Skip to main content

Federal Reserve Chair Janet Yellen appears before the Senate Budget Committee to examine the nation's economic and fiscal outlook, on Capitol Hill in Washington, Thursday, May 8, 2014.J. Scott Applewhite/The Associated Press

Benjamin Tal, the No.2 economist at Canadian Imperial Bank of Commerce, says Stephen Poloz's Bank of Canada is poised to be the "most powerful central bank in the universe." To explain what he means, consider the Federal Reserve's sudden worry about the state of the U.S. housing market.

Mr. Tal, who made the comment last month in an interview, wasn't talking about Canada's central bank usurping the Fed as the institution that sets the tone for global financial markets. Rather, Mr. Tal posited that a generation of first-time home and automobile buyers reared on ultra-cheap money will be supersensitive to even the slightest of increases in interest rates.

"That will make monetary policy more effective," Mr. Tal said.

The Bank of Canada hasn't had to confront the extent of its power yet because it's firmly in neutral; Mr. Poloz is neither inclined to raise nor lower the benchmark interest rate. The Fed, on the other hand, has been reducing the amount of mortgage-backed securities it buys each month since the end of 2013, and has made clear it intends to end its asset-purchase program this autumn. As a result, the average rate for a 30-year mortgage was 4.51 per cent in April, almost one percentage point higher than a year earlier.

Something happened in the last few weeks to spark a new level of concern about the housing market at the Fed.

Last month, Ms. Yellen told an audience in New York that "while the housing market still has far to go, it seems to have turned a corner." Thursday, for a second consecutive day, Ms. Yellen told lawmakers in congressional testimony that recent housing data are "disappointing" and that the "recent flattening out in housing activity could prove more protracted than currently expected, rather than resuming its earlier pace of recovery." (A year ago, the Fed's policy committee was feeling good about housing, noting in statements that the market was "strengthening.")

Sales of existing homes fell in March for the seventh time in eight months, dropping to an annual rate of sales that was 7.5 per cent slower than a year earlier. New building permits are weaker than they were 12 months ago, and sales of new homes in the first quarter were 1.8 per cent lower than in the first three months of 2013.

The closest Ms. Yellen came to offering an explanation for the sputtering housing market is potential first-time buyers who are saddled with unprecedented levels of student debt, making mortgage payments unaffordable, or even disqualifying them for additional lending from the U.S.'s newly prudent banks. Household formation slowed to an annual rate of 424,000 in the first quarter, compared with last year's rate of about 450,000. The trend rate in the United States dating back to the early 1980s is more than 1 million per year.

"We need to see some pickup in household formation in order to see continued recovery in the housing market," Ms. Yellen told the Joint Economic Committee Wednesday.

Financial institutions held outstanding student debt worth $1.26-trillion (U.S.) in the first quarter, compared with $831.6-billion in 2009. Some 7.5-million part-time workers would prefer full-time work if they could find it, according to the Labor Department's latest employment survey. Rents are 2.6 per cent higher than a year ago, making it harder for graduates to save enough to cover the higher down payments that lenders now demand.

"The cost of rent is going up, while the median income of renters is going down," Jeffrey Gundlach, chief executive officer of DoubleLine Capital, said Wednesday in an interview with Bloomberg Television, after announcing Monday that he is betting against U.S. home builders' stocks. "If you want to talk about a new normal, there's a new normal in housing market."

In her testimony, Ms. Yellen remarked that borrowing costs still are remarkably low by historical standards. The problem with historical comparisons in the current context is the present generation of first-time homebuyers cares little about the double-digit interest rates their parents faced three decades ago. A college graduate in his or her mid-20s knows nothing but rock-bottom interest rates. A 30-year mortgage rate of 5 per cent seems expensive, especially when you already are carrying tens of thousands of dollars of debt and you can find only a mediocre job.

If Mr. Gundlach is correct, and there is a new normal in the housing market, then it's possible the Fed's forecasting models failed to predict this wrinkle in expected consumer behaviour. A slower housing market isn't necessarily an argument for new stimulus measures, but it will encourage policy makers to leave borrowing costs exceptionally low for even longer.

They can do so because an interest-rate increase today packs a far bigger punch than it did before the financial crisis.

Report an error

Editorial code of conduct

Tickers mentioned in this story