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Home» Alberta Lending » “Canadian housing market: correction, NOT a crash“ -PIMCO Canada Inc.

“Canadian housing market: correction, NOT a crash“ -PIMCO Canada Inc.

Posted by Dave Fitzpatrick - November 25, 2014 - Alberta Lending

The world’s biggest bond fund manager, PIMCO Canada Inc., expects a “cyclical decline” in Canada’s housing market, but says there’s little chance of a meltdown.

There has been much media attention on Canada’s housing market lately, with some forecasters calling for “the bubble” to pop in 2014. While we think the housing market in Canada is overvalued and due for a correction, the correction will likely happen over several years.

There are two important assumptions that underpin our housing forecast. First, a correction is not a bubble bursting in a disorderly manner. Second, the correction will start in 2014.

  • While we expect a correction in Canada’s housing market to begin this year, the macroeconomic environment and the availability of mortgage credit suggest a housing crash is unlikely.

In our view, for the Canadian housing market to “burst” in a disorderly manner, one of three events would have to happen in 2014: Interest rates would need to rise substantially, the unemployment rate would have to spike higher or the supply of mortgage credit would have to be disrupted. With real growth of about 2% and a relatively subdued inflation forecast, we see no reason for interest rates to substantially rise in 2014. Given this macroeconomic environment, it is also unlikely that the unemployment rate will spike to 8%-10% (which, we estimate, would be needed to cause a disorderly housing correction). Finally, the Canadian banking system continues to provide sufficient mortgage credit to keep the housing market financed.

At PIMCO Canada, we have been bearish on housing for a while from a secular perspective, but this is the first time we are forecasting a cyclical decline in the housing market. Our forecast reflects a number of factors. First, higher housing prices show the market is more stretched than in previous years. Second, the four rounds of mortgage credit tightening implemented by the federal government are now more clearly having the desired effect. Finally, we expect the cost of capital at Canadian banks to rise in 2014 due to regulatory changes and expect the banks to pass on these higher costs to consumers in the form of modestly higher mortgage rates.homes-on-bar-chart-300x300

Specifically, Canadian banks are attempting to meet new Basel III leverage rules that make low-yielding assets like mortgages less attractive and could therefore constrain mortgage lending. In addition, we expect Canadian banks to implement bail-in language in new senior debt offerings and issue non-viable contingent capital structures that will explicitly expose bond investors to the risk of conversion into equity during a crisis. Investors will likely demand higher interest rates to hold these securities, and banks are likely to pass along the increase in rates to their customers (including residential mortgage clients).

To summarize our view, the combination of modestly higher mortgage rates, tighter mortgage underwriting standards, a continued modest economic recovery and a housing market where valuations are stretched will result in a decline in housing activity and housing prices in 2014, but not a crash.

Original article here.

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