RateMiser Economics - Our Mortgage Blog

Re-inflation or Deflation that is the Question A barbell investment strategy is one employed when there are two very different but compelling, forecasts at play.  If you want to know what kind of economic environment begs for a barbell strategy, look around, we're living in one.  The current economy is a tug of war between re-inflation and deflation.   Note, I said re-inflation, because significant inflation is revealing itself to be a nice problem to have in many countries, if you can get it.  Inflation, you see, is very forgiving and much easier to manage than deflation.

Re-inflation

In today's economy the optimists believe in a return to normal growth and inflation levels, hence re-inflation.  "Re-inflation" means a fairly rapid recovery of ground lost in the last two years.  Sure the durable goods and housing numbers are up smartly over last year, but last year was 50% below the boom levels of the prior year in many cases. So we would require a 100% increase to get back to where we were!  

The re-inflation camp sees this lost ground being regained over the next three years.  Re-inflation is distinct from inflation because at the core, inflation usually flows from demand for goods owing to a strong job market and we do not have a strong job market. 

With "re-inflation" (or slow, unsteady recovery) being the optimistic scenario, we will see a slow and unsteady climb to higher mortgage rates.  Variable mortgage rates will rise over the next few years from their current level of 1.9%, but are still likely to average less than current fixed rates of around 4.25% over the next 5 years.  For those who don't want the aggravation, the new MERIX 50/50 hybrid mortgages with half the mortgage fixed and half variable are a good product.  Homes are likely to appreciate in the very low single digits under this scenario.

Don't Fight the Fed Seeking guidance for the future of the economy is tough, but over the years, stock market performance has been one of the best leading indicators for where the economy is headed next.  But how do you guess where the stock market is going when all the data is mixed and in the rear-view mirror?  "Don't fight the fed", is the rallying cry of investors who want to get the jump on a murky statistical outlook.  The expression refers to an historically reliable relationship between central bank rate changes and economic growth.  Whenever central banks have cut rates sharply, like they did 18-24 months ago in Canada and the US, the economy has generally been sure to respond, 18-24 months later.  So, any time now...

Deflation

On the other side of the barbell is the preferred strategies of the, "Deflation" camp.  This is the outlook that suggests there is more severe economic pain to come.  This camp believes the only thing keeping us from an all out depression (unemployment in the high teens or worse, stock markets down more than 50%...) so far has been government stimulus. 

Deflationists, point to the lack of business lending and the lack of consumer borrowing that is going on, despite incredible rate cuts!  This widespread weak demand is pulling home values and wage rates down in the US and will potentially effect Canada in a similar way.  There is also an argument that the average age of the population has passed the point of peak spending and so this falling demand trend will continue for years.

The "Deflation" scenario also begs for variable rate mortgages, because the one thing the Bank of Canada has been able to do is hold prime rate down.  But there is also likely to be much more uncertainty in this economic environment.  So deflation argues for aggressive debt consolidation to reduce minimum payments in case of job loss and in-law suites for additional income sources!  All but the most clearly rationalized home prices are vulnerable to decline under the deflation scenario.

What is a Mortgagor to do?

So take your pick.  Is your economic outlook stable? or outright depressing?  the V-shaped, sharp recovery forecaster camp has had to step to the sidelines for now.  I'd say their odds are down below 20%.  I'm betting the odds of re-inflation are at 50% (single digit house price growth) and Deflation an ominous 30%.

Our view is that variable rate mortgages, consolidating debts to improve cashflow, and using pre-payment privileges to shorten amortizations is still the best way to go.

Home buyers should be conservative and income property biased for now.  A time will come when buying a mansion will be the right investment move.  But this is a time for converting mansions into suites!