HIGHLIGHTS OF THE WEEK
United States
- Investor sentiment remained relatively upbeat this week on constructive economic data, positive earnings reports, and hopes for near-term pro-growth policies.
- Still, safe-haven assets remained in demand, supported by rising geopolitical tensions and anxiety over the first round of the French presidential election this Sunday.
- Overall, economic data has been coming in relatively healthy, both in the U.S. and other advanced economies, but the dichotomy between soft and hard data is hard to miss. This is particularly the case for the U.S. where survey data surged while hard data suggest that economic growth largely fizzled out in the first quarter. Having said that, some convergence appears to be in the offing.
Canada
- The Canadian housing market made headlines yet again this week with another strong gain in both home prices and sales in March, mostly driven by hot conditions in the Greater Golden Horseshoe Area.
- Interest rates are not going to be the instrument to cool housing activity. The consumer price report this week showed a dip in inflation in March, supporting the view that the central bank will be on hold at least until next year, despite a pick-up in economic activity in recent months.
- Rather, the Ontario government has stepped in with a pack of 16 policy measures aimed at cooling demand, tackling the supply shortage and promoting affordability. The biggest of the measures include a 15% nonresident tax and the expansion of rent control to all rental units. Combined, these two measures are likely to take some steam out of sales and prices in the near-term.
UNITED STATES – HARD AND SOFT DATA BEGINNING TO CONVERGE
Market sentiment remained relatively sanguine this week. Equities in the U.S. were supported by a string of positive earnings reports and hopes for near-term pro-growth policies. Treasury Secretary Steven Mnuchin indicated that tax reform is "pretty close," helping lift spirits of investors who in recent weeks began to question the Trump reflation trade. Sentiment was also supported by robust growth in China at the start of 2017, with the economy growing by 6.9% (y/y) during the first quarter. Oil prices tanked this week on a large build in gasoline inventories in the U.S. while the dollar remained range bound – neither helped nor hurt by this week’s FOMC speeches from across the hawk-to-dove spectrum, with George, Rosengren, Kaplan, and Kashkari expressing their views prior to the blackout period which begins on Saturday. Generally, safe-haven bonds remained in good demand, with long-term Treasury yields hovering around 2.2% or nearly 40 basis points lower than their mid-March nadir.
The bid for safe assets is at least partly related to rising geopolitical tensions on the Korean Peninsula and in the Middle East. There is also plenty of anxiety over the French election, which has been further heightened after yesterday’s terrorist attack on French police. Polls suggest that a populist candidate, whether Le Pen or Mélenchon, is in good position to make it through to the second round but unlikely to clinch the runoff election. And even if so, there is still a long-road ahead before any referendum on the EU is even considered (see our French election preview).
Populist candidates have been boosted by weak economic growth and high unemployment in Europe. But, the economic data has been coming in better as of late. Reports this week confirmed the constructive data flow. Inflation advanced by a decent 1.5% (y/y) in March, while both consumer confidence and Eurozone PMIs surprised to the upside. At 56.7, the preliminary April composite PMI suggests growth carried into the second quarter after a good start to the year. Having said that, any survey data should be taken with a grain of salt, given the increasingly diverging performance of hard and soft indicators recently.
The hard-soft split is perhaps nowhere as apparent as in the U.S. where measures of consumer and business confidence surged while economic growth appears missing, with first-quarter tracking a meagre 0.5%. However, data released this week suggests that some convergence may be in the offing. Both the Philly and Empire indexes, which track activity across the Mid-Atlantic region, pulled back from their lofty levels recently (see Chart 1), while initial claims and housing activity remain very healthy – home sales reached a decade high in March as permits and starts continued to grind higher.
How exactly the convergence will manifest will be of utmost importance both for Fed policymakers and investors alike. Many among the FOMC expect to raise rates twice more this year. But, should the soft data weaken and converge closer to what the hard indicators are suggesting, two more hikes may not be an achievable target. On the other hand, should hard data trend higher, the Fed may be more anxious to raise rates, and may even begin the process of reducing their large balance sheet.
CANADA – HOPEFUL FOR FOOLER HOUSING MARKET CONDITIONS
The Canadian housing market made headlines again this week with another strong gain in both home prices and sales in March, mostly driven by hot conditions in the Greater Golden Horseshoe Area (it’s not just the GTA anymore!). Home prices were up by 32% year-over-year in the Greater Toronto Area and by almost 40% in some surrounding areas such as Durham, Barrie, Welland and St. Catherines.
While these gains are a sweet deal for current homeowners, it is becoming increasingly more difficult for would-be first-time homebuyers to jump into the market. Moreover, every month of double-digit home price growth brings with it a risk of a deeper correction down the road. In the absence of policy intervention, there was nothing on the economic docket in 2017 to slow this train. In particular, five-year mortgage rates fell 10 basis points during the first two weeks of April, giving back a third of the increase experienced since Trump’s election in November. Meanwhile, despite a pick-up in Canadian economic growth over the first quarter of 2017, this week’s Canadian inflation report supported the view that the Bank of Canada will remain on hold at least until 2018. Overall consumer price inflation dipped to 1.6% (year-on-year) in March, from 2.0% in the prior month and all of the central bank’s preferred measures of inflation fell short of the Bank’s 2% target (Chart 1).
So, the Ontario government decided to step in this week, with a package of 16 new policy measures aimed at cooling demand in the Golden Horseshoe, addressing Ontario’s housing shortage and promoting affordability. Some of the measures were tied to improved oversight of real estate agents, rental agreements, tax evasion, speculation and the municipal building permitting process. But, there were some big-ticket items in the package, including a 15% non-resident buyer’s tax (with exceptions for students, those seeking permanent residency and refugees), the extension of rent control to all rental units, lowering of taxes on purpose built rentals and some monetary incentives to encourage building, the opening up of provincial vacant land for new home development and giving municipalities the right to tax vacant homes and land (of which Toronto is likely to implement).
These policies are likely to dampen housing activity in the short-term. Using Vancouver as a guide, the non-resident buyer’s tax may push both non-resident and domestic speculators out of the market, bringing home sales across Ontario more in line with historical averages. Meanwhile, rent controls will put pressure on already depressed rates of return on rental properties, and prices will likely have to adjust lower to encourage further investment. As such, we have revised our housing forecast for Ontario and the GTA lower over 2017 and 2018 (Chart 2) to reflect these changes, and are now expecting a moderate correction in the average home price next year. Over the long-term, the mix of policy offers some incentives for increased housing supply. But, our view is that the overriding impact of rent control will be to restrict future investment in both condo and purpose-built rental development.
Overall, Ontario’s move will help buy some time in the near-term while the Bank of Canada remains on hold for a while longer. But the longer-term challenge of housing supply will remain even in light of this week’s efforts.
