The Bank of Canada released its review of the financial system Thursday and warned that it was important to remain vigilant to the risk of household indebtedness.

The bank said that while the mortgage stress test and interest rate hikes have slowed household borrowing and improved credit quality, there are still high levels of indebtedness and a large portion is held by households that are highly indebted.

However, it noted that the share of Canadians falling behind with credit payments is low and steady.

“New measures have curbed borrowing, reduced speculative behaviour in housing markets and made the financial system more resilient. While the fundamentals in the housing sector remain solid overall and the sector should return to growth later this year, we continue to monitor these vulnerabilities closely,” said BoC governor Stephen Poloz.

Another risk to the system

Governor Poloz highlighted rising risk to the financial system from corporate debt, especially among lower-rated companies.

He also said that assessment is needed of the risk from climate change.

The most important risks to Canada’s financial system remain a severe nationwide recession, a large house price correction and a sharp repricing of risk in financial markets.

But the BoC says its recent stress tests found that Canadian banks are in good shape to deal with these scenarios.

“Global uncertainty is rising, and risks to financial stability have edged up in the past year. Still, confidence in the resilience of Canada’s financial system remains high, and we are seeing improvements in some of the key vulnerabilities we’ve been worried about for many years,” said Governor Poloz

The Bank of Canada will make two interest rate cuts during 2019 according to Capital Economics.

That’s because BoC governor Stephen Poloz may have underestimated the downturn in the housing market and the wider impact to the economy, senior economist for Canada Stephen Brown told BNN Bloomberg.

He said that with condo presales in Toronto and Vancouver in 2018, developers have found it harder to secure investment in new projects. That, says Brown, is likely to have an impact on employment and consumption, making a big dent in the country’s output.

“Condo developers have to sell about 70% of the units in their condo before they start construction, in order to secure financing,” Brown said. “So the current housing starts represent homes that were actually sold, as pre-construction units, around 18 months ago.”

He noted that the figures he’s looking at are niche and not being widely considered.

On interest rates, Brown and his team are forecasting a drop this year to 1.25% from the current 1.75% which will be facilitated over two rate cuts.

The Canadian government is monitoring whether tougher mortgage rules are having the desired effect but doesn’t favour allowing longer mortgage terms, Prime Minister Justin Trudeau said.

Trudeau, speaking to an industry group Thursday, was asked about raising the maximum amortization of a mortgage to 30 years, from 25 years, for first-time buyers. The prime minister said he opted instead to introduce a program that sees the government take a stake in some home purchases, as well as increasing the funds a buyer can take from retirement savings.

“We’re looking at things that are not going to disrupt the market in unexpected ways,” Trudeau said at the Canadian Home Builders’ Association conference in Niagara Falls. “We’re listening to everyone about their concerns and we are going to keep watching that stress test and make sure that it is having the desired effect, but we are seeing fewer and fewer people take on those overreaching debt-loads, particularly in the higher sectors of the market.”

Canada’s housing market has been a preoccupation of policymakers for years — grappling with a surge in prices in Vancouver and Toronto, and fears that a bubble could develop. Officials have tightened mortgage eligibility rules and imposed other measures to curb runaway growth. Bank of Canada Governor Stephen Poloz said this week he’s confident the sector will return to growth.

Trudeau said his government tried to take measures that would stabilize Vancouver and Toronto but not “have an overly negative impact elsewhere around the country.”

The tougher stress test for mortgage eligibility was about “taking some of the froth out of those markets but also ensuring that people weren’t stretching themselves further than was wise, particularly given the fact that we can see interest rates rising in the future, and recognizing Canadians carry a high level of personal indebtedness that we need to respond to.”

He acknowledged the industry’s call for 30-year mortgages, but said “yes, it can lower your mortgage payments on a monthly level but actually, overall, increases the amount that you’re going to be paying out in interest over time. Which is why, when we looked at all the different measures we had, we really, really liked the shared equity program.”

Canada posted a record job gain last month, along with a decline in the jobless rate and a pick-up in wages, providing the strongest signal yet that the economy is coming out of a six-month slowdown. Other data this week portend a rebound in economic activity, including a strong bounce-back in exports and a surge in housing starts.

Statistics Canada announced this morning that employment rose by a whopping 106,500 in April, the biggest one-month gain since the start of this data series in 1976. This was dramatically above the median forecast of economists of 12,000 net new positions. The Canadian jobless rate fell a tick to 5.7%, near a four-decade low.

This report showed broadly based strength across regions, sectors and provinces. Full-time jobs jumped by 73,000, part-time positions rose as well by 33,600.

On a year-over-year basis, employment grew by 426,000 (+2.3%), with gains in both full-time (+248,000) and part-time (+179,000) work. Over the same period, total hours worked were up 1.3%.

Employment increased in Ontario, Quebec, Alberta, and Prince Edward Island. It declined in New Brunswick and was little changed in the other provinces. Quebec posted an unemployment rate of 4.9%, the lowest in recorded history. Jobs in Alberta gained steam following two months of little change.

Employment gains were spread across several industries: wholesale and retail trade; construction; information, culture and recreation; “other services”; public administration; and agriculture. At the same time, employment decreased in professional, scientific and technical services.

Construction punched above its weight for the first time in many months. Gains were concentrated in Ontario and British Columbia. This likely foreshadows a stronger spring season in existing home sales.
Provincial Unemployment Rates
(% 2019, In Ascending Order)

Province                                      April     March
British Columbia                        4.6            4.7
Quebec                                         4.9            5.2
Manitoba                                     5.2            5.0
Saskatchewan                             5.4            4.9
Ontario                                         6.0            5.9
Alberta                                          6.7            6.9
Nova Scotia                                 6.9            6.2
New Brunswick                          8.0            7.9
Prince Edward Island               8.6            8.9
Newfoundland and Labrador 11.7            11.5

For many months the labour market strength has been the mainstay of the economy. Many had warned as recently as last month that Canada could be headed for recession amid a perfect storm of negative factors — falling oil prices, volatile financial markets, higher interest rates, cooling housing markets and global trade tensions. But many of these elements have begun to dissipate.

Exporters showed across-the-board resiliency in March after shipments tumbled in February. Toronto’s housing market, the country’s largest, is stabilizing after a recent slump. There are also signs consumers continue to spend and borrow, aided in large part by the buoyant labour market, even amid worries about the outlook.

Even wages have strengthened. Pay gains for permanent employees rose to 2.6% year-over-year, the sharpest rise since August. Total hours worked also increased, rising by 1.3% annually in April, up from 0.9% in March. Youth unemployment fell to record lows.

Bottom Line: This very positive report opens up the possibility that the Bank of Canada might take a more hawkish stance at their next meeting. It might well be that a rate hike sometime later this year is no longer off the table. One critical uncertainty, however, is the heightened trade war between the US and China. If the two sides hike tariffs sharply, a possibility given the current sabre rattling, Canada’s economy could once again be hit in the cross-fire.

Foreign Investment in Montreal’s property market surged a whopping 183% in 2018 over the previous year—the likely the result of foreign buyer taxes in Toronto and Vancouver.

“It’s not a coincidence that after the foreign investor taxes in Toronto and Vancouver, interest moved to the Montreal market,” said Altus Group’s Senior Director of Innovation and Growth Strategies Vincent Shirley. “Foreign investors originally looked at the Vancouver and Toronto markets but they also recognized Montreal as a discounted market. There are more factors involved than just that: The fundamentals in Montreal are really strong right now and the job market is very good too.”

According to Altus Group’s Montreal Flash Report 2019, year-over-year investment property sales volume in the city increased 18% last year, hitting $6.5 billion, thanks in large part to renewed interest in Montreal Island properties located downtown and on either side of Mount Royal. Sales volume on the Island of Montreal reached $785 million.

The report also noted that almost half of total new condominium sales last year were concentrated in downtown Montreal, while the rest of Montreal Island received about one-third.

“There is a lot of job creation on Montreal Island and demographics are very strong,” said Shirley. “We had a lot of structural issues for about 40 years with a very high unemployment rate, but we’ve seen it go down the last two or three years. There’s a lot of compression with the unemployment rate and now we’re at 6% or so, but it’s forecasted to go down to 5.5% next year because job creation is very strong, as are prospects for future employment.”

In fact, Montreal is becoming a leading hub for artificial intelligence and its pharmaceutical sector is also robust. Shirley noted that Montreal’s universities serve as pipelines for those industries in particular.

Even more prominent is Montreal’s port, which is, bar none, Canada’s busiest.

“Montreal’s port accepts over 75% of commodities that come through all Canadian ports,” said Shirley. “A lot of venture capital is invested in Montreal’s technology and AI industries and our pharmaceutical sector is very strong.”

Despite Montreal’s good fortunes after decades of political upheaval surrounding language and Quebec’s place within Canada, there is reason for slight consternation. The Montreal municipal government intends to implement the so-called “20-20-20 rule,” says Shirley.

“It’s going to be 20% social housing, 20% affordable housing, and 20% family housing,” he said. “The real estate industry understands affordability and inclusionary zoning is important, but we just want to make sure the push for it doesn’t disturb the economics of Montreal and development doesn’t go into the suburbs.”

The Bank of Canada will announce its April interest rate decision next week but a survey shows little expectation that it will make a change.

Nine out of 10 economists including those from TD, Laurentian, the Conference Board of Canada and University of Manitoba – expect that the BoC will leave rates unchanged at 1.75%.

“All combined, the global slowdown and specific factors weighing down on Canadians households and the oil sector are justifying to keep the overnight rate at current level,” said Sebasiten Lavoie, chief economist at Laurentian Bank Securities.

However, the poll by Finder.com found that Atif Kubursi of Economic Research Ltd. and McMaster University, is predicting a rate cut, citing “sluggish growth and poor export performance.”

While the others are ruling out a cut in April, four now believe Governor Poloz could announce one in July and longer term we could see a 1.15% rate within the current cycle.

Recession fears

While a rate hold and cut will be good news for the housing market, the underlying reasons for economists making their predictions is more concerning.

Canada is either somewhat or very likely to go into recession in the next 12 months, according to half of the panellists.

“Uncertainty remains elevated, and recent trends (January notwithstanding) have been quite weak – domestic demand contracted over the latter half of 2018. Retail sales remain soft, as do housing markets,” said Brian DePratto, senior economist at TD Economics.

The panel expects the CMHC First Home Buyers Incentive to have either marginal or little to no impact on housing affordability but they believe that property prices will stabilise by the end of the year. Montreal house prices are expected to increase the most

The International Monetary Fund has expressed concern about rising risk in the Canadian housing market.

The IMF’s Global Financial Stability Report says that the risk has grown over the past two years and is near to levels seen during the financial crisis of the last decade.

However, there’s a major difference between then and now; the action taken by Canadian regulators to ensure that the financial system is robust and able to withstand another crisis.

While the B-20 mortgage guidelines – and the stress test in particular – has many critics, the IMF says that tougher mortgage policy and measures such as foreign buyers’ taxes, are the correct ones to protect the financial system from downside risks from the housing market.

Canada up, USA down
While Canada’s housing market has become riskier, the report says that the US risk is lower than it was due to declining levels of household debt and prices more in line with income.

But it says that Canadian markets have become riskier, especially Hamilton, Toronto, and Vancouver.

The employment report had long been a lone bright spot in an economy that had sunk across the board, so the March slump is not surprising. According to today’s jobs report from Statistics Canada, employment fell by 7,200 last month, mostly in full-time positions in the service sector. Canada’s jobless rate held steady at 5.8%, close to a multi-decade low and wage growth ticked modestly higher, although, at a 2.4% year-over-year gain, it remains lower than the reading earlier this cycle.

Employment was up 290,000 over the prior six months, so it was only a matter of time that the jobs numbers would reflect the weakness in the overall economy.

Bottom Line: The Bank of Canada will remain on hold and possibly even cut interest rates if the economy slows further. There is little evidence that underlying inflation trends will rise. The headwinds of global uncertainty, weak trade, energy market vulnerability and the housing slowdown contribute to the Bank’s cautious stance.

In another trade loss, China has stopped buying Canadian canola seeds. About 40% of Canadian canola seed exports usually go to China. The Huawei dispute and potential Meng Wanzhou extradition has escalated trade tensions between Canada and China, seriously hurting Canadian farmers. As well, the US tariffs on steel and aluminum exports continue to weigh on the economy. It appears there is little prospect that the renegotiated Canada-Mexico-US trade deal will be confirmed by the US Congress this year, adding to the uncertainty.

All of this has led some to begin calling for a Bank of Canada rate cut. Higher interest rates alongside regulatory changes have already contributed to significantly slower household debt growth and housing markets.

Housing Markets Remain Soft in March in Vancouver and Toronto

According to local real estate boards reporting this week, the end of winter did not spark a flurry of home buying in Vancouver and Toronto. Fragile market conditions deteriorated further in Vancouver where policy measures introduced by all levels of government continue to keep buyers on the sidelines. Home resales fell to their lowest level since 1986 (down another 7% from February), and the benchmark price eased for a ninth-straight month (down 8.5% since the June 2018 peak). Property values in the GVA are likely to remain under intense downward pressure in the near term.

March activity was the slowest in 10 years in Toronto. Resales increased a little less than 2% month-over-month (on a preliminary seasonally-adjusted basis)—minute in comparison to the 13% month-over-month drop in February. A lack of supply could have been a factor holding back activity as new listings fell 4.5% from a year ago. This possible explanation finds some support in the fact that the benchmark price rose at a faster pace in March (2.6% y/y) than February (2.3%)—suggesting that buyers had to bid more aggressively in the face of limited supply.

This winter has been particularly hard on residential real estate markets across most of Canada. The March results published in the last couple of days in Vancouver and Toronto—as well as in Victoria, Calgary and Hamilton—offer little in the way of a meaningful rebound during the all-important early spring season. While recent declines in mortgage rates and the new first-time home buyer incentive announced in the 2019 federal budget could be catalysts for a rise in activity later this year, the stress test and other market-cooling policy actions will continue to weigh heavily on buyers.

We will have more complete data on housing mid-month when the Canadian Real Estate Association releases national and local data.

The current decline in the bonds market is good news for Canadian fixed-rate mortgage borrowers with rates heading lower.

As the bond market yields invert – as they did Monday in Canada – the cost to banks of borrowing in the market declines, meaning they are able to finance mortgages at a lower rate and pass savings on to customers.

It’s not all good news though because the inverted yield, also seen in US bonds, is often a foreteller of weakening economic conditions and potentially recession.

However, this risk is likely to mean that the BoC will remain highly cautious of increasing interest rates.

An outlook from TD Economics’ Beata Caranci and James Orlando suggests that Canada may need “the real interest rate to remain close to or below zero for a long period” with the deleveraging process only just starting.

There is a growing cohort of investors and analysts that believe the BoC’s next move on rates will be a cut and that is proving good news for variable rate mortgage borrowers too.

Janine White, vice-president of Ratesupermarket.ca told CBC News that rates will climb in the next couple of years but “for the rest of 2019 the prediction is that the variable rate is going to be stable and maybe has a chance of coming down.”

A major item from this week’s federal budget will further reduce, rather than enhance, affordability for first-time homebuyers.

The First-Time Home Buyer Incentive—in which the Canada Mortgage and Housing Corporation will provide up to 10% on the purchase price of a new build and 5% on a resale—caps household income at $120,000. The policy further states that “participants’ insured mortgage and the incentive amount cannot be greater than four times the participants’ annual household incomes.”

First-time buyers who think the incentive raises their qualifying power are in for a surprise. According to Ratehub.ca, under current qualifying criteria, including the stress test, buyers qualify for homes that are 4.5-4.7% their household income. By using the First-Time Home Buyer Incentive, they would reduce their qualification amount by 15%.

“The total a first-time homebuyer gets between their mortgage and the incentive they receive from the government can’t exceed four times their household income,” said James Laird, Ratehub.ca’s co-founder and president of CanWise Financial. “This qualifying criteria is actually stricter than the regular qualifying criteria that exists today. I was surprised the policy itself was launched like this since that section of the budget is called ‘Affordability’ and it actually reduces affordability.”

According to calculations provided by Ratehub.ca, a household with $100,000 of income that puts a 5% down payment, qualifies for a $479,888 home.  This leaves a mortgage amount of $474,129 after down payment and the CMHC insurance premium.  The household qualifies for a mortgage of 4.74 times their income.

If the same household elected to participate in the First-Time Home Buyer Incentive their maximum purchase price drops to $404,858, because this is the maximum they can afford while keeping the total between their mortgage and the government incentive below 4.0 times their income ($400,000).

“The number one issue facing first-time homebuyers is how much they qualify for, not the monthly payment after the home closes, and that’s what this is aimed at,” continued Laird. “They qualify for less if they use this program.”

That might not be the only problem with the First-Time Home Buyer Incentive. A similar program launched by British Columbia’s Liberal government was axed last March by the NDP after it was revealed that only around 3,000 homebuyers used it—far fewer than the expected 42,000.

“Given the evidence provided through one of the largest provinces in the country trying a program that didn’t work, I’m not sure what the federal government thinks will be different,” said Laird, adding that housing measures in the budget were spare on details.

“I was amazed that one of the key parts of their budget hadn’t been properly thought through and didn’t contain detail. I expect that before this program actually goes live, one, we’ll get more detail, and two, it will be amended to take care of this issue.”