What if?

OMG. What if interest rates never fall. Are we pooched?

The latest inflation stat from crazy America lands on Wednesday. The expectation is it may be hot. If so, Mr. Market will push its forecast of rate reductions even further into the future. Like maybe December.

Says our economist pal Derek Holt: “When converted to annualized rates, US core CPI inflation has been running at well over 4% m/m SAAR in each of the past three months and about 3½% m/m SAAR in the two months prior to that. Compared to the 2% inflation goal, that’s just far too hot to entertain easier monetary policy at this juncture.”

In short, the Fed has tapped the bakes. The hold will continue if Wednesday delivers a fat stat. Maybe the CB will even hike, some people say. After all, the American economy is ducky with GDP growth, record markets and seriously-low unemployment. Pressures on prices include higher energy costs, rising service costs and more expensive cars.

Yeah, we know. For well over a year the consensus view has been that rate cuts were just around the corner. At one point five or six chops were forecast for 2024. Now it might be one or two. Or none. The Bank of Canada has a greater likelihood of reducing the cost of money here because of economic weakness, but history shows we follow the Fed 94% of the time. So, who knows? This is a moving monetary target which already has torpedoed most of the Canadian real estate market. In Toronto and Vancouver, for example, rutting season became a rout.

Now, the brutal question. What if rates never come down?

There was an interesting Reuters piece on just this yesterday. Not only did it parrot what this pathetic blog has said for a long time – Covid-type, crazy-low, 2%-mortgages are not coming back – but it went further in speculation. There are solid reasons the cost of money cannot possibly ever (at least for a generation) drift much lower than at present, the argument goes.

Why?

The biggie is debt. Just look at Canada. Households owe $2.2 trillion in mortgages alone, all of them financing every five years or less. The federal and provincial government debt of an equal amount ($2.1 trillion) is financed mostly by the issuance of bonds, which routinely roll over. And every year we add more – another $40 billion this year in Ottawa alone – costing over $50 billion in interest. US federal debt alone is $34 trillion. It’s also been growing like a weed under both Trump and Biden. Now military spending is going nuts.

In short, nobody can live within their means. So borrowing is endless and rampant. All that money must be financed, putting pressure on credit markets and squeezing the cost of funds higher. It’s supply and demand. Can’t fight it.

Beyond that there are other pressures for never-lower interest rates. Like demographics and an aging population in the world’s most developed nations. Again, Canada’s a prime example. Lok at OAS (as we recently detailed). In costs us $75 billion a year to send money to old people, and that’s set to rise another $10 billion shortly. The biggest single public expenditure. Wrinklies produce less, consume more, burn through gobs of expensive taxpayer-funded health care and collect pensions that a reduced number of employed workers finance. Lower savings across society combined with higher government costs are a driver of rates.

Then there’s the unknown expense of dealing with climate change, the transition to a costly green agenda, the physical damage more storms and disasters may cause, the withering impact on global agriculture and the immense human migration that scientists say is inevitable if temps keep rising.

Finally, AI might make economies way more productive, stimulating growth, the demand for capital and higher rates. The flip side is widespread job replacement and the cost of supporting people who no longer have meaningful work. How much will UBI soak governments? And then, Gaza. Plus Ukraine’s energy infrastructure. It’s been eight decades since the world faced such immense reconstruction expense after stunningly-widespread and utter destruction of systems and property. Where is that money coming from, other than through more debt, borrowing and financing costs?

Well, you can see the logic. Those pandemic and pre-Covid interest rates were an aberration. An outlier. Maybe CBs and governments in most of the world blew it by gushing money and trashing interest rates to ward off health-induced depression. Or perhaps they did what they had to. Too soon to tell. But the consequences are becoming clear.

We know multiple rate reductions are off the table. This year may bring a small Canadian cut, but there’s serious doubt the Fed will move until inflation data is convincing. And it may never be…

Meanwhile the real estate market hangs on by its fingernails. Buyers retreat. Sellers still delusional. Sales levels are eroding. Huge troubles in the precon space. New builds are paralyzed. Condos appear doomed. And the spring rush never came.

How can prices hold?

About the picture: “Long time reader and now two time emailer,” writes Kenneth. “A number of years ago I emailed you asking for advice about buying a condo in Calgary. Thankfully you answered and I didn’t end up buying. I continued to rent, got married, we continued to rent & save and eventually bought a lovely piece of dirt in Calgary (which has substantially appreciated in value) to call our own. While we didn’t adhere to your Golden Rule, we didn’t completely gut our savings. Buying our first house enabled us to get our first dog, Jasper. Thanks for all you do, please continue to do so for all our benefit.”

To be in touch or send a picture of your beast, email to ‘[email protected]’.