The housing market reset begins

Based on the latest CREA data released, buyer fatigue has set in following an acceleration in housing activity over the past year. As expected, with two months of data in the books for the second quarter, Ontario existing home sales reversed course - declining by over 13% relative to the prior quarter. This helped dampen price gains on a trend basis mostly in the higher end singles market. I expect much of the same in the following months as a re-opening of the economy shifts consumer purchases away from durable goods consumption to services. This is good to see given that resale demand overshot its sustainable longer term level by over 30 per cent in Ontario based on first quarter data. Also, FOMO brought a number of buyers forward and this helped dampen activity so far in the second quarter. However, with the market still on the cusp of a sellers and overheated market, a further adjustment in demand is needed to keep prices in check as we await more supply to kick in.

But what will the demand trigger be?

FOMO which brought buying forward is certainly a demand factor that could create a vacuum in the months ahead. But rising interest rates were a key trigger in cooling housing markets historically. Why should we care about the direction of bond yields and the yield curve more generally? Well, bond yields foreshadow expectations about economic growth, inflation and North American mortgage rates. Canadian long term bond yields follow US yields quite closely so no surprise why I spend most of my time studying the US bond market.?

With North American bond yields reversing course since the first quarter, bond market expectations have shifted from being in the persistent to the transitory inflation camp. However, the jury is still out on whether inflation is indeed transitory. Furthermore, it is not a question of if but when central banks will begin to tighten monetary policy. The Fed threw a curve ball into financial and currency markets this week preferring to focus on rate hikes that are several months away rather than the imminent reversal of its bond buying program. Quite interesting but won't speculate why this happened to avoid rumors. The next level to watch is 1.40 per cent on the US 10 yr. bond yield (see chart below). Should yields find support there, a reversal to the upside is likely in both US and Canadian longer term interest rates.

Here are some factors that could contribute to a rising risk of higher inflation and interest rates:

·?????????Significant pent-up demand could be unleashed causing slack to be absorbed faster then expected

·?????????With strong pent-up demand, consumers are less price sensitive. This could prompt businesses to pass on rising input costs especially in the broader service sector. The latest published Bank of Canada Business Outlook Survey results point to this possibility

·?????????Tapering has begun in Canada and will soon begin in the US. This should push bond prices lower and yields in the opposite direction. Any surprises on the inflation front could amplify this adjustment

·?????????Inflation not only showing up on an annual basis but also on a monthly basis which is more of a trend measure. Both US and Canadian inflation trend readings beat expectations recently

All eyes now turn to the all important September and October data for further clues if housing markets are moving in the desired direction.

With that, wishing you and your families a happy and healthy summer season.

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