Everyone Expects Rates To Be Cut, So They’re Climbing Even Higher 

Advanced economies like Canada are experiencing something that hasn’t been seen since the early 80s—no one believes Central Banks. It doesn’t matter how hard the Bank of Canada (BoC) or US Federal Reserve (the Fed) tries, most people don’t see them playing the tough guy. Few are tapering their demand from levels seen during record stimulus, helping to keep inflation elevated from stable targets. The result? Central Banks will continue the beatings until morale erodes, and that means taking rates higher than anyone expected. 

More Like Lack of Interest Rates, Amiright? Okay, What Are They?

The primary role of a central bank is to ensure a stable currency, which means controlling inflation. The biggest tool they have to control inflation is interest rates, which is used to throttle or boost expectations and credit. 

When inflation is too low, they lower interest rates to stimulate credit demand. Like, how could you NOT borrow money at these low rates, right? People borrow to buy things, which means cheap credit leads to more demand, which leads to higher prices (a.k.a. inflation). 

In the case of housing, low rates also provide greater leverage to borrowers. This allows them to more easily absorb higher prices, since they can borrow more of their future income. Yes, debt is your future income used today, borrowing growth for whatever reason policymakers feel they need it. 

OMG, There’s A Shortage of Everything, Everywhere!

To put it bluntly, the goal of a rate cut is to help intentionally overrun supply. Credit is created faster than production can scale, so it’s a great way to boost prices (a.k.a. inflation). Keep in mind the goal of inflation in general is to keep the economy flowing, and convince you that the pain of delaying a purchase is greater than waiting. 

When inflation is too high, they do the opposite—they raise rates, throttling credit and slowing demand. The pain of buying today is supposed to be perceived as too high in contrast to waiting, when incomes will be higher or prices lower. By reducing access to capital, and incentivizing higher returns on savings, they’re trying to reduce demand faster than supply, helping to slow price growth (aka inflation). 

In the case of housing, this prevents people from being able to absorb higher home prices. Heck, it might prevent people from absorbing the current price of goods, and can bring future prices down.     

Ultimately, this all boils down to the central bank setting the public’s expectations. There’s either a shortage (so buy!), a surplus (so wait), or it’s balanced (it’s unclear if this happens outside of theory).   

Say They’ll Cut Rates One More Time, The Central Bank Dares You

How many times have you heard, “the central bank can’t raise rates,” or “they’ll be cut soon?” If you’re in Canada, that’s basically everyone and their dog… every week. Few believe the central bank can maintain elevated interest rates for long enough to impact asset values. This has resulted in no meaningful impact on demand, letting elevated inflation persist. 

Canada demonstrated this very clearly right after the “conditional pause” announcement from the BoC. Home prices began to climb a month later, at a very rapid rate. Experts began to explain that rates will be cut by year end, helping ease concerns that people should slow their demand. Stretching the budget isn’t a huge issue if it’s just a few months, but it’s a problem if prices keep rising.

The result is the central bank needs to break the consumer’s confidence, and sharply. Some experts are finally getting the message, after the BoC’s “surprise” hike a few weeks ago. Now the bond market is pricing in another increase to the overnight rate by next month, and possibly higher. Rates need to climb until expectations are broken. 

The US Federal Reserve sent bond yields soaring this month, after communicating this issue. At the press conference after the FOMC decision, he emphasized no one in the Fed’s committee sees interest rates being cut this year. He then mentioned they’re, “a couple years out.”

But For Real. They’ll Cut Interest Rates, Right? 

Does that mean no rate cuts next year? Who knows, but the harder stance is finally setting market expectations. The Government of Canada (GoC) 5-year bond yield, which influences the 5-year fixed rate mortgage, closed at 3.85% yesterday, up 10 points from a day before. It also happens to be the highest close since 2008. 

The key difference is that back then, interest rates were falling after the global financial crisis (GFC). To restore buying activity after a global liquidity crisis that crushed asset values, they needed record low interest rates.

Is that the case today? For rates to return to pre-2020-levels, we would need crisis-level confidence in borrowing. Do people believe the same incentive is required today as was needed after the GFC? The answer to that question will help you understand how many more rate hikes are needed, and how long they need to be elevated. This isn’t 2008.

18 Comments

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  • Ray 12 months ago

    No one will be expecting to hand their keys over to the banks either.
    But they will.

    • Joe M 12 months ago

      Nah the bailout is just gonna be letting people stay where they are while the government forces banks to further subsidize/concede to the bad loans.

      • Alex 12 months ago

        It’s always the opposite. The people get kicked out and the banks have their books recapitalized.

  • Mark Bayly 12 months ago

    Would help if the government would stop lying about the inflation rate which is double what they are saying .

  • Santa 12 months ago

    Rates are normalizing. 5-8%. Never going back down to 2%.

  • Oldguy 12 months ago

    I am old enough to have lived and worked through the 70s and 80s and it looks like we are going back to the days of 19% mortgages. But nobody believed that it could happen then and they don’t believe it now. Does anybody know what AIB stands for?

    • J 12 months ago

      Mortgage balances have quadrupled. A normal 7% is enough to crash this house of cards.

      Immigration +++ in an attempt to slow the crash down and dupe new comers out of their life savings. Shame on Canada.

  • Frank 12 months ago

    To focus only on inflation until something breaks is not necessarily the right approach. With carbon tax on the way up, that cost is downloaded to consumers from farmers and trucking firms. Which in turn, adds to inflation. The out of control spending by a gov that believes the budget will balance itself also speaks of incompetence, a PM and Deputy PM who care nothing of the very people they pillage from and treat like subjects as opposed to voters they represent. One simple thing, axe the carbon tax. If not , expect endless rate hikes and don’t even get me started on climate change, another lie ,more taxation, more inflation.

    • Jim FitzGerald 12 months ago

      Couldn’t agree more! The biggest employer in this country is our government that keeps handing out raises and incentives. We are doomed!!

    • P 12 months ago

      Yup. You came here to talk about rates and inflation alright.

    • Fraser 12 months ago

      bang on

  • Hanif Esmail 12 months ago

    What about the inflationary
    Consumer goods & foods prices.

    A 2.63L bottle of hand soap could be purchased prepandemic for about $4.00. Today 3 years later, the same 2.63L bottle costs $10.99.
    A can of tomato paste before pandemic could be purchased for about 33 cts.
    Today the same can costs $1.20.
    In the last three years, prices should have gone up about 15% to 20% at the most . The price increases today are almost 300% and 400% higher in some cases.
    Is that inflation? Really?

  • Brent 12 months ago

    In the past week two real estate agents banged on my door asking if I was interested in selling. I chatted with them about the general “temperature” of the market today. They both said similar things, namely that there is no shortage of demand, but there is a shortage of supply;”Even at these crazy high prices”. Interestingly they both said that there was no ease up in money coming from overseas even with the ban on foreign buyers. They both said the ban can be easily skirted. The housing crisis in Canada can be easily fixed by forcing municipalities to streamline the pemitting process. The other fix that is readily available is to lower immigration levels to 100K a year till the country solves the housing issue. Of course, if you suggest either if these ideas you will be lables as “anti-human” and “racist” by the people who benefit the most from the current state of affairs.

  • Alan 12 months ago

    Interest rates should realistically be above the actual rate of inflation to deter leveraged borrowing and speculation. An example should be made out of Real Estate first. But this being a country of landlords, speculators and brokers, they will keep bankrupting future generations. If only the government committed half the resources and determination they have in Ukraine, things would have been very different.

  • Oldguy 12 months ago

    Why are my comments always erased?

  • Bob Vila 12 months ago

    Please do not forget that inflation greatly benefits nations with high national debt like Japan and the USA. It is possible to inflate away the national debt value. The debt remains a stable number while that same amount of dollars is worth much less and thus easier to repay relative to other things. This is why Bank of Japan is still actively pursuing inflation with ZIRP. It has not had its turn yet at devaluing its massive debt.

    So getting inflation down rather slowly is a benefit to the USA and will be a benefit to Japan. It is not a benefit to the citizens living in those countries who are poor. Their quality of life will worsen inevitably.

    • Quix 12 months ago

      If that happens, the Liberals are out of office hard. The vast majority of the working population can’t afford to buy housing because of all the governmental meddling. We’re already at the point where retaining workers is becoming hard.

  • Sergey 12 months ago

    When you see guy pissing on house fire trying to put it down, you definitely start doubting sincerety of his efforts. With what is going on they should have start adding 1% each time and completely make it impossible to use housing as investment vehicle. Those owing more than one property must be forced to sell. Housing is basic human need. No play ground for parasites who do nothing but use other people money and efforts to create cash flow for themselves making majority unable to afford decent housing.

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