Canada’s housing bubble has burst: David Rosenberg

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Canada’s housing bubble has burst: David Rosenberg

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The upcoming recession could be deeper than people on Bay Street are expecting

Publication date:

October 28, 2022 • 1 day ago • 3 minutes read • 112 comments Canadian house prices are now down 9 percent from their peak on the way to a roughly 30 percent decline, says David Rosenberg. Canadian house prices are now down 9 percent from their peak on the way to a roughly 30 percent decline, says David Rosenberg. Photo by Tyler Anderson

By David Rosenberg and Alena Neiland

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Canada’s real estate bubble has burst. The MLS home price index is now down nine percent from its peak last February on track for a roughly 30 percent decline, which we think is consistent with deteriorating affordability and the Bank of Canada’s over-aggressive monetary tightening.

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We estimate that the negative wealth effect associated with such price falls will shave about 2.5 percentage points off gross domestic product (GDP) growth. Add to this the deleveraging effect of higher interest rates on consumption and investment, and the impact on trade of the expected downturn in the United States and the global economy, and it’s not hard to see why the coming recession in Canada could be deeper than the Bay Street folks expect.

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All of these factors last played a role in the early 1990s when Canada entered a Bank of Canada-induced recession

Individuals spend more when the value of their assets (e.g. stocks and houses) increases because they feel they are getting richer. This is happening through multiple channels: there is a behavioral aspect that leads to spending more of earned disposable income, as well as improved access to credit, an issue that has dominated over the past decade given the persistently low cost of borrowing. As homeowners continue to make regular payments on their mortgages, their credit scores improve, making them better candidates to take on more debt.

But with the Bank of Canada’s overnight lending rate up 350 basis points since March (with more to do), the theme of rising wealth is bound to fade as access to credit dries up and house prices plummet. The MLS home price index is already down 9 percent from last February’s peak and the correction is far from over.

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Households are being hit as they head into this recession by a confluence of factors: rapid credit cutbacks, higher debt-service costs amid near-record household debt, and inflation limiting disposable income. Added to this is the dwindling wealth on both the equity and residential real estate markets, which is also weighing on sentiment.

The last time all of these factors played a role was in the early 1990s, when Canada entered a Bank of Canada-induced recession and home prices fell nearly 30 percent from their 1989-1996 peak.

This housing reduction is just beginning

While consumption will slow down due to the multitude of factors mentioned above, the wealth effect will also make a negative contribution. If house prices end up falling 30 percent from the peak — which we think is consistent with the deterioration in affordability and the Bank of Canada’s over-aggressive monetary tightening — consumption would fall about 5 percent (using the central bank’s estimate of nearly six cents per dollar in marginal propensity to consume due to changes in housing wealth), representing a decline in annual GDP growth of about 2.5 percentage points.

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Even assuming that Canada Mortgage and Housing Corp. Right, with a more modest 15 percent fall in home prices from peak to trough, the GDP hit from the wealth effect will be about 1.3 percentage points, which is still significant. Worse, there is reason to believe that the macroeconomic impact will continue to be skewed to the downside, as this analysis does not even account for the deleveraging effects of higher interest rates on consumption and investment.

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The Bank of Canada, while acknowledging the negative wealth generated by housing (though not necessarily the magnitude), is unwilling to give up its hawkish stance amid still hot and above-target inflation. With more monetary tightening on the horizon, the overnight swap market is now pricing in a top rate of 4.25 percent by year-end, so these housing losses are only just beginning. And given consumer sensitivity to the drop in home prices, Canada’s recession is likely to be deeper than many Bay Street types are anticipating.

As such, the Canadian dollar will see many more months and quarters of weakness, not only because of the bear market in commodities, but also because of the severe impact on the economic outlook from escalating weakness in home equity values ​​and the multiplier effects on the broader consumer Entire.

David Rosenberg is the founder of the independent research firm Rosenberg Research & Associates Inc. Alena Neiland is an economist there. You can sign up for a free one-month trial on Rosenberg’s website.

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