NPRs and the housing market

Benjamin Tal: Let me tell you that they are as confused as all of us. They don’t know. I’m not sure that they even know now what they will do in September, quite frankly, because you know and you know it better than anybody else that for every bullish indicator or economic indicator, I can give you a bearish one.

Bipan Rai: Hello everyone, and welcome to another edition of the FX Factor podcast. I’m your host, Bipan Rai, and today I’m joined with a frequent guest of ours, CIBC’s deputy chief economist Benjamin Tal. Benny, welcome back to the podcast.

Benjamin Tal: Thank you. It’s a pleasure.

Bipan Rai: Yeah, excellent. And you know, I should start off by really referencing the report that you released today on Counting Heads in Canada. A conundrum. And really the focus of this piece was on the growth in the number of non permanent residents in the country. Why don’t we just start off by talking through the fact that even if we do have increasing housing supply, that at least on the supply side, it’s going to take some time to meet the growth on the demand side. And of course, that’s being led by the amount of NPRs that are coming into the country. What are your thoughts on this? If you could really just summarise what you wrote about today?

Benjamin Tal: Yes, you’re absolutely right. You know, it will take years, even if tomorrow we do all the right things and we want. But if we do all the right things about supply, it will take five, seven years to see something happening because it takes time. Meanwhile, you know, demand is rising like there is no tomorrow. So you have to run faster in order to stay in the same place. And that’s more or less where we are. The point that I’m making is that we have to run even faster than that because the official numbers are undercounting the number of non permanent residents by roughly 1 million. And that’s extremely important to understand because if you think that we are in a housing crisis now, it’s actually worse than perceived. And I’ll tell you why, because I think that your listeners would be interested in that. There are two sources for this undercounting. One is the census, you know, picture for the following situation. You have a 22 year old international student arriving from, let’s say, India or China or other country. They are young, they are innocent. They don’t know what’s happening. They are confused. And the census people come to them and say, you answered the census only if this is your permanent residence. Now, this is not your permanent residence, your parents house back there. You know, over there is your permanent residence. So you’re not answering the census. So we are estimating 250,000 people are not doing that. So we are undercounting non permanent resident students by 250 K and even Stats Canada admits that that’s the case. Now, why is it important? Because CMHC, when they put together the assumptions about household growth and therefore demand for housing and therefore allocation to municipalities, but what are they going to use? They are using actually the census number, which means that if the census is undercounting, you are definitely undercounting the forecast. And that’s exactly what’s happening. The undercounted household formation by 1.5 million over the past ten years. So that’s one thing. The other thing is that let’s focus on this foreign student. Now, this foreign student is 24, is about to graduate, is visa is expiring and Stats Canada and that’s important assumes that the minute or 30 days after your visa expires you are out of the country. That’s their model. So they assume that that’s the case. But you are not out of the country. You are staying. This student is staying. They are applying for all kinds of things. Work visa to be a permanent residence. Nobody is counting them because the model assumes that they are out. 750,000 people undercount. This is huge. So we have 1 million people more than we think. So if you think that this is a housing crisis, it’s actually worse.

Bipan Rai: Well, that’s quite eye opening, especially when we factor in that 750,000 of these, I guess you can call the NPRs that are undercounted is due to simple statistical assumptions made by StatsCan. I mean, you know, from that perspective and I know you’ve met with the government a few times about this, Benny, what are the sort of policy prescriptions that you say Dr. Tal would prescribe to a situation like this?

Benjamin Tal: Well, first of all, clearly Stats Canada has to fix that, and I think they are working on it because we cannot continue. In the past, it was not a big deal because the number of non permanent residents was relatively small compared to population, but now it’s huge. So every mistake is huge. Major implications on policy. So that’s one thing. I think that what we have to do is clearly introduce a sense of urgency when it comes to the housing market. You know, when we had Covid, it was an emergency. It was a crisis. We acted very fast in a big way. We have to treat housing like Covid, fast, big, be practical and think big and think that we have to look at maybe capping the number of foreign students or at least linking their number to the ability of the country, of universities, colleges to house them. You cannot just accept people like there’s no tomorrow without the infrastructure to deal with it. That’s one thing. The other is that we have to stimulate supply and by doing so, we have to actually increase the rental segment of the solution. We need to see purpose built, rental rising significantly the way we have seen in the 60s and 70s. And what I told the government in the last meeting was provide incentives to developers, remove the HST, remove the capital gain tax on the sell if you use the money to invest in another purpose built. There are many other things that we can do to provide incentives to developers to build not condos, but purpose built rentals. And I think that the government is listening.

Bipan Rai: How about the other measure that was taken several years ago? This is certainly pre-pandemic when we had the government sort of suggest that rental increases would be in line with inflation. Could we see that rule rescinded? Because that does have an impact on supply over the long term, wouldn’t you agree?

Benjamin Tal: Absolutely. That’s a rent control. And, you know, I will quote a Swedish economist that said back then, rent control is the best way to destroy a city. Maybe besides bombing, you don’t want rent control. Yeah, the rent control is basically subsidising current tenants at the expense of future tenants. It’s all coming from a good place. I totally understand that. But it’s not helping. It’s making the situation worse because it means 0% increase in purposeful rental while you need 20% increase. Right. Right. We have to think of other solutions. Provide supply. Better supply is the best way to improve affordability. It’s the best rent control, if you wish.

Bipan Rai: And what about some of the other markets in Canada? I mean, when we talk about the housing market and I guess when a lot of people talk about the housing market in Canada, they’re really talking about the larger cities like Toronto and Vancouver. But, you know, we travel a lot within the country as well. Is there a way we could sort of sort of make it a little bit more attractive for NPRs to come into the country to some of these other markets? Is that something that the government is also looking at?

Benjamin Tal: Absolutely, because the distribution is uneven. We have a situation in which most of them are going to Toronto, Vancouver, Montreal. We know the story. So it’s really asymmetrical and that’s not a good thing. So we have to provide incentives to go there. It can be through taxation, it can do all kinds of other things. But I think that this is something that is very difficult to fight because people come where their family is, where their friends are. So I think that this is a more difficult to do, but I think that the incentives can help. And what we know, especially when it comes to new immigrants, they go to Nova Scotia, they go to New Brunswick, They stayed there for a year or two. And then we look at their taxes and they back in Toronto. So we have to find a way to help those promises to maintain, to keep those new immigrants that arrived there.

Bipan Rai: What does this mean for the housing market in general in Canada? I mean, you know, we’ve talked about this before and how, you know, maybe the sort of quote unquote bubble that everyone’s been sort of pointing at when it comes to Canada might not actually pop to the same degree. I mean, in your mind, if you were to project the housing market in, say, a city like Toronto or in Vancouver over the next 5 to 10 years, what does that landscape look like relative to the past?

Benjamin Tal: Well, first of all, if you look at the next 5 to 10 months, the direction is flat or down, which is a very good thing because during Covid, the prices went up by 40%. You need to see prices going down. We know that the condo space is struggling. We know that developers cannot sell and we know it takes much longer. So it’s really a buyer’s market slowly, although it’s not a cheap market by any stretch of the imagination. The decline in prices recently is only a fraction of the increase during Covid. So we still have a lot of way to go before we see some affordability and that will not be reached anytime soon. But over the next year, we’re going to see the market struggling, which is a good thing, under the weight of high interest rates. From a long term perspective, it’s very clear to me we have a huge mismatch in the supply demand situation and if we don’t fix it, the situation will get worse and worse and worse. And therefore it’s crucial to introduce a sense of urgency to deal with the supply situation while keeping demand at bay.

Bipan Rai: Let’s step back and talk a bit more about the NDP’s. If you’re the Bank of Canada and you’re looking at this growth in population, I mean, how are you framing it in the near term, let’s say near term, over the next six months to maybe a year versus over the long term? How would you look at this sort of increase in aggregate demand?

Benjamin Tal: That’s a very good question, because the ultimate question that you are asking is basically to what extent new immigrants and non-permanent residents are a supply story or a demand story. What is more important, the supply aspect, namely the labour market or the demand aspect, namely housing and consumption? And I think that when it comes to new immigrants and non-permanent residents in the near term, which is a year, a year and a half, it’s actually inflationary. It’s more demand than supply, because we know that many of them, especially the non-permanent residents, are employed in relatively low productivity, low wage industries, which means that their contribution to the economy is not very significant. Clearly, we have GDP growth rising, but per capita it’s actually going down and it’s much worse in Canada than in any other country because we are getting many more of them in absolute terms and in relative terms. And that’s the issue. So if you look at productivity, in fact, productivity is worse than perceived because we are not undercounting close to 1 million people. Can you imagine if you add them to the calculations of population, you have a situation in which the demographic story suggests that the productivity is actually worse. So it has major implications for GDP measurement, for productivity, and therefore the fight against inflation. I think short term new immigrants, not permanent residents, are inflationary. Long term, it’s a question of the point system. If you change the point system in a way that is more accurate and reflects the mismatch in the labour market, then you get the productivity increase that we need. I’m not sure that’s the case with non permanent residents because I think that the model is not working well.

Bipan Rai: If we are the Bank of Canada then and we’re deliberating on what to do going forward. We’ve hiked rates already in June and July in response to the stronger than expected demand numbers towards the end of Q1 and into the early part of Q2. Looking ahead and of course taking stock of the data as we have it today, what do you think the Bank Canada does at its September meeting?

Benjamin Tal: Let me tell you that they are as confused as all of us. They don’t know. I’m not sure that they even know now what they will do in September, quite frankly, because you know and you know it better than anybody else that for every bullish indicator, economic indicator can give you a bearish one. But this is a biased market. This is a biased bank. Namely, they will choose to overshoot and undershoot. We all know that. And that’s the only risk for September. They have no business raising interest rates. In fact, they had no business raising interest rates in June and July, in my opinion. They are already overshooting. But this is a biased market and this is a biased bank. I can suggest the following. I can say that if the Bank of Canada was an AI machine, they will have stopped in June. But they are not. They are human. They have fears, they have doubts, and therefore they will overshoot. So the only reason why we still talk about September or October is that they will take overshoot over undershoot any time, and that’s basically more or less where we are. So, quite frankly, I can tell you and I will not admit it very frequently, so don’t get it. Get used to it. I simply don’t know. I don’t know. I don’t know if they will move in September or October or at all. But I think that we are very, very close to the end of the tightening cycle in both countries.

Bipan Rai: So if we’re talking about, you know, a word like overshoot that has a very, very nasty history when we’re talking about monetary policy. Right? So I mean, and I’m going to ask you this question because I know I get asked this frequently. We have a central bank that, let’s say, in our opinion, is overshooting. How likely is it that it’s going to trigger a recession over the next 12 to 24 months in Canada? If that’s the case.

Benjamin Tal: They are overshooting, but not by much. So I think that we are in a process now of managing the overshooting, the size of the overshooting. If you stop now and even if you go to 525, I think we’ll be fine with 0% growth over the next six months. It might be a very mild recession, maybe not. I really don’t care. But the labour market will be fine if you go crazy and for some reason you stick to this 2% target while you have 2.5%. Or if you ignore the fact that most of the inflation that we are getting now is because of interest payments on mortgages which should be excluded from the calculation and you go crazy with this target and you go to 575, six, something crazy. Then we have an old fashioned recession, not a wannabe recession. So our call is basically a soft landing. But even if we get a mild recession, for me it’s the same thing. Those rates are consistent with that. The more important story is that when are they starting to cut? We all know what’s coming in 2025, 2026. 57% of mortgage outstanding will be reset. And that’s something that will impact the psyche of consumers and the economy as a whole. Therefore, it’s really important to see rates going down in the second half of 2024, and that’s exactly what we are expecting.

Bipan Rai: Right. So let’s talk about something that I think is very germane to a lot of different asset classes and certainly it became a hot topic earlier this month, and that is a level of where we think the equilibrium long term interest rate is, and not just in Canada but also in the United States. There’s a prevailing view that it hasn’t really changed much since before the pandemic. So let’s say in between 2 to 3%. Firstly, do you agree with that view? And if not, what are the reasons why?

Benjamin Tal: Well, yes, I agree with that. And first of all, we have to discuss one more thing, and that’s the target, the inflation target. Now, you and I can discuss until we are blue in the face, to what extent the target should be raised irrelevant. They are not going to touch it any time soon. We all know that. So clearly this is fixed 2%, although we can say that maybe it should be two and a half, 275, whatever. The number is stuck at 2%. Then we have four inflationary forces in the background. We have a situation in which De-globalisation is inflationary, replacing globalisation. We have just in case inventory replacing just in time inventory inflationary. The labour market, demographically speaking, is inflationary and all those green initiatives, they are inflationary, let’s face it. So you have four inflationary forces cooking the target is the same. By definition, interest rates have to be higher than they were before. So therefore I think that we are at five, 525 or whatever the number will be. We’ll go to about three, 275 and call it a day, notably higher than it was before. Remember we started this episode at 175, so it will be higher than what we have seen in 2019 and higher than the previous neutral for good reasons.

Bipan Rai: Let’s talk a little bit about the US now. The last little while we’ve seen sort of the market move to reprice the Fed a little bit over the coming meetings to be more of a 50/50 chance that they are going to hike at either the September or November meetings. Do you agree with that? And if not, I mean, what is your base case for the Fed going forward and what are the other issues that they should be considering when it comes to the US economy? Yes, I.

Benjamin Tal: Think that all the answers are in the labour market and the labour market is normalising. You look at the number of vacancies going down, you look at the quit rate, which is the most telling indicator, it’s actually back to normal. You look at the spread between, you know, people that quit their job and people that stay. The spread is basically back to where it was before in terms of wage increase. So the market is normalising and that’s where all the answers are because it’s all about wages. Wages are decelerating. Therefore, I think that the move in September is not given by any stretch of the imagination. I think that, again, the overshooting versus a undershooting is going to determine whether or not the Fed will be moving. But again, I believe that the Fed is very close to the end. If they move in September, that would be the last move.

Bipan Rai: And do you agree that there’s a different degree of interest rate sensitivity for both the US and Canada and that could be tied to the mortgage market, the nature of the debts held in the United States versus Canada?

Benjamin Tal: Yes, absolutely. And that’s something that was postponed but was not eliminated. Namely, we have been saying for a while that the Bank of Canada is much more powerful than the Fed because of the fact that we simply have more leverage and other mortgages for five years. However, all this business with extending payments and keeping payments for mortgage for variable rate mortgages orders, this postponed the impact. But this impact will come big time in 2025 and 2026. So this is something that we have to take into account. So it’s not that the effectiveness of monetary policy in Canada was eliminated, it was postponed. It will be coming. And that’s why it’s important to see interest rates going down before it’s too late.

Bipan Rai: Again, you know, if we’re looking at this from a foreign exchange perspective, I mean, there’s several different compelling reasons why we’re bearish to the US dollar next year, one of which is that we see an earlier than expected end to the quantitative tightening program. Benny, do you have a strong conviction there when it comes to early next year? Do you think the Fed is probably going to pull the plug sooner than expected?

Benjamin Tal: Absolutely. I think that the labour market is normalising fast. I think that inflation will slow down. Notably, I think that this market will be operating at about 0% GDP growth over the next 6 to 9 months. I see no reason not to accelerate the process. That’s exactly what I see with major implications for the dollar.

Bipan Rai: There’s definitely a divergence growing between the GDP and GDI measures for for the US economy, and I think that’s going to be paid a little bit more tribute to in the in the coming months.

Benjamin Tal: Absolutely.

Bipan Rai: One last question before we wrap this up, Benny. What is your call for the Fed next year? We do know that they’re going to cut rates. Are they going to go at a more aggressive clip than the Bank of Canada?

Benjamin Tal: I doubt it. I think that the Fed and the Bank of Canada will be holding hands when they start cutting interest rates. I think it will be more or less in line with the Bank of Canada, more or less the same magnitude. So I see them moving together very nicely. I don’t see a divergence in any significant way.

Bipan Rai: All right, excellent. Thanks again, Benny, for joining us today. We look forward to having you again.

Benjamin Tal: A pleasure. Talk to you soon.

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