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Despite softening origination activity, mortgage professionals should welcome the current “reset” to healthier market conditions.

That was the message from CIBC’s Deputy Chief Economist Benjamin Tal, a keynote speaker at this week’s National Mortgage Conference hosted by Mortgage Professionals Canada in Vancouver.

CMT spoke with Tal ahead of his speech, where he said we should continue to expect softer housing activity compared to what was seen during COVID.

Mortgage professionals “should be encouraged by that because the slowdown that we are seeing now is a reset to a much healthier market,” he said. “What we have seen during COVID was a recipe for a bubble if it didn’t stop, and it’s stopping.”

Tal added that the industry will have to navigate some “short-term pain,” in terms of the rate of growth in mortgage originations, but that it should mean a return to more “predictable” markets on the other side of this “adjustment process.”

But it also means challenging times for borrowers, some of whom will be impacted more than others.

“There is one cohort that is very vulnerable, and that’s the COVID cohort, the people who took mortgages in 2020 and 2021 when interest rates were extremely low,” he said.

While those with fixed rates and fixed-payment variable mortgages have largely been protected from rising monthly payments, that will change come renewal time in 2025 and 2026, Tal added.

“That will be a significant issue for them because, although I expect interest rates to go down in 2024, I suggest that there will be a permanent increase in the terminal rate and the neutral rate,” he said.

Higher rates will be the “new norm”

The Bank of Canada has so far hiked its overnight target rate by 300 basis points this year, bringing it to 3.25%. It is currently expected to end this rate-hike cycle at anywhere between 4% and 4.25%.

“And then they will start cutting in 2024, but by how much?” Tal asked during his keynote address. Historically, the BoC would bring rates back down to an average level of 1.75%, but Tal doesn’t expect that to be the case this time.

He said today’s inflationary forces, such as de-globalization, “just in case” inventories and rising wages, to name a few, are “more powerful than before.”

“So, you have more pressure coming from beneath and you have to keep the target of inflation the same. What do you have to do? You have to keep interest rates higher than before the previous cycle,” he explained. Assuming a terminal rate of 4%, Tal expects the Bank to cut that back to 3% or 2.75% and “call it a day.”

“And that would be the new normal,” he added.

The risk of the BoC hiking rates too much

A key risk facing the economy is the extent by which the central bank hikes its rates, with Tal suggesting there is a “non-zero probability the Bank of Canada will overshoot just to make sure they’re not behind the curve.”

That’s because they’re focused on controlling inflation, which is a lagging indicator.

“Inflation tells you what happened in the past, not in the future. If you look at the past four or five recessions, inflation peaked six months after the beginning of the recession,” he told CMT.

Tal believes that if the Bank stops hiking rates at 4%, it will portend a “soft landing/mild recession” for Canada. That would entail negative growth, but wouldn’t have a significant impact on the labour market.

“However, I believe that we’re already entering overshooting territory, and if they take [the overnight rate] to 4.50%, 4.75%, that would be the difference between a mild recession and a more significant recession with some implications for the labour market,” he said.

Housing activity has not been distributed evenly

Tal outlined some of the reasons for the current environment, including of course the COVID-19 pandemic and its impact on the supply chain, and also how homeowners largely benefited from the low interest rates associated with a recession without experiencing the rise in unemployment associated with a recession.

Essentially, four years worth of consumption were squeezed into one year in 2021, leading to a supply shock both for consumer goods and housing.

“We simply borrowed activity from the future, and the future has arrived.”

Benjamin Tal, CIBC Deputy Chief Economist

“We have never, never seen anything like that. There was a sense of urgency to get into the market,” he said. “People basically front-loaded activity. We simply borrowed activity from the future and the future has arrived.”

Looking at the past four years and the coming year together, Tal said he sees a very healthy housing and mortgage market, except for the fact that activity is not distributed in a normal way.

“It doesn’t mean that it’s a free-fall; it doesn’t mean that the market is crashing,” he said.

“But it means that we are reallocating activity over time and that’s the way to explain the situation and the slowing in the market to clients.”

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