The Canadian dollar has come under pressure in recent months as the Bank of Canada continues to face an uneasy housing market with a neutral policy and low interest rates. At the close on Friday, December 27, 2013, the loonie lowered against major currencies. Against the USD, the Canadian dollar was at 93.42 US cents. Against the euro, the loonie touched near a four-year low at C$1.4816.
There are a number of factors that point to weakness in the Canadian dollar. The Bank of Canada’s hesitancy to intervene is only one of the issues. In December, 2013, the Bank of Canada expressed little concern for the high levels of household debt which has been fueled by rising real estate prices.
The strengthening of the US economy and the Federal Reserve’s paring of the stimulus points to a stronger dollar unless Congress gets in the way. As the Fed increases its tapering, the loonie will sink lower against the USD.
On Friday, yields in the US benchmark 10-year Treasury climbed above 3.0 percent, the highest level in two years. At the same time, the Canadian 10-year note shed 53 cents yielding 2.786 percent.
Behind the Downturn
The Canadian economy escaped the 2008 Great Recession relatively unscathed. While the financial crisis in the US saw 427 banks fail between 2008 and 2011, Canadian banks remained strong with no uptick in failures. Since the Great Depression, Canada has had the uncanny ability to be little affected by the financial drama of its southern neighbor.
However, there appear more reasons to bet against the Canadian dollar than support it. The demographics of the Canadian workforce are changing. Through structured immigration, the country’s population continues to grow at a solid pace. There has also been a migration to metropolitan areas like Toronto, Vancouver and Montreal. Today’s Canadian workers want to live near their place of employment, increasing demand for condominiums in these big cities.
A Housing Bubble
Unlike American lenders in the buildup to the 2008 housing crash, Canadian lenders have been committed to borrowers having skin in the game. You do not see minimal down payment loans or low doc loans in the Canadian banking system.
Yet, one of the pressing issues Canada faces is the strong possibility of a housing bubble, signs of which have already begun to surface. The condo market is tenuous and prices in the housing market have climbed too high too fast.
In December, Deutsche Bank estimated that housing prices in Canada were overvalued by 60 percent. The Bank of Canada saw the problem coming and tried to stem the tide by toughening mortgage policy and increasing rates earlier in the year. Prices and sales declined sharply in the first and second quarter of 2013 but rebounded during the summer. The net effect of the intervention was that demand only subsided momentarily.
The Deutsche Bank report indicated that prices compared to rent were 88 percent overvalued. Home prices compared to income were 32 percent overvalued. The report also incorporates historical housing data.
Canada’s Re/Max real estate brokerage has a positive view of the 2014 market. The broker reports the number of home sales will increase about 2 percent next year. And, sales in 2013 were strong, about 453,000 units. The average selling price of a Canadian home in 2013 was a whopping $380,000, well above the average selling price in the US.
In 23 of 25 (92 percent) Canadian housing markets surveyed by Re/Max, prices rose in 2013. The Hamilton-Burlington area saw prices rise on average by 7.5 percent, the highest growth rate in the country.
During the US housing crash, home prices fell 30 percent on average. In many communities, the losses were greater. Personal balance sheets suffered big hits. If the bubble bursts, Canadians are not likely to suffer those type losses but debt will be high and rising unemployment will usually follow. The weakness in the loonie will only add fuel to the fire.
