Canada’s largest bank is turning more bearish, according to its latest forecast. In the bank’s Q3 2022 earnings filed this week, RBC made downward revisions to its base case forecast for home prices. Combined with recent statements explaining the bank sees a “historic” correction, they’re sending a clear message to consumers — the outlook for housing continues to erode faster than positives have appeared.
Every quarter banks are required to prepare macroeconomic forecasts for risk planning. These scenarios help the bank prepare for economic shock or a boom. It’s an IFRS-9 reporting requirement, and helps regulators and analysts understand market risks. At least 3 scenarios are required — a base case, and two alternatives (one upside, one downside).
The base case forecast is what we call a “Goldilocks scenario.” It’s not too hot, and not too cold. Things just keep humming along with no significant change in outlook. It might not make sense logically, but it does from a quantitive perspective. After all, it makes no sense that Goldilocks can tread into bear territory without getting her head ripped off. However, statistically, there can be a 50-50 chance of it happening.
The alternative scenarios include one downside and one upside. It’s exactly what it sounds like — the worst and best case forecasts that could happen. This helps an organization stash some cash for a rainy day, but not too much so they can still make investments during a boom. The downside is a market bear’s wet dream, unlikely ever to be fully realized. The upside is an unlikely bull stampede, where unicorns and Canadians without mortgages exist. Things have to go extremely wrong in either case for either scenario to happen.
It’s important to note that management has qualitative data that isn’t easily modeled. Things like quantifying social anxiety or political fallout. Behavioral factors, such as fear of missing out (FOMO) or the joy of missing out (JOMO). In our experience, banks often state if they see a scenario playing out to an alternative. It can happen in the days leading up to the report, or management outright explains it at earnings.
Remember the last point. We’ll come back to it soon.
Canadian Real Estate Got A Downward Revision In RBC’s Base Case Scenario
RBC’s base case forecast got a downward revision in its near-term outlook. The bank sees the CREA House Price Index (HPI) falling 5.6% over the next 12 months. It’s a downward revision of 2 points compared to the previous quarterly filings. The following 4 years are expected to see an average compounded growth of 5.1%, up 0.8 points from last quarter. A sharper decline but a faster recovery.
RBC has strongly indicated they’re weighing risk to the downside. Not just outright saying it last quarter, but they’re also called a “historic” correction just a few days ago. The bank explained it sees the RPS HPI (an alternative price index) falling 12.4 points over the next year. The RPS is roughly a third of the movement observed in the CREA HPI. RBC outright explained this will likely be the largest correction seen in at least 40 years. Clearly their opinion is weighted more towards the downside.
Canadian Real Estate Still Expected To Fall 30% In A Downside Scenario
The downside, or worst-case, scenario is unchanged from the previous forecast. RBC sees prices falling 30% over the next 12 months in this forecast. Housing would then see compound annual growth averaging 4.2% over the following 4 years. More forecasts are looking like this than they are the base case scenario. BMO and Oxford Economics are two notable examples.
Canadian Real Estate Still Expected To Rise 11% In An Upside Scenario
The alternative “upside,” or best case, scenario sees double-digit growth. RBC has forecast 10.9% growth over the next 12 months in this case, unchanged from last quarter. Compound annual growth averaging 9.6% for the following 4 years is also expected. It’s extremely high growth, but it may not seem that way to some after the frothy market just seen.
RBC’s forecast doesn’t show much of a revision for the best or worst-case scenarios. The only meaningful change is in the base case, which got a downward near-term revision. When considered with recent statements, it’s clear their expectations are to the downside.
However, it will be hard for the average person to see any risk these days. The last recession resulted in soaring home prices, an unusual dynamic not often seen. It’s resulted in many people, including some professionals, explaining home prices rise in the event of a downturn. The moral hazard is real, and it might just be the bubbliest sign for Canadian real estate. It always goes up, and if things get worse, it goes up even higher. The central bank is expected to always make people whole, even if it causes wide-scale economic disparity.