[ad_1]
Advanced economies like Canada are experiencing something that hasn’t been seen since the early 80s—no one believes Central Banks. It doesn’t matter how hard the Bank of Canada (BoC) or US Federal Reserve (the Fed) tries, most people don’t see them playing the tough guy. Few are tapering their demand from levels seen during record stimulus, helping to keep inflation elevated from stable targets. The result? Central Banks will continue the beatings until morale erodes, and that means taking rates higher than anyone expected.
More Like Lack of Interest Rates, Amiright? Okay, What Are They?
The primary role of a central bank is to ensure a stable currency, which means controlling inflation. The biggest tool they have to control inflation is interest rates, which is used to throttle or boost expectations and credit.
When inflation is too low, they lower interest rates to stimulate credit demand. Like, how could you NOT borrow money at these low rates, right? People borrow to buy things, which means cheap credit leads to more demand, which leads to higher prices (a.k.a. inflation).
In the case of housing, low rates also provide greater leverage to borrowers. This allows them to more easily absorb higher prices, since they can borrow more of their future income. Yes, debt is your future income used today, borrowing growth for whatever reason policymakers feel they need it.
OMG, There’s A Shortage of Everything, Everywhere!
To put it bluntly, the goal of a rate cut is to help intentionally overrun supply. Credit is created faster than production can scale, so it’s a great way to boost prices (a.k.a. inflation). Keep in mind the goal of inflation in general is to keep the economy flowing, and convince you that the pain of delaying a purchase is greater than waiting.
When inflation is too high, they do the opposite—they raise rates, throttling credit and slowing demand. The pain of buying today is supposed to be perceived as too high in contrast to waiting, when incomes will be higher or prices lower. By reducing access to capital, and incentivizing higher returns on savings, they’re trying to reduce demand faster than supply, helping to slow price growth (aka inflation).
In the case of housing, this prevents people from being able to absorb higher home prices. Heck, it might prevent people from absorbing the current price of goods, and can bring future prices down.
Ultimately, this all boils down to the central bank setting the public’s expectations. There’s either a shortage (so buy!), a surplus (so wait), or it’s balanced (it’s unclear if this happens outside of theory).
Say They’ll Cut Rates One More Time, The Central Bank Dares You
How many times have you heard, “the central bank can’t raise rates,” or “they’ll be cut soon?” If you’re in Canada, that’s basically everyone and their dog… every week. Few believe the central bank can maintain elevated interest rates for long enough to impact asset values. This has resulted in no meaningful impact on demand, letting elevated inflation persist.
Canada demonstrated this very clearly right after the “conditional pause” announcement from the BoC. Home prices began to climb a month later, at a very rapid rate. Experts began to explain that rates will be cut by year end, helping ease concerns that people should slow their demand. Stretching the budget isn’t a huge issue if it’s just a few months, but it’s a problem if prices keep rising.
The result is the central bank needs to break the consumer’s confidence, and sharply. Some experts are finally getting the message, after the BoC’s “surprise” hike a few weeks ago. Now the bond market is pricing in another increase to the overnight rate by next month, and possibly higher. Rates need to climb until expectations are broken.
The US Federal Reserve sent bond yields soaring this month, after communicating this issue. At the press conference after the FOMC decision, he emphasized no one in the Fed’s committee sees interest rates being cut this year. He then mentioned they’re, “a couple years out.”
But For Real. They’ll Cut Interest Rates, Right?
Does that mean no rate cuts next year? Who knows, but the harder stance is finally setting market expectations. The Government of Canada (GoC) 5-year bond yield, which influences the 5-year fixed rate mortgage, closed at 3.85% yesterday, up 10 points from a day before. It also happens to be the highest close since 2008.
The key difference is that back then, interest rates were falling after the global financial crisis (GFC). To restore buying activity after a global liquidity crisis that crushed asset values, they needed record low interest rates.
Is that the case today? For rates to return to pre-2020-levels, we would need crisis-level confidence in borrowing. Do people believe the same incentive is required today as was needed after the GFC? The answer to that question will help you understand how many more rate hikes are needed, and how long they need to be elevated. This isn’t 2008.
You Might Also Like
[ad_2]
Source_link
