Myles Zyblock, Chief Investment Strategist of Scotia Global Asset Management – which manages over $200 billion* for millions of investors in Canada and around the world – shares his latest market and investing insights.

This month, Myles examines how the Bank of Canada’s rate hikes have chilled the real estate market and what the outlook for the rest of 2023 may be.

One of the intended consequences of the Bank of Canada’s aggressive rate hikes was to cool the economy to force down high levels of inflation. From the latest Consumer Price Index (CPI) report that measures inflation, it appears that the central bank is succeeding (the March inflation rate was 4.3% versus 8.1% last June).

However, the economic price for the Bank of Canada’s actions has not been free. The housing market has taken a toll, with both sales and prices under significant downward pressure. Furthermore, construction activity has cooled and is threatening the health of the economy – economists are now united in call for a technical recession (regarded as two consecutive quarters of negative economic growth) in 2023.

More recently, the housing market was named the top risk to the financial system by the Office of the Superintendent of Financial Institutions (OSFI) in its annual report. The concern revolves around the potential for defaults in response to sharply higher interest rates.

Is it all doom and gloom? Ultimately, if recession can be avoided, or if it is shallow enough and the labour market manages to remain resilient, then the risk levels surrounding the housing sector should start to dissipate. Currently, there are indicators of house prices showing signs of promise for the latter half of 2023.

Housing sector weighing on economic outlook

The rapid rise in interest rates has cooled construction activity. New permits have been in decline and this has led to a fall in actual housing starts. For the month of March, residential housing starts declined 11% and are down by 12.5% versus levels a year ago. This latest data is likely to feed negatively into the residential investment series in GDP.

Canadian households’ incomes have not kept pace with house prices

Contributing to the headwinds facing the housing sector is the pace at which home prices have climbed versus disposable incomes in Canada, especially when compared to our southern neighbours.

Canadian house prices have been growing at 3% compared to 1.4% for disposable income – more than double the rate, after adjusting for inflation.

Interest rate hikes weighting on households

OSFI has cited the housing market as a top financial risk, with the potential for bankruptcies. The rapid rise of interest rates in Canada has been felt by households via higher borrowing costs. For example, the mortgage debt service ratio has spiked alongside banks raising their interest rates.

Ultimately, households’ ability to service their mortgages is directly tied to being employed. The proportion of residential mortgages in arrears is sitting at a low ebb and is unlikely to rise without a decline in the economy and employment levels. At this juncture, the labour market remains on firm ground.

How will Canadian banks be impacted?

While OSFI has sounded the alarm on the housing market, TSX Banks’ performance has been poor this year and among the laggards alongside energy companies. There is a lead-lag relationship between the health of banks and the economy with the latter likely to follow in the banks’ growth trajectory.

There is a bright side, however, and that is because leading indicators for the housing market are pointing to a bounce for bank stocks.

Are the clouds parting for the housing sector?

While the level of uncertainty surrounding the housing sector remains elevated, the outlook could be brightening. One positive sign is the Bank of Canada is effectively taking a pause in their rate tightening cycle. The fixed income futures market has a rate cut priced in by year’s end.

A second positive sign is the sales-to-listing ratio, an indicator of demand relative to supply, for cities such as Toronto and Vancouver. A rising ratio points to a potential recovery for the second half of 2023.

Myles June Headshot

Myles Zyblock is a recognized North American strategist, regarded for his investment insights that blend finance and psychology to capture major inflection points in financial markets. Myles has over 25 years of experience in guiding and advising on asset allocation for a diverse set of institutional and retail advisors globally. Myles joined the firm in 2013 as the Chief Investment Strategist, working closely with the Investment Team. His experience spans multiple asset classes and geographic regions.