The Fall Selling Season

Canada's new home builders will get a much better picture of the underlying direction in housing demand this fall. The summer has been an uneasy time with wide-ranging views on Canada's housing market outlook. Buyers typically take a break in Canada during the summer months and it is impossible to detect new trends during this seasonally slow period.
New and existing home sales results for September and October are likely to dispel some of the pessimism that has recently arisen. However, it still seems clear that the market has shifted in favour of buyers and they are now more cautious and willing to wait before buying.

Job Security Worries
For the first time in more than five years, Canadians have begun to worry about job security. This is an important issue which is bound to be felt in the housing market, especially in central Canada where the still-elevated Canadian dollar is pressuring manufacturing companies to cut overhead costs.
Full-time employment has always been a good indicator for housing demand and the latest news is not good. The July numbers show a slide which has put Canada's job head-count back to where it was at the beginning of the year. However, this is still a vast improvement on comparable performance in the United States where there has been a net loss of 463,000 non-farm payroll jobs since the end of last year.
Consumer finances in Canada remain relatively healthy. House prices are not falling in Canada, and household net worth is being sustained. It is growing much more slowly now but it is not declining. The S&P TSX has been able to hold its gains through to last year after a great run since 2002. Canadians do not face hefty mortgage payment resets and there is no mortgage default and foreclosure problem in Canada. Fortunately Canada's banks are still willing and able to lend. The credit tap has not been turned off in Canada the way it has in the United States. Mortgage credit and household credit still shows substantial year-over-year gains.
In addition, on an income per-worker basis, Canadians are also much better off than their U.S. counterparts. Average weekly earnings are still showing a positive gap with consumer price inflation. These real income gains are being eroded, however by rising inflation. It is possible that real income growth per worker will basically disappear by early 2009. A cautious approach to 2009 business plans is therefore advisable for new home builders.

Inflation Risk
Inflation risk will add to the list of things to worry about. Accelerating inflation could put the Bank of Canada and the Fed on the sidelines and unable to respond to possible further weakness in the North American economy.
It would be hard for the Bank of Canada to cut rates if inflation were running above its target boundaries. There is a good chance of this happening. The Bank of Canada is forecasting that Canada's CPI will be showing year-over-year increases in excess of 4 per cent by the fourth quarter of this year.
Consumer price inflation in the U.S. is already much higher. The July figures show a 5.5 per cent year-over-year increase for the all-items index. The latest surge in producer price inflation in the U.S. suggests that even higher U.S. inflation numbers lie ahead. Producer prices are regarded as a leading indicator for inflation at the consumer level. They give an idea of what kind of price pressures are in the production pipeline.
Finished goods producer prices in the U.S. were 9.8 per cent higher in July than in the same month a year ago. It is not just oil prices that are behind the U.S. inflation surge. Non-petroleum prices for imports coming into the U.S. are running 8.0 per cent higher than a year ago. Global supply chains no longer seem capable of holding inflation down. In fact, the emerging economies now appear to be part of the problem.

Interest Rates
Inflation trends in Canada can move independently of what is happening in the United States. However, interest rates are a different matter. The best way to forecast Canadian interest rates, especially the longer rates which are important for mortgages, is to have a good forecast of U.S. interest rates. In turn, U.S. rates are directly influenced by what is happening to U.S. inflation.

House Prices
It is important to remember that new house prices are not declining in Canada on a national basis. Even in Ontario, which is facing the greatest economic challenge, prices still show significant gains from this time a year ago. The gains are not as large as they were but they are still positive results. There are price declines on a regional basis in western Canada between May and June in centres such as Saskatoon, Edmonton and Victoria. Hamilton and Sudbury also posted small month to month declines in June.

Pressures on Energy Prices May Linger
The inflation outlook is a controversial topic. In the past, increased margins of excess capacity would eventually push inflation lower in recessions. The economic models of the past may not be reliable guides to the future though. Economists and central banks may have to abandon the notion of core inflation. Pressures on food and energy prices no longer seem to be random events that will revert to the mean. They may now be structural and here for the long term.
The supply response to sustained high oil prices that happened in the 1980s will not happen again. The key oil producers today are the national oil companies and they have different incentives from the private international oil companies. At the margin and given time, Americans will reduce their oil consumption but it may take pump prices of $6.00/USD per gallon to make this happen. Market forces will eventually bring oil prices down as a result but this may not happen until after 2010. In the meantime, there is an unhealthy interaction between food and energy prices. Motor transportation costs are a big component of food prices. Also, the shift to biofuels will take up larger and larger shares of the U.S. corn crop each year.

U.S. House Prices Keep Falling
The U.S. housing downturn has not yet hit bottom. If you want to be optimistic about the outlook for financial markets you have to believe that foreclosures will return to tolerable levels and that house prices will stop declining. Unfortunately these prerequisites seem unlikely anytime soon. House prices are still falling. This is bad news for the financial system. It means more write-downs on structured investments backed by mortgages. Banks will have to set aside more cash for investment losses and loan defaults.
Daniel Mudd, CEO of Fannie Mae, thinks that the U.S. housing crisis is halfway over. George Soros is not as optimistic. He thinks we are not even at the half-way point yet. ARM resets will not decline from elevated level until late in 2011 and waves of mortgage defaults and foreclosures are likely to be a fact of life for the next three years.
At this point all of the federal government's initiatives to stabilize foreclosures appear inadequate. Falling house prices mean more Americans are upside-down on their mortgages. There are already an estimated 8.5 million American homeowners (11 per cent of the total) in this position. A continuation of falling house prices could push this figure to over 12 million in 2009.

Credit Conditions Tightening
This onslaught of bad news about U.S. housing markets has influenced home buyers' attitudes in Canada. House prices are holding up but there is no longer a rush to buy. Existing home sales have been trending downward since last fall. New listings in the resale market are up sharply. B.C., Saskatchewan, Ontario and New Brunswick show big increases in listing.
Credit conditions are also tightening in Canada. The banks now require a higher return for taking on risk. Given the international reach of the credit shock it is unlikely that the Canadian banks would move much out of step with their American counterparts.
Our housing start estimate for 2008 is a healthy 212,000 units. However, 2009 is expected to be a more difficult year. We have lowered our housing start forecast for next year to 185,000 units. Looking further ahead into 2010, a decline under 180,000 units is possible.

Peter Andersen, a CHBA economist, is president of Andersen Economic Research Ltd. of Toronto. The firm specializes in economic research and forecasting for the Canadian home building industry.