Canada’s Real Estate Bubble Is Getting Even More Irrational: US Federal Reserve Data

Canadian real estate buyers are getting more irrational, says the world’s biggest central bank. The US Federal Reserve (The Fed) published its Q2 2021 exuberance index recently. The index, considered a “smoking gun” for bubbles, shows Canada is well into a real estate bubble. Researchers say markets that become exuberant will experience a correction in the future. The longer it takes to correct, the larger and more dangerous it becomes.

US Federal Reserve Exuberance Index 

The US Federal Reserve Exuberance Index seeks to identify exuberant markets. It looks for “explosive dynamics” in prices, which is growth in excess of fundamentals. Exuberant price growth is considered irrational and based on emotion. Emotional buying is prone to rapid corrections which can become a threat to more than just one buyer.

One or two-quarters of exuberance isn’t an issue. It happens, but persistent exuberance is something that needs to be addressed. When buyers show persistent exuberance, the whole market is now considered exuberant. An exuberant market is better known as a bubble. 

After the Great Recession, the Fed helped create the tool as an early bubble identifier. They call it their “smoking gun,” and is meant to help policymakers act on bubbles early. By addressing the issue early, countries can minimize the damage.

How do we use this tool? The index makes understanding market exuberance straightforward for analysts. They provide two sets of numbers, a country’s index and a 95% critical value threshold. If the quarter rises above the threshold it’s an exuberant quarter. After five consecutive quarters of exuberance, you have an exuberant market. That’s a bubble.

Canadian Home Buyers Are Becoming More Exuberant

Canadian real estate just logged another quarter as an exuberant market. The country’s housing printed 3.08 in Q2 2021, rising 0.06 points from the previous quarter. It’s now more than double the threshold value of 1.37 needed to be considered an exuberant quarter. This is the sixth consecutive quarter, meaning this is an exuberant market. Canadian real estate is now in a bubble, but it might be a lot worse than that just six quarters.

Canadian Real Estate Exuberance

The US Federal Reserve Exuberance Index score compared to the 95% critical value threshold. When the index rises above the threshold value, the quarter is considered exuberant. Five consecutive quarters of exuberance means the market is exuberant. 

Source: US Federal Reserve; Better Dwelling. 

Canadian Real Estate Might Be A Bubble On A Bubble

The Canadian real estate bubble is only six quarters old by this measure. As you can see above, it wasn’t very long since it was last an exuberant market though. Starting in Q2 2015, housing saw 14 consecutive quarters of exuberance. It spent a little time under the threshold starting in Q3 2018, spending 4 out of 5 quarters below the threshold. It isn’t enough time for a period to be considered non-exuberant. Additionally, the quarters under the threshold are barely under it.

Canadian real estate is either one longer bubble or a bubble on a bubble. If the bubble started in 2015, then Canada has been in a 25 quarter bubble, or 6.25 years. If the bubble is only six quarters, it’s a bubble on a bubble since it didn’t correct between. In either case, the gap between fundamentals and prices has expanded this whole time. The impact is essentially the same, meaning a larger correction is still needed.

The Fed says an exuberant real estate market will require a correction, though it can’t tell you when. Policy intervention to extend a bubble can delay a correction, making timelines unpredictable. Asset managers like Hilliard MacBeth warn this makes the issue worse. It’s essentially passing on a deficit of market inefficiency, meaning it has to be paid back later. With interest.

14 Comments

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  • GTA Landlord 9 months ago

    The description for this article in the email genuinely made me LOL. Nice one.

  • Terrance Yu 9 months ago

    I don’t think any sane person can see this and not conclude things are going to end badly.

    And the sheer number of people that can’t see that is the biggest sign of a bubble. A bubble isn’t a bubble until everyone says it doesn’t exist. We’re seeing the public say prices rising 60% in the middle of nowhere is because some small town is the next Manhattan and should trade at the value as Queens.

    • KG 9 months ago

      I don’t know if it’s a bubble or not but I know my friends think home prices are going to rise 20% per year going forward and think there’s a zero percent change that won’t happen. It’s almost like meeting a cult member defend a conviction. They get PISSED when you say it. It ain’t right.

      • n 9 months ago

        My friends been saying that since 2009, they shouldnof bought in…. itll probably double again in 10 years. Prices of everything are going up.

    • Nick 9 months ago

      As long as money laundering (stolen money from poor people in poor countries) continues…

  • Jason Chau 9 months ago

    The IMF, Federal Reserve, World Bank, BIS, Moody’s, Fitch, and UBS are crazy.

    The only person that really knows the true value of housing is a guy that bought his house in 2001 for a can of soup and needs it to go higher because he thinks retirement would have been as easy as buying a house and now he’s secretly torn up. He is the true market genius.

  • Ron 9 months ago

    People buy hard assets with fiat currency- that’s what it is . Hedge against information .

  • Ellyn D’Uva 9 months ago

    My parents bought me a house. Many people think prices will continue to rise indefinitely but how high can they go?

    20% YOY is enormous.

  • Ellyn D'Uva 9 months ago

    If you drive around at 2pm you’ll notice that the roads are packed no matter what day.
    Very few people work these days, most just live off their house.

  • Heather 9 months ago

    Gad, what a mess. Canada is in debt for COVID-19. When this housing bubble bursts, it’s really going to be awful.

  • Eric 9 months ago

    Not a bubble when you factor in central bank monetary policy and government intervention. You are seeing the market adjust to the new financial environment created by government (ultra low interest rates, government guarantees to backstop housing investments). Its just reaching a new equilibrium of prices. This is the new normal

  • Jay 9 months ago

    This analysis by a US organization is quite humorous.

    Most of the world wants a piece of Canada. Situations that apply in the USA do not apply in Canada. The pent up demand for good housing stock in Canada will continue and level off..

  • Millenial 9 months ago

    Americans are fleeing the US. Unfortunately we might see the irrationality continue.

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