Canada's housing market is faltering just as the U.S. market roars back to life.
This sudden reversal of the narrative that has prevailed since the U.S. housing bust in 2006 is about to make Mark Carney's interest rate juggling act much trickier.
The Bank of Canada's next rate-setting announcement is Tuesday, followed by the monetary policy report Wednesday.
There won't be a rate hike – not yet, anyway. But the betting among some Carney watchers is that the bank governor will drop his implicit projection of higher rates soon, or at least modify the bank's now-familiar pledge of "some modest withdrawal" of rock-bottom rates and monetary stimulus.
Mr. Carney is facing an unusually uneasy global economic environment. China's potent economy is slowing. Europe's debt crisis continues to fester. And while U.S. prospects are looking up – most notably in housing – the uncertainty surrounding the November election and the looming fiscal cliff have economists and investors on edge.
But it is the home front that is probably keeping Mr. Carney up at night. For the first time in five years, he has a major domestic problem to fret about – housing.
The housing market is not a proxy for the whole economy. But one of the lessons of the Great Recession is that housing matters a lot – to employment, to wealth, to consumer confidence, to job creation and to the financial services industry.
Sales of existing homes plunged 15 per cent in September – the latest hint that the long and surprising boom in Canadian housing is coming to an end. More than half of major markets saw sales drop 10 per cent in the month, and prices have stalled. Overheated Toronto and Vancouver are cooling fast.
It was inevitable. When the average price of a home in Vancouver hit $1-million, it was pretty clear that prices had finally outstripped the ability of most buyers to pay.
And yet debt, particularly mortgage debt, continues to rise. Canadians are suddenly flirting with the same debt danger zone that triggered real estate crashes in the U.S. and Britain. New figures from Statistics Canada show that households are carrying a record level of debt relative to disposable income – 163.4 per cent in the second quarter, up from 161.7 per cent at the end of last year.
So does that mean Canada is headed for a U.S.-style meltdown? Unlikely.
Debt-to-income is a crude measure of how much leverage people can bear. The ratio of debt service charges relative to income is a better gauge. And as long as interest rates stay low, most homeowners will stay solvent.
Most Canadians are on five-year, fixed-rate mortgages. So the risk comes when homeowners renegotiate loans at a much higher rates, or lose income.
Contrast that to the U.S. housing bust, where a large percentage of homeowners had risky subprime mortgages that features low teaser rates, followed by rapidly escalating interest charges in a low-rate environment.
But after years of foreclosures, a swelling inventory of abandoned homes and plunging prices, the U.S. market is heating up again. Builders dug ground on new homes at an annual rate of 872,000 in September – the fastest pace since July 2008. Building permits are also picking up, suggesting even stronger starts in the months ahead. And prices of existing homes are now on the rise nationwide after being in free-fall since mid-2006.
In a speech last week, Mr. Carney took the unusual step of spelling out what steps the Bank of Canada would take to address the problem of excessive household debt in Canada. The bank, he said, would "clearly declare" its intentions before doing anything.
Mr. Carney may theorize about raising rates. But he talks as if rates won't move any time soon. Last week, for example, he said monetary policy is likely remain "accommodative … for some time."
The pace at which Canadians are piling up debt is slowing. But it is still growing, perhaps dangerously so. As long as interest rates stay low, people feel comfortable to take on more. Only higher rates – or at least the inevitability of higher rates – will change the calculation people make.
Danger lurks as long as the money is easy.