Will "The Fed" Reconsider?

Until a few weeks ago, it seemed likely that the US Federal Reserve FOMC was well on it way to announcing an interest rate increase – but with the recent market volatility, things may be changing. With China showing signs of causing a global economic slowdown and the future of Greece in the Eurozone still uncertain, a growing number of economists and policy experts have expressed concern about the timing of the Fed’s next rate increase.

The latest market moves are likely to intensify concerns over whether China’s economic slowdown will spill over into the U.S. and whether the Federal Reserve is likely to delay plans to start to raise interest rates from near zero for the first time in about a decade. – Wall Street Journal, August 25th 2015

Additionally, a recent op-ed by former U.S. Treasury Secretary, Larry Summers in the Financial Times urges the Fed to avoid making “a dangerous mistake” by raising rates in September. However 5-year through 30-year US Treasury bond rates were dropping on Tuesday, with short-term bond rates increasing. The volatility is continuing with the overnight market in China and elsewhere overseas.

So – how does this affect housing in Victoria? When the US Federal Reserve does raise rates, it will further devalue the Canadian dollar (currently hovering about $0.75 US). The only monetary tool that the Bank of Canada can use to increase the value of the Canadian dollar is to raise the overnight rate – bumping up the prime rate that banks use as the basis of variable rate mortgages. Additionally, an increase the the Fed’s interest rate will boost US Bond rates (both government and private), causing Canada’s banks to raise their bond rates – which form the basis for the fixed-rate mortgages in Canada. In other words, if the Fed holds off on an rate increase – then the current low interest rates will persist … but when rates are raised, Canadian fixed-rate mortgages will climb and variable-rate mortgages will follow suit when the Bank of Canada raises their rate.

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76 thoughts on “Will "The Fed" Reconsider?

  1. Pingback: August Sales – History Repeats Itself | House Hunt Victoria

  2. Funny to see the median price still up in Calgary over the same time last year when oil way more than double today’s price. That’s called resilient.

  3. I’m with you totoro… of the last four corrections, 3 were sideways corrections (‘69-72, 94-98, 10-14) with the exception being ‘81-85.

    It’s usually ~10 years before the next corrective phase, so that should give us roughly another 8 years.

  4. What about Oak Bay? Nothing around our humble abode seems to sell for much under a million, or if it does it’s likely to be torn down and replaced by a MacMansion.

  5. I agree that prices are extraordinarily high … I’m just not sure that this will ever reverse/correct…

    Hm, or as the eminent Yale University economist, Irving Fisher, famously stated in 1929: the stock market “has reached a permanently high plateau”.

  6. if the supply were to increase sharply and substantially that would be a supply-driven rout and prices would tumble. But I would guess that the number of listings would have to increase at least 5 times their current level in the core for that to happen.

    But if interest rates increased there would be a contraction in demand, partly due to a reduction in affordability and party due to a change in sentiment resulting from that change in demand, quite apart from any change in supply. Then you have conditions for a crash with no compelling factors to constrain the downward movement. Instead of “buy now before prices rise” the wisdom will be “buy later when prices have fallen further”.

  7. When you say end do you mean when will it stop rising? I don’t think the market has been rising for very long has it?

    People with suites are unlikely to be the ones in trouble if prices drop or there is a recession – they have a buffer and can always price at market or slightly under.

    I agree that prices are extraordinarily high for people starting out. I’m just not sure that this will ever reverse/correct given that prices stalled for a good while. Maybe that was our correction?

    Averaged out, prices have risen faster than inflation my entire life and this pattern shows no signs of stopping as far as I can tell.

  8. An orderly correction in prices would be demand-driven as higher prices cool the market. However if the supply were to increase sharply and substantially that would be a supply-driven rout and prices would tumble. But I would guess that the number of listings would have to increase at least 5 times their current level in the core for that to happen. To me that seems unlikely but certainly not impossible. One out of every 100 homes in Victoria is for sale. In Sooke it is one out of 20.

    Spiraling interest rates would certainly be a cause of an increase in listings. If interest rates went up 2 or 3 percent home owners would be looking at what their mortgage rates would be at renewal time a year or two or three from now. They may decide to get out while the going is good.

    In areas dominated by basement suites. If the economy were to slide into a recession then basement renters would be looking at cheaper purpose built apartment units, moving to another city for work or moving back to their parents’ home. That would cause home owners relying on the basement suite income to not be able to make their financial obligation to the bank. That’s not likely as we haven’t seen any cancellation in any of the big construction projects or a drop in building permits. All I’ve seen is a substantial drop in the vacancy rate for purpose built apartments which at this time could mean many things.

    I have always thought that if a market correction is coming there should be some precursors to warn people. I still think so – and that’s why I’m always commentating on the market. But no one really knows how this market might end.

  9. If anyone is interested here is a break down of median prices by neighborhoods in Victoria for August. When you break median prices down into hoods, there isn’t a large data set. The medians therefore while appearing to be reasonable may not necessarily be accurate.

    $857,000-rockland
    $794,000-fairfield west
    $756,000-dowtown
    $706,500-fairfield east
    $629,000-james bay
    $540,000-jubilee
    $534,500-fernwood
    $518,500-hillside
    $518,000-oaklands
    $476,500-central park
    $475,000-mayfair
    $461,000-burnside
    $460,000-victoria west

    There are many reasons why the price of homes vary widely over such small distances in Victoria. Rockland for example has very large lots.

    The zoning in Fernwood and Oaklands favors basement suites resulting in a higher than typical percentage of properties with suites in contrast to the zoning in Mayfair. When you tour Mayfair you find the streets are not congested with cars and it is a quieter and prettier neighborhood than Fernwood- yet the prices are lower.

    Vic West has a higher percentage of smaller lots than other hoods and you have to cross over water. Which eliminates witches, warlocks and MLA’s as prospective purchasers.

    Being able to walk to the downtown office is reflected in the prices paid for James Bay and Fairfield West. Being far enough away to discourage the homeless and their shopping carts is shown in the prices paid in Farfield West

    Central Park is just scarey

  10. Median price for August a record $587,500, but new listing 5% higher than last year!

    When demand exceeds supply, price increases are constrained by “affordability”, but when supply exceeds demand, price falls are subject to no corresponding constraint: hence markets tend to fall, or crash, more abruptly than they rise.

    Whether the Fed raises or not, the BoC is likely to do so after the election, since (a) our trade balance is headed for surplus, which means the slump in the dollar has gone far enough; and (b) a new government will likely want to put a property correction/crash behind it as soon as possible so as to lay the blame where it belongs, on Stephen Harper. If by a miracle Harper manages to cling to power, then we can expect further housing market stimulus, e.g., billions for home renovations.

  11. isn’t that a sad fact. 900000$ just to be considered better than the jones…
    Tofino here we come.

  12. Tue Sep 1, 2015 8:10am:

    Aug Aug
    2015 2014
    Net Unconditional Sales: 741 609
    New Listings: 952 904
    Active Listings: 3,688 4,316

    Please Note
    Left Column: stats for the entire month from this year
    Right Column: stats for the entire month from last year

  13. You left out all the QE1,2 and 3 stimulus packages and free money the banks and CMHC have handed out the last 15 years. Combined with never before seen emergency interest rates, this will definitely be a wake up call when rates finally rise. Couldn’t come soon enough to save more sheep from walking in front of the train.

  14. Oil is down tonite and the short squeeze is most likely a “false start” as most analysts believe. Credit squeezes on LOC’s are putting many Canadian oil companies in major jams. $40 range oil is a killer for most.

    “Citibank’s Morse said the ongoing price volatility suggests Monday’s surge is likely “another false start.”

    “The bullish 20-25 per cent crude oil price spike since late last week looks driven more by sentiment than by reality,” Morse said, noting that the bank expects WTI and Brent prices to post another “fresh leg lower — perhaps making new 2015 lows — before year-end.”

    Other analysts also remain pessimistic. Bank of Nova Scotia released its revised forecast to US$45 for U.S. crude, before prices started rising mid-day Monday.

    “A prolonged battle for market share between Saudi Arabia and the U.S. shale producers, Russia and Iran appears likely to keep oil prices below US$50 over the next twelve months,” wrote Scotiabank’s economic and commodity market specialist Patricia Mohr, in a report on Monday.”

    http://business.financialpost.com/news/energy/oil-prices-rally-on-signs-of-falling-output-prospect-of-opec-talks-but-analysts-warn-of-false-start

    As oil loans sour, Canada’s energy sector faces risk of being cut off by banks

    http://business.financialpost.com/news/fp-street/as-oil-loans-sour-canadas-energy-sector-faces-risk-of-being-cut-off-by-banks

  15. I thought I’d take another quick look at your “Fed reconsider” query before dinner and compare the Fed interest rate with our prices…
    Looking backwards almost 40 years, it looks like prices here should get a big jolt when the Fed does finally start a rate tightening cycle. I suspect it’s something to do with how joined at the hip we are to the US economy.

    Unfortunately I don’t have the monthly price data for Vic, but we follow Van close enough. Anyhow we’ll discuss it more on your upcoming post.

    Anybody notice how much oil is up this past week 😉

  16. The sales activity for houses in the core has been most dramatic in the $600,000 to $800,000 range for August. The core for the previous three years was ranging between 176 to 191 sales over 6 months of data for the $600,000 to $700,000 range. This Last 6 months has seen an increase to 272 sales.

    Similarly the $700,000 to $800,000 price range tended to have between 112 to 130 sales for the 6 month period. That has shot up to 199.

    A couple of price ranges for houses in the core has dropped insignificantly in the $300,000 to $500,000. But most are at their highest sales activity. Only in 2007 and 2009 were there more sales in the various price ranges.

    That has pushed the median and average prices of houses in the core up to new highs. But most of the market price increases are for houses in that 600 to 800 range. Very few of these homes would be characterized as upper income. They are average family homes that you find in every city in Canada.

    Starter homes in the core start around $375,000. These are your 2-bedroom shacks, houses on busy streets, homes in need of repair, homes with screw ball additions.

    One has to pay over $900,000 to get anything that would start to be considered an upper income house these days. The WOW! factor kicks in about 1,4 million and so do your property taxes at $9,000 a year.

    Most of us believe that if you buy a starter home fix it up, then sell it, you can move up the property ladder. I look at that ladder and see a couple of the rungs are missing. It’s a big step up from starter home to middle income house these days. A rung is missing in the ladder and that makes it tough to move up to that next home.

  17. Mon, Aug 31, 2015 8:00am:

    Aug Aug
    2015 2014
    Net Unconditional Sales: 707 609
    New Listings: 905 904
    Active Listings: 3,664 4,316

    Please Note
    Left Column: stats for the entire month from this year
    Right Column: stats for the entire month from last year

  18. For most home sales, they are through the real estate board. Only a small fraction of a couple percent are private sales. Except when you leave the world of the common man and enter the uber riche market in the multi millions.

    Those deals seem to have a much higher percentage of private sales. Then when you look deeper…

    You start to see some patterns emerge. All cash transactions. Buyers and sellers in the same industry. Mortgages taken back by the previous owner, vocations described as businessman, housewife, student.

    I would be concerned living next door to some of these multi million dollar nouveau riche owners. Because some time in the early morning hours a black SUV with a fox hunt logo will show up wanting the money back.

    Lai Changxing

  19. I didn’t mean it in a bad way… I enjoy pulling a “dodge and spin” move once in a while 😉

    To be honest, I don’t think nominal rates have a lot of correlation with prices especially in such a large economically diverse country. Real rates are another story and are harder to figure out, but we’ll discuss along with your ‘real’ price chart on a future post.

    Enjoy the winery.

  20. Haultain is an extreme example, but was the norm and more in early 80’s where deals were done at 50% off when the official down move was 30%. Average correction was 10% in last down move. Show me more 30% offs in SFH’s ,besides the suckers in Langford condos. Which real estate company do you work for again ?

  21. We can use 5yr fixed rates rather than the bank rate if you like David. I’ll try to make it super easy for you to see.

    So 5yr mortgage rates went up 4%, during the exact same time period as Victoria prices went up ~80%. Even if we use your annual averaged rates (1987 11.14, 1990 13.24) you can clearly see rates went up with prices. I know you’ll try to dodge and spin in otherwise again, but I don’t know how it could be any clearer.

    And Hawk, prices corrected nearly as much ‘10-’13 as ‘81-’84. If you don’t believe it just take an example like 1711 Haultain that sold for $447,500 in 2010 and then $300,000 a couple years ago to a brilliant flipper at bottom 😉 That’s more than 30% off.

  22. You still have to pay taxes on the sale of a corporation. I think the capital gains exemption is limited to $750,000. It depends on how much real estate is in the portfolio.

    And in some cases, you may wish to include your home as part of the deal when selling a corporation.

    Say you own a tech company and a personal mansion in Toronto. You may want to structure the deal that the buyer of your corporation also purchases your personal home at an inflated price. That lowers the tax you pay on the sale of the corporation and your principle home is capital gains tax free.

    This isn’t for the ordinary Joe but the multiple million dollar homes. Why will it work? Because the only ones that check if the sale is above board are the appraisers working for the CRA. Overworked and underpaid government appraisers that most likely don’t have the special set of skills to value the one-of-a-kind properties.

    For example, a property with a fair market value of $25,000,000 is registered at land titles at $40,000,000. Unfortunately this becomes a part of public records and may be used to set a new benchmark for home equity lines of credit for other mansions.

    Appraising mansions is a specialty. The normal practice of selecting comparable sales and adjusting for differences between them is not very useful when you’re dealing with a one-of-a-kind property.

  23. Victoria housing in 87 was coming out of a major post crash and had room for prices to rise. Prices hardly corrected last blip in 2008 because Harper flipped billions of bank mortgages into taxpayers laps in CMHC. Prices are at an affordability top at record low interest rates, not coming off a major price bottom.

    Mortgage rates were also not 7% in 87, they were in the low teens, like 11 to 12% range. Bank rate at 7% was a short term blip. You’re misleading people here once again.

  24. I remember ’86/’87 well … IMHO, 1986 was one of the best times to buy in Victoria and prices hit their (inflation adjusted) lowest price and interest rates were dropping. As the vast majority of mortgage holders have 5-year terms – here are the 5-year fixed mortgage rates (CANSIM v122497) offered over the 15 years from ’80 through ’95:

    Year 5-year
    1980 14.32
    1981 18.15
    1982 17.89
    1983 13.29
    1984 13.61
    1985 12.18
    1986 11.22
    1987 11.14
    1988 11.60
    1989 12.05
    1990 13.24
    1991 11.16
    1992 9.52
    1993 8.70
    1994 9.34
    1995 9.22

    In 1986, the average Victoria SFH price was $102,054 ($197,885 in 2015 dollars) climbing to $191,774 ($294,609 in 2015 dollars) in 1991. The 5-year rate was virtually unchanged – from 11.22% to 11.16%. Prices climbed for a wide range of reasons (including rebounding from the mid-’80’s lows), but it wasn’t due to the prevailing interest rates.

  25. This why you cannot trust the numbers China doles out on growth,etc. No wonder the IMF won’t let them into their basket of currencies.

  26. When our banking system was deregulated that allowed a lot of suitcase banks to offer mortgages in Canada. That’s where you might find most of the problems with mortgage fraud. Not in most of the big banks in Canada. HSBC excluded.

    These suitcase lenders rely heavily on the brokers and appraisers to verify information. Sadly, these are the lenders that suffer the losses. And these are not necessarily big corporations. They can be a family that made a lot of money in the past and now lend out their personal savings in the form of mortgages.

    Personally, I don’t think there is much in the way of appraisal fraud in Victoria. I think there are more incompetent appraisers practicing today because of Appraisal Management Companies. Appraisers that would have been fired before but today are retained by AMCs because they provide a low fee. There are only a few of them but every broker knows who they are.

  27. This was in a Global BC article the other day. Leaves room to wonder how much they are BS’ ing. To imagine Canadian banks as saints of the financial lending world seems pretty lame to me. Not “sure”, and not “certain” sounds like “most likely” to me.

    “The quality assurance program and the checks that we do, I’m sure encompass some calling. But I can’t tell you for sure right now,” Raipal said. “I’m sure we do, but I can’t tell you for certain.”

    http://globalnews.ca/news/2186549/banks-step-up-scrutiny-after-flare-up-of-liar-loans-in-housing-market/

  28. Thanks for the information, and “interesting” tax avoidance loophole. I also bought my house through a private sale. Any idea what percentage of sales in the Victoria market might be private sales?

  29. Sure thing, but you should quickly try to understand the period we most resemble is ’86/’87 …oil & commodity crash, population influx, 75-cent loonie, demographics, falling vacancy rate, US economy & house prices starting to boom, BC economy starting to boom…

    The bank rate nearly doubled from 7.14% Mar ‘87 to 14.05% May ‘90 (see link) as Victoria average prices almost doubled in that same time frame (see VREB historical stats).
    http://www.bankofcanada.ca/wp-content/uploads/2010/09/selected_historical_v122530.pdf

  30. Private sales would not be included in the VREB statistics. The sale will be recorded at the land registry and BC Assessment will review the sale and if in their opinion the property is an arms length transaction it will be used in their statistics.

    Unless the sale is included as shares in a sale of a corporation. Then the sale will not be shown in the land registry and no purchase tax would be paid. Just a nice little loop hole allowed by our BC government to assist investors.

  31. I just found out that a neighbour sold their house in a “private sale”. Would a sale like this get recorded in the VREB sales statistics?

  32. … in a few years when rates have doubled from today’s levels and the average Vic house is nearing a million.

    I think that it’s time to revisit by blog post from late June: “Housing prices follow mortgage rates?“, where I looked at Victoria real estate over the past 15 years to see if housing prices and interest rates are inversely proportional to each other. With the exception of government meddling with the introduction of 40-year mortgage amortizations in 2006-08, it was pretty clear that rising prices and falling interest rates track each other closely.

    Please explain further your theory of rising interest rates and rising prices.

  33. From your link Mike, it states this is historical info, not a guarantee of the future as you propose.

    “To be sure, the GDP report provides a backward look at the U.S. economy. Since the spring, it has been hit with deepening concerns about a slowdown in China and recent turbulence in global financial markets. It remains unclear how the U.S. will fare in the months ahead if developments abroad deteriorate. “

  34. $1 million in a few years ? You need to put down the pipe Mike, aint gonna happen. Rates doubling will mean many Victorians claiming bankruptcy long before a million is ever seen.

  35. Bear to bull market (20% gain) in 4 days for oil is impressive! If you’re rebalancing the old portfolio this autumn, you might want trade some US for a bit more Canuckistan.

    On rates, my guess is the 5-year rate is soon headed for the 2011 highs. If correct, it’s going to leave housing bears scratching their heads in a few years when rates have doubled from today’s levels and the average Vic house is nearing a million. I mean, just take a look at where someone like Leo bought on this chart in Spring ‘13… the 5-year has more than doubled since he bought and he’s probably already up over a hundred grand. Need I say more 😉

  36. Here is a link to support my world view… Fed won’t raise rates in September….
    “I don’t see how it’s possible that inflation will be picking up in the United States. We’re just going to have a stronger dollar, falling commodity prices, growth prospects that aren’t that good, more competition from imports in the U.S. market so that labor won’t have any bargaining power and wages won’t be going up.”
    http://finance.yahoo.com/news/china-jitters-globalization-bode-ill-050727182.html

  37. I think it’s a bit of both. US is the anchor in this global economy of turmoil. Does it matter though if they are stronger or everyone else is weaker? The result is the same, a stronger US dollar. You bring up a relevant point. The US is not isolated and if it’s dollar gets too strong buying it’s debt get’s too expensive, buying it’s production gets too expensive etc… So, it must take into account the global situation in their rate decision. I think they want to see some global stability first.

  38. A few of our friends are the same way. Massively in debt. The debt just keeps on getting bigger. They just can’t seem to make a dent in the mortgage. A roof this year, drain tiles the year before, a car.

    They’ve just come to the believe that they will never pay off their home.

    -of course there is always life insurance…

  39. The Westshore Parkway will open up new areas for development. This parkway is going through a lot of rocky undulating land of little use. Rezoning to residential will improve its value as subdivided residential land. The government should make some good coin selling this off to developers.

  40. Greed and fear in my humble opinion. Greed that they will make more paper profits before they pull the pin and perfectly time the market. Fear that they will miss out if they cash out. The rest have no reason to move or are trapped in a sea of HELOC debt. I know a few of the latter.

  41. Six hundred tons of gold sounds a lot but its only about $18 billion, so not much of a factor in an $8 trillion plus economy.

    Agreed though, what happens in the money market must be a key factor determining interest rate policy. But with the US trade gap widening the Fed will surely welcome weakening of the US dollar.

    Canada’s trade deficit, however, is falling sharply, which might warrant an interest rate quite soon.
    ?s=catbtotb&v=201508061745h

  42. Dead cat bounce from a $60 drop and billions lost. Hasn”t even broke the 20 day moving average. The chart is busted for a very long time Michael.

  43. I hope you paid attention to that energy chart I posted on Tues night Hawk.
    If so, you owe me a beer or two 😉 Many big energy names up 10-15% since yesterday morning.

  44. It’s not that the US dollar is particularly strong, it’s just that other economies (such as Canada’s) are particularly weak. In the US: employment is up, markets (outside of the past few weeks) are doing well, housing and consumer confidence are both doing well. (See: WSJ article.)

  45. That’s a really interesting way of looking at the numbers. Rather than those in the core not wanting to sell – I would pose the question: “Why do so many people in Sooke and the Western Communities want to sell?”.

    Returning to last weeks’ blog post “Will traffic improvements affect prices?“, I cannot help but wonder if the planned Westshore Parkway Connection may cause a decrease in listings of Sooke and the Western Communities.

  46. It also depends on who is buying our debt. If it is mostly funded locally it’s not as big of issue. If it’s not… it is an issue

  47. I thought I would take a look at the ratio of dwellings of all types in each district (2011 census) and the number of current listings. Just to illustrate how low or how high inventory is currently in each area.

    For example: The City of Victoria (including Vic West) has 47,961 dwellings and there are currently 476 listings of all residential types. That’s a ratio of 1 listing for every 100 dwellings (rounded)

    Here are the districts in order from least to most
    Esquimalt 1:115
    Saanich 1:105
    Victoria 1:100
    Oak Bay 1: 85
    Highlands 1;85 (Highlands at only 2,000 houses may be to few to be reliable)

    View Royal 1: 65

    Central Saanich 1:60
    North Saanich 1:55
    Sidney 1;50

    Metchosin 1:60
    Colwood 1:45
    Langford 1:40
    Sooke 1:20

    I think we can all see how the distribution falls inline with prices. This is just looking at supply – not demand.

    So why are those living in the core districts so reluctant to list their homes for sale?

  48. Wouldn’t a rate increase also increase the ever strengthening US dollar which is also not desired. With all the craziness the US is even more seen a stronghold. I think there is plenty of demand for their debt still. I think they will not raise rates in Sept.

  49. @LeoM
    Nice summary!

    Quite simply, governments must raise rates sufficiently to discourage investors from redeeming government treasuries.

    … and this is why the US Federal Reserve may be obliged to raise rates this fall, even when there is a lot of economic uncertainty and inflation is nowhere high enough to warrant raising interest rates.

    Remember, U.S. Treasuries are sold at auction to the lowest interest rate bidder. If no one bids low, then the rate is increases as few basis points until someone buys.

    Rates for all short term (2-year and less) US Treasury Yields have been steadily climbing:
    http://www.bloomberg.com/markets/rates-bonds/government-bonds/us

    Next Tuesday (Sept. 1st), Statistics Canada is due to report the second-quarter figures for the Canadian economy. We will then find out whether Canada is in a technical recession.

  50. That is the number being reported as it pertains to all American debt held by China. The $1.7trillion in treasuries previously held by China only represents a portion of the U.S. debt held by China. China is divesting all forms of US debt, not just the widely reported Treasuries.

  51. Compelling chart but to me it looks like we still have room to go even lower with our rates or do nothing as the US raises theirs 😉 The length of time that it has been flat also illustrates that we are in somewhat new territory. I feel (even though they deny it) that our gov would prefer a lower currency right now for the benefits that it offers vs enticing more foreign investment. Expect a $0.70 dollar…

  52. Where do you get $500 billion from?
    The latest update of Treasury data and estimates have China at owning $1.47 trillion of Treasuries and a total reduction of $180 billion recently. Are you not including the re-buying in your numbers? After buying so much a 10% reduction doesn’t seem crazy to me…

  53. You can spin the China story as nothing to worry about but you miss the point that billions if not trillions have been lost in the last week. Not all of China housing is doing well either, only the few big cities. Their market crash is a symptom of much deeper global credit problems.

    “The smaller cities in China’s interior that make up the bulk of its housing market are still struggling with a buildup of vacant homes and little prospect for improvement as growth weakens and its young people flee.”

    http://www.wsj.com/articles/smaller-chinese-cities-miss-housing-recovery-1438075980

  54. Great post LeoM, that’s exactly what is happening here. China is setting off a currency war like none other and the volatility is going to be huge moving forward. Gold is getting interesting again.

  55. The notion that interest rates and inflation are always in equilibrium is wrong. Low interest rates during low points in the economic cycle and high interest rates during red-hot economic cycles, is only half the equation and it’s possible to have rising interest rates during a declining economic cycle.

    The common belief is that interest rates will rise because of inflation concerns. That belief is mostly wrong these days. The real threat to low rates is when big international investors (like China) dump government debt (Treasuries).

    Interest rates may rise even if inflation is stagnant at less than 2%.

    Interest rates increases are commonly used to stop inflation increases during times when the economy is running red-hot; but during these days of an economic slump and low inflation, the main reasons for governments to consider rate increases is simply because governments are teetering on bankruptcy if investors, en masse, tried to redeem their holdings of government debt that is held as Government Treasuries-bills/bonds/notes.

    Quite simply, governments must raise rates sufficiently to discourage investors from redeeming government treasuries.

    For the past 10 years, U.S. Treasuries have been trusted by foreign mega-investors as a secure place to stash hundreds of Billions of cash; consequently the U.S. Government could pay lower and lower interest to these debt holders; and the U.S. had almost no significant competition for the world’s surplus cash.

    But things are changing. Investors are dumping U.S. Treasuries. China has redeemed over $100 BILLION in U.S. Treasuries in just the past few weeks. China started dumping US Treasuries months ago and that caused the U.S. Fed to start warning of a rate increase.

    If you want to predict the future of interest rates, just watch what the mega-investors are doing with their U.S. Treasuries holdings, and whether or not the mega-investors are lined up for new treasury auctions at low rates, or are the investors demanding a higher return. Remember, U.S. Treasuries are sold at auction to the lowest interest rate bidder. If no one bids low, then the rate is increases as few basis points until someone buys. QE was used to buy this debt at low rates when no one else bid low.

    In the past five quarters China has been a net seller of US Treasuries, to the tune of about $500 BILLION.

    Oh yea, one last thing… China recently purchased over 600 tonnes of GOLD in a single month, and they are buying more, a lot more.

  56. The Chinese stock market started unraveling in mid-June while the latest round of the Greek debt crisis also reignited in June.
    https://en.wikipedia.org/wiki/2015_Chinese_stock_market_crash
    https://en.wikipedia.org/wiki/Greek_government-debt_crisis#2015

    I agree that daily fluctuations are not worth bothering with, but the longer-term trends do matter! This is why I re-balance my investment portfolio each quarter. (It also means that I’m not competing with the high frequency traders.)

  57. At some point, our dollar could devalue such that the government has a hard time borrowing money (by issuing treasury bills, etc.) in order to fund the day-to-day operations of running government. The only way to entice people willing to invest is to raise the interest rate. This is why the rates in Canada typically follow the rates in the US, otherwise if the US is offering a higher rate – investors will not bother with investing in Canada.

    Forces Behind Interest Rates
    http://www.investopedia.com/articles/03/111203.asp

  58. I’m sure our low dollar has a lot to do with it… Unfortunately our manufacturing sector has significantly shrunk over the past 10 years.

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