Friday, June 12, 2009

How US Treasury Sales Immediately Impacted Canada This Week


It has been another banner week for the US Federal Treasury and Treasury sales. This week alone the Fed had to convince “investors” to buy up $150 billion worth of debt! This follows three weeks where the US auctioned off $87 Billion, $127 Billion and $138 Billion. This is an astonishing amount of debt for investors to absorb (and there's lots more to come).

This insatiable demand for debt sales has now created a historic crash of the bond market with TLT (the 20 year bond fund) losing almost 30% of its value. The ten year rose to 4% and that will take 30 year mortgages well over 6% in the United States.

This last statistic is particularly important for us because as US mortgage rates go, so do Canada's mortgage rates.

As such three of Canada's major banks decided to push mortgage rates higher yesterday despite the fact the Bank of Canada did not change it's rate and the BOC govenor wishes lending rates to stay where they are.

Nothwithstanding, the Royal Bank of Canada, the Bank of Montreal and Bank of Nova Scotia all announced they had increased the rates charged for money for homebuyers. Five year mortgages at these institutions will now cost a borrower 5.85%, four-tenths of a percentage point higher than the previous rate. Likewise, the rate for a three-year term rose 0.40 of a percentage point for the trio of banks, reaching 4.55%.

And why did they do this even when the Bank of Canada had not changed the lending rate?

CBC reported the news this way, "Analysts have noted that the cost of borrowing for longer periods of time more likely reflects the prevailing view of inflation in the next couple of years rather than the current short-term collapse in economic activity. Governments have responded to the ongoing recession by running deficits and printing money, factors that can boost short-term activity but hold out the threat of longer-run price increases. Thus, lenders will be reluctant to extend cash for longer periods without a commensurately higher interest rate."

But the Bank of Canada lending rate is still 0.25%. What gives?

The article goes on to note, "More ominously, the U.S. government got the cold shoulder from debt buyers Wednesday when Washington sold off $14 billion US in long-term bonds. Traders said Washington has been forced to flood debt markets in order to cover its stimulus spending. In bond economics, falling prices equal higher interest rates. Thus, industry experts now expect interest rates on longer-term borrowing to start rising again."

You see? It's all about US Treasury and Bond sales, which is why we follow the topic so closely.

Interestingly... Global News covered the rate increase on their 11:30pm newscast Wednesday night. The last interview of the piece was with a CMHC rep who pointed out that Vancouver prices are still falling and are expected to fall further over the next year, suggesting that future lower prices might more-than-offset future rate increases.

In other words rising interest rates are going to beat down house prices so that anyone buying at the higher interest rate will still be able to afford roughly the same size house because the lower selling prices (and thus mortgage size) will produce a similar monthly payment despite the higher interest rate.

Gee... and on what blog did you hear that prediction first?

And it's an important point, because it will happen.

When rates do skyrocket to 1981 levels (22%), anyone trying to sell their $650,000 home is screwed. They would need a buyer to assume a mortgage that will equate to a monthly payment of $11,700 per month... and that's simply not going to happen.

The only way that house is going to sell is if the price falls to $220,000.

The CMHC rep knows what all of us who were old enough to live through those times in 1981 know... that high interest rates will crush our bubble inflated Vancouver Real Estate market like a flimsy tin can.

So I ask you, what would you rather have?

(1) A $600,000 mortgage at last weeks low 2.99% variable interest rate, or
(2) A $220,000 mortgage at 1981's 22% interest rate?

Both will run you about $2,500 per month in monthly payments.

The difference? If interest rates skyrocket, you won't be able to renew your mortgage if you choose option (1). You will lose your home.

If interest rates skyrocket, as so many analysts now predict, a seller will never be able to sell a $650,000 property unless he slashes the price to $220,000 because no one can afford a $600,000 mortgage at 22%.

And when you consider how many local homeowners, who have bought in the last five years, will have to surrender their homes to banks under foreclosure when owners can't pay the monthly payments required when they have to renew under these rates... the downward pressure of forced bank sales will easily push prices down to $220,000, if not lower.

Remember banks don't keep foreclosed properties, they move them off their books ASAP.

If you buy under option (2), you still have the same monthly payment as option (1) BUT when rates go down again, you'll be laughing.

So why would anyone buy in today's market when virtually all economists are predicting a return to late 1970s style inflation and interest rates?

Why indeed.


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