Amidst the flurry of coverage analyzing and re-analyzing U.S. Federal Reserve Board Chair Janet Yellen’s speech at Jackson Hole, Wyoming this week, saying that she believes “the case for an increase in the federal funds rate has strengthened in recent months” there has been speculation an increase in interest rates south of the border could create a troubling scenario in Canada.
In an interview with investor site Maudlin Economics, Jared Dillian, a former Lehman Brothers trader, prominent finance writer and author of Street Freak: Money and Madness at Lehman Brothers, sounded the alarm.
Dillian pointed out that with the prime rate in Canada sitting at 0.5 per cent, he could see a cut of 0.25 per cent and then it’s not far to go to get to zero.
“I think they could go to zero or negative in 2017 very easily,” he said in the interview. Dillian speculates that this discrepancy between rising U.S. interest rates and the Bank of Canada’s conservative position will act as headwinds on the already weak Canadian dollar.
He also asked his crystal ball about the often talked about Canadian housing market which he says is in “extreme bubble territory” with average prices in Vancouver pushing over $1.5 million and $500,000 across the country.
“Debt-to-disposable-income for consumers is 165 percent which is much higher than it was in the US at the top of our housing bubble,” Dillian said in the interview. “(Overall) it’s a pretty interesting situation, I don’t see how it can get much worse.”
If there is a housing collapse, the former trader says he expects it will be a long drawn out one unlike the relatively quick crisis the U.S. experienced.
But Isaac Holloway, an economist and assistant professor at Western University’s Ivey Business School told Yahoo Canada Finance that while he agrees with some of Dillian’s sentiments – for instance that the U.S. is apt to see interest increases before Canada putting pressure on the dollar – some of the financial writer’s speculations are a bit too gloomy.
“It’s true that the Bank of Canada started talking about the possibility of negative interest rates as a possibility but as a probability anytime soon is fairly unlikely,” says Holloway. “To me that’s a little bit alarmist.”
He also points to Dillian’s recommendation that those owning Canadian homes should sell them and buy them back cheaper in a few years after his predicted housing reset is a bit “imprudent.” For one, rent is also rising with those being crowded or priced out of the housing market opting to rent for a little longer than they typically would.
This, explains Holloway, is putting upwards pressure on the rent, which makes Dillian’s advice for homeowners to sell if they can, a risky choice.
“There’s going to be a lot of costs along the way and they might have to wait a long time before prices are actually low enough it does make sense,” says Holloway.
And finally, Dillian’s advice to short the Canadian dollar given it’s a “sure thing” makes Holloway a little uneasy. In theory, Dillian’s approach to short stocks comes with the caveat that if consumers start defaulting that’s going to hit the banks.
“(But) as long as the Canadian interest rates stay low, it’s possible that this debt binge is going to keep going… Canadian rates are going to increase when the economy seems like it’s starting to do better –when exports start picking up, when business investments start picking up,” says Holloway.
He points out that there will be an offsetting effect.
“So on the one hand the increased rates are going to put pressure on borrowers (but) on the other hand the broader economy will be, by definition, healthier,” says Holloway. “At that time, it’s not clear which one of the effects is going to drive the overall performance of the banks.”