which appeared in the Law Times last month, is about the $40,000 parrot. Although the bird, which was housed in a Toronto condominium in violation of the no-pets rules, was the focal point of the case, Lem says it was no more than a red herring for condominium lawyers. (Read the story here.)

Michael and Margarita Bazilinsky live in a condo unit on Holly St., near Yonge St. and Eglinton Ave. In November 2010, the corporation contacted them about a bird believed to have been in their unit. Michael responded that he had had a bird for two weeks but it had since been returned to its owner.

In December 2010, and again in February 2011, the condominium lawyers wrote the Bazilinskys demanding that they remove the bird from the unit. The lawyers threatened court proceedings to enforce compliance.

Tuesday Morning Interest Rate Update (May 22, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

Well that didn’t last long.

Greece’s political parties were unable to form a coalition government and as such, Greek voters will head back to the polling stations on June 17^th. In the interim, the anti-austerity Syriza party has gained the most momentum and that development has put markets everywhere on edge. Consider that in the past two weeks depositors have withdrawn more than $5 billion euros from Greek banks and there are also rumours of bank runs in other peripheral countries like Spain and Portugal.

Syriza party leader Alexis Tsipras is promising that he will renegotiate the terms of Greece’s bailout package and is reassuring Greek voters that the euro zone simply cannot afford to let Greece default (it is true that approx. 70% of Greece’s debt is held by foreign investors and that the largest portions of this debt are held by Spanish and Italian banks). He also knows that Greek citizens are frustrated by their austerity dominated economic prospects and he is scoring easy political points by tapping in to their visceral resentment of the foreign-led belt tightening that is sapping all hope for the future.

But Mr. Tsipras must also account for the fact that the majority of Greeks still want to remain in the euro zone. His have-your-cake-and-eat-it-too answer is to hand German Chancellor Angela Merkel a gun and dare her to pull the trigger (the gun being Greece’s next bailout payment).

Will she?

Chancellor Merkel must make a very difficult call. While a Greek default would destabilize the euro zone and risk pushing other peripheral countries into default, if she makes new concessions she will be held accountable by German voters who show little appetite for more compromise. Furthermore, any new deal offered to Greece will become the basis for negotiations with a long list of the euro zone’s other struggling countries such as Portugal, Ireland, Spain, Belgium, and Italy. That adds an order of magnitude to the true cost of any new Greek compromises.

The Greek election on June 17^th will be a day of reckoning for the fate of the euro-zone’s monetary union as we know it. Meanwhile, as the Syriza party’s popularity increases, a Greek default and exit from the euro zone (now popularly known as the “Grexit”) looks increasingly likely. Uncharted territory beckons.

Five-year Government of Canada (GoC) bond yields were 7 basis points lower for the week, closing at 1.42% on Friday as the rising demand for the safety of our bonds continued to correlate with increased fears of a euro-zone break-up. Given that five-year fixed-rate mortgages are still being offered in the 3.29% range, there is plenty of room for more discounting, but most lenders have so far chosen to let their profit margins widen instead. The only exception to that rule so far is one small lender which is now offering high-ratio borrowers a no-frills five-year fixed rate at 2.99% on a time-limited basis.

Variable-rate mortgage holders took note when Bank of Canada Governor Mark Carney recently warned that short-term interest rates might rise faster than the market expects, but he hedged his comments by acknowledging that his decision would be weighed carefully against heightened market risks, chief among them the unfolding euro-zone crisis. A messy Grexit is exactly the type of event that will cause him to recalibrate his timetable.

The bottom line: Fear should continue to dominate markets everywhere until the game of high-stakes brinkmanship between Greece and the Troika (comprised of the International Monetary Fund, the European Commission and the European Central Bank – with Germany at the controls) plays itself out. That fear will continue to fuel demand for the safety of GoC bonds and should thus keep Canadian mortgage rates at ultra-low levels until the situation in the euro zone becomes much clearer and more stable.

David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave

Monday Morning Interest Rate Update (May 14, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

Last week’s big news came from our latest employment report, which showed that the Canadian economy added 58,000 new jobs in April – a multiple of the 10,000 or so jobs that most analysts were expecting. Better still, if we add this impressive result to the 82,000 new jobs that were created in March we get the best two-month run for job creation that our economy has seen in more than thirty years.

The nature of the jobs was also encouraging, with 85,800 new private sector jobs more than offsetting 19,200 fewer public sector jobs for the month. As our various levels of government continue to shrink their budgets and reduce the size of their labour forces, we will need our private sector to drive job creation for the foreseeable future.

(As an aside, the April report included an interesting comparison between the Canadian and U.S. employment rates, which are normally calculated using different methodologies. The report rejigs the Canadian employment data using the U.S. formula and the resulting “apples-to-apples” comparison puts our employment rate at 62.6% versus the overall U.S. employment rate of 58.4%. That’s a significant gap that helps explain why Canada has now replaced all of the jobs it lost in the 2008-09 recession while the U.S. economy is still more than 5 million jobs short of its pre-recession peak.)

Bond market investors who bet on the future direction of our short-term rates reacted to the second positive Canadian jobs report in a row by pricing in the 100% probability of a .25% increase in the Bank of Canada (BoC) controlled overnight rate by December of 2012 (Reminder: variable-mortgage rates are based off of the BoC’s overnight rate).

But that enthusiasm has not yet spilled over into our longer-term Government of Canada (GoC) bond yields, which barely moved on Friday (Reminder: five-year fixed-mortgage rates are based off of GoC five-year bond yields).

While short-term bond traders are a notoriously fickle bunch, investors who trade the longer end of the rate curve tend to adjust their views more gradually. Here are some thoughts on why they are still taking a wait-and-see approach to the possibility of higher rates:

• The Canadian economy saw six months of moribund job growth before the robust March and April rebound. Our combined job growth over the last eight months now puts us in line with our long-term average growth rate.
• While the job creation data was strong, growth in average incomes is still barely keeping pace with inflation and this means that the purchasing power of the average Canadian is largely unchanged.
• The upbeat hiring numbers stand out against a backdrop of otherwise less-than-impressive economic data. Our current GDP growth rate is cause for the greatest concern - we are well below the 2.5% level that the BoC was forecasting when it predicted that our economy would return to full capacity in early 2013 and consensus estimates for first-quarter GDP growth are now in the 1.3% to 1.6% range. If the economy doesn’t start growing faster, our recent jobs momentum won’t be sustained.
• Much was made of last week’s CIBC report showing that year-over-year household credit growth has now slowed to 5% (its lowest level since late 2001). Given that Governor Carney has referred to our rising debt levels as the “biggest risk” to our economy, reduced rates of borrowing should make it less likely that he will raise the BoC’s overnight rate as an emergency response to reign in rampant borrowing. Also, while less borrowing reduces the risk of a debt bubble, it also lowers demand and acts as a headwind against both future job creation and economic growth.
• Many investors are expecting more bad news from the euro zone where Greece can’t form a pro-bailout government and Spanish ten-year bond yields are back within a sniff of 6%, and from the U.S., where the strength of their economic recovery is still very much up for debate.

We’ll get our next key data point this Friday when Statistics Canada releases its latest Consumer Price Index (CPI). While the market expects the April CPI to show slowing price inflation, which would make short-term rate increases less likely at the margin, BoC Governor Mark Carney made some pre-emptive comments last week to temper any overly-enthusiastic reactions to the report.

He warned that “inflation can be allowed to run below target for a longer period than usual if tighter policy is warranted”. In other words, he was reminding the market that below-target inflation will not stop him from raising rates to keep other risks in check, like rising household debt levels.

Five-year GoC bond yields were down 2 basis points for the week, notwithstanding a mild Friday rally in response to the latest jobs data. Five-year fixed rates are still offered in the 3.29% range for conventional borrowers who have down payments of at least 20% of the value of their property. High-ratio borrowers who have down payments of less than 20% can now find five-year fixed rates as low as 3.14%. While on first blush that looks like the less you put down the better your rate, when the cost of mandatory high-ratio default insurance is factored in, borrowers who put down less than 20% still pay more in the end.

I still don’t think today’s variable-rate mortgages are compelling with their very small discounts off prime and I explained that view in this recent Rob Carrick interview as part of his Let’s Talk Investing series.

The bottom line: On their own, the recent strong job reports suggest that higher mortgage rates may be on the way, but so far there hasn’t been a lot of other supporting data to bolster this view. That said, we’ll keep watching the tea leaves for any signs that make Mr. Carney’s words more likely to turn into action.

David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave

Is Toronto’s Real Estate Market Going to Crash?

John Pasalis in Toronto Real Estate News

The media have stepped up the real estate bubble rhetoric lately so I thought I would take some time away from the busy spring market to offer my thoughts on the one question that’s on most people’s minds, is the Toronto real estate market going to crash?

Most buyers are worried about buying at the peak of the market and with all the bubble talk in the mainstream media they are right to being asking themselves, is this the peak?

If we have hit the peak then we would expect to see a decline in house prices within the next 6-12 months.

So what causes house prices to fall?  There’s actually only one basic economic condition that will cause house values to fall, when the supply of houses coming on the market for sale significantly out numbers the demand for homes.  There could be a number of different factors that cause demand to decline or the supply of homes to increase but it’s the imbalance between the two that drives house prices down. 

With that in mind, we’ll start off by taking a look at the balance between the supply and demand for houses in the resale market.

We can measure the balance between supply and demand by looking at the sales-to-inventory ratio for any given month.  The sales-to-inventory ratio is simply the number of houses that sold in a month divided by the number of houses available for sale.  In a balanced market we would expect to see roughly 2 houses selling for every 10 that are available for sale, or a 20% sales-to-inventory ratio.  When the sales-to-inventory ratio is above 20% the demand for homes exceeds the supply which causes prices to rise and similarly when it’s below 20% the supply exceeds the demand which causes prices to fall.  

The following chart shows the relationship between the sales-to-inventory ratio and changes in house prices from 1989 to April 2012.  

Monday Morning Interest Rate Update (May 7, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

When Bank of Canada (BoC) Governor Mark Carney recently warned market watchers that he believed mortgage rates will rise faster than most observers expect, he based this view on three fundamental predictions that were outlined in the BoC’s most recent Monetary Policy Report:

1. The Canadian economy will return to full capacity in early 2013.
2. The U.S. economic recovery is now on a more solid footing.
3. The recession in Europe will end in the second half of 2012.

Given that Governor Carney and the BoC control our short-term interest rates (and can also heavily influence our longer-term interest rates), tracking the relative progress of these three developments will allow us to gauge the likelihood and timing of future rate increases. To that end, here is what happened last week on all three fronts.

Spring Mortgage Market Update (2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

It’s time for the powers that be to pick our poison.

Do they keep short-term interest rates at ultra-low levels to protect our broader economy from the economic turmoil still raging beyond our borders, even if doing so increases the risk of a debt bubble?

Should they instead raise short-term rates (and longer-term rates, by association) to slow household borrowing and restrain house-price appreciation in major markets like Toronto and Vancouver, even if doing this could stall our still vulnerable economic momentum?

Or do they try to isolate mortgage borrowing, the area of greatest concern, by tightening regulations and underwriting standards at the risk of triggering the very house price correction they seek to avoid?

Buying a Cottage Unlike Other Real Estate Transactions

Bob Aaron in Legal

The beginning of the cottage season is a good opportunity for a reminder that recreational real estate transactions are unlike any other property dealings.

Speaking to about 1,000 real estate lawyers at a Law Society seminar earlier this month, Midland lawyer Fred Hacker pointed out that the main difference in cottage deals is the emotional fervour that surrounds the transactions. “Buyers aren’t buying a piece of real estate,” Hacker said. “They’re buying their sanctuary, their retreat, the focus of their family life, a lifestyle and the stuff of dreams.

“And sellers aren’t just disposing of real estate; they’re parting with memories, sentimental attachments, their history, and, in many cases, the best years of their lives.”

Flaherty Should Cool Toronto’s Condo Market (Not Just Warn Us About It)

John Pasalis and Urmi Desai in Toronto Real Estate News, Toronto Condos

Over the past couple of years we’ve heard Mark Carney and Jim Flaherty escalate their concerns about condo markets in Toronto and Vancouver but we have yet to see the federal government introduce any concrete policies to try to cool things down.

One of the key problems with Toronto’s pre-construction condo market is that it is almost entirely fueled by speculators. Speculators are buying condominiums in the very early stages of a project with the expectation that prices will go up significantly once the building is completed.

This is a problem because for most consumers, real estate makes up a huge part of our individual financial portfolios as we seek out the financial discipline and sense of personal security that home ownership offers. Speculators, on the other hand, pursue the same assets for very different motives - high risk, short-term profits. (When referring to speculators, we do not mean investors who purchase to rent out condos as they are holding these assets for the long-term.) These are conflicting motives that threaten the health of the asset class for everyone.

This is why (John's note: and believe me I am very surprised by this myself) we are about to argue for more taxes. Many taxes are ill-thought out, poorly conceived and executed instruments that do not deliver their theoretical benefits, but that does not negate the good that these policy instruments can do with the right goal in mind - in this case, to protect an entire asset class for the benefit of all.

It’s time for Flaherty to cool Toronto’s pre-construction condo market by introducing policies that curb speculation.

Monday Morning Interest Rate Update (April 30, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

The global economic recovery is on a very tenuous footing. While determined optimists can string together enough positive threads in the latest economic data to make an argument that the downturn is bottoming out, the realist in me isn’t biting. Encouraging signs aside, the world’s largest economies are still far too vulnerable to withstand the next major setback, which could seemingly come from almost anywhere but will most probably originate in Spain, the fourth largest economy in Europe and the twelfth largest in the world.

In fact, I now believe that some kind of Spanish debt default is all but inevitable.

When the European Central Bank (ECB) launched its Long-Term Refinancing Operation (LTRO), which allowed euro-zone banks to pledge (and leverage up) suspect quality debt in exchange for three-year loans with a fixed 1% interest rate, it looked like Spain might have at least bought itself some time.