Canada’s central bank has finally stopped juicing the mortgage market… or at least it’s taking a break. Bank of Canada (BoC) data shows December was the first ever drop in the amount of Canada mortgage bonds (CMBs) held. It’s too early to tell if it’s just temporary, or if it’ll start again. If the buying is actually past peak, it could mean cheap mortgage cash might be more difficult to come by soon.
Canada Mortgage Bonds (CMBs)
I’ll spare you the full explanation for the umpteenth time, but let’s go over the basics if you need a refresher. Lenders originate mortgages, pool them, then sell the pool as mortgage backed securities (MBS) to the government. To pay for the MBS, the government sells Canada Mortgage Bonds (CMBs) to investors for the funds. The cash flow from the MBS is used to pay investors that bought the CMBs. To be blunt, CMBs are a state-backed security for financing mortgages.
Government backed securities are very secure, especially in advanced economies like Canada. That security means investors are generally willing to accept a smaller return. Still, it functions as any market should. When demand falls, interest paid rises as an incentive to get more investors. When demand rises, interest paid falls, as the market becomes more competitive. The free market manages risk very well this way, but that all breaks when the state becomes the market.
When real estate sales slowed in 2019, the BoC decided to buy CMBs on a non-competitive basis. You know, for no reason at all. This functioned as a cap on rates, preventing them from rising too much. When the pandemic started, they began buying them on a competitive basis. Investors competed with the central bank’s unlimited capital, for lower returns. The BoC actively drove rates lower. This contributed to flooding the market with cheap mortgage debt. Yes, the market is even cheaper than rock bottom interest rates would typically support. In October they said they would halt the program, but it wasn’t until December that we saw the balance fall.
Balance of CMBs Falls For The First Time Ever
The BoC has finally shown a monthly decline in the amount of CMBs they held. Central bank disclosure shows they held $9.66 billion in CMBs on Dec 30, 2020. This is a small uptick of 0.02% from the week before, but a monthly decline of 0.65%. Of course, the annual increase is still a whopping 1,803.13% from a year before.
Canada Mortgage Bonds (CMBs) Held By The BoCThe dollar value of Canada Mortgage Bonds held as assets by the Bank of Canada, in millions of dollars. Source: Bank of Canada, Better Dwelling.
What does CMBs past peak mean? Considering real estate prices and sales are soaring during a recession, the BoC overestimated the impact of the pandemic. When they set out to flood the mortgage system, they were expecting a doomsday scenario. In reality, it’s a big event, but the excess capital they flooded the market with is turning into a bigger issue at a high level. The tapering also lines up nicely with reports Canada’s economy is recovering faster than expected. In other words, they mis-priced the amount of capital needed to flood the market. When policy changes happen, it generally takes about 6 to 12 months to hit the market. This can potentially contribute to higher mortgage rates down the road.
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Can someone explain why mortgage rates can rise if the overnight rate doesn’t change? Thanks.
Capital is priced based on supply. What Canada did with QE is what the US did to recover from the housing crash in 08. It’s a plan designed to correct a 30% drop.
It looks like they tried to respond to a forecasted drop of 30% in real estate prices, hoping it would correct it in six months (around October). Prices didn’t crash though, because the government flooded the market with cheap income too. CEWS, CERB, etc. adds up to much more than the income lost.
In the end, prices didn’t drop, and sales took off in October when cheap money flooded the market in excess. By then it was too late, the market didn’t lose income and got a life for prices. Now everywhere in Canada has rising prices.
Probably too late for the spring market. Maybe a couple of bps increase, but it was way too slow to do this in the first place.
Does this mean home prices should go down or at least stabilize? If a semi/townhouse is going for $1M in GTA, where do prices go from here?
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