There are a lot of predictions right now that a recession is just around the corner. At least the bond market thinks so. The entire Canadian yield curve is below the overnight rate, which has been historically speaking- a strong indicator. The spread between 10 year and 3 month yields is the most inverted since 2007.

Spread between the 10 year and 3 month yield.

Of course people have been calling for a recession for awhile now. Particularly in Canada where household debt levels are off the charts. Housing bulls have found a way to justify the debt levels, usually citing the correlating asset prices which are directly dependent on underlying debt levels continuing to grow. It’s a pretty flawed argument but so far it hasn’t mattered since household balance sheets have failed to blow up after more than a decade of warnings.

However, with the recent yield curve inversion and now residential investment falling, those warnings are ratcheting up again. Friends over at Better Dwelling noted Residential investment marked its fifth consecutive quarterly decline. Residential investment fell to 6.50% of GDP in the first quarter of 2019, down from 6.94% the same period last year.

Canada Residential Investment as a percentage of GDP.

The predicative nature of residential investment as a recession indicator has been well documented by Norway’s Central Bank.

The report finds that “residential investment improves predictability the most for countries with high home-ownership rates. For instance, we find substantial forecast improvements by including residential investments as a recession predictor for Spain, Norway and the US – all of which have a high home-ownership rate. For countries with low homeownership rates, such as Japan and South Korea, residential investment does not contain predictive information about future recessions above other leading indicators.”

Home Ownership Rates by Country.

Given the relatively high rate of homeownership in Canada it shouldn’t be a surprise that of our past two major recessions in Canada, both started after 5 consecutive quarterly declines in residential investment.

Residential investment

Oddly enough, Bank of Canada Governor Stephen Poloz continues to maintain his hawkish stance towards pushing interest rates higher in the face of a weakening housing market. Recently suggesting in Bloomberg interview, “The natural tendency is for interest rates to still go up a bit.” While adding, “If you look at markets that didn’t have any froth, people are adapting quite normally. I think that most people are mentally prepared. And, in Canada, historically when these things have happened, people understand they’ve gone maybe underwater, but you know that within a few years they’re no longer underwater and life goes on. People pay their mortgage and we’re okay.”

Poloz might be reaching for the handbrake sooner than he thinks.


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