Canada's Housing Bubble

Jul 11, 2010 Saxo Bank actionforex.com

Blowout Canadian Employment Data boosts CAD

Imagine nonfarm payrolls rolling in at around +800k for the month, as this is the approximate per capita equivalent that indicates the strength of the Canadian employment report. On the surface, it's a very strong report. As always, however, there are a couple of caveats here that prevent us from jumping on this data as a sign of a dramatic new surge in Canadian fundamentals. First, the Canadian agency responsible for collecting the employment data doesn't seem to perform the statistical trickery that keeps the US payrolls data looking relatively smooth by comparison. Almost monthly, therefore, the Canadian employment change hops back and forth, and considering the strength of this month's hop, we should expect next month's data to come in relatively close to zero - just like April's even stronger 109k jump in payroll yielded to May's more modest 25k advance.

As well, with the US economy showing very strong sides of deceleration, Canada's economy will never completely escape the fallout, since it is always to some degree a satellite economy to the huge mother planet to the south. As for USDCAD, while the move below the 200-day and 55-day moving averages looks impressive here and we have strong signals from rate spreads that fully justify this move south in the pair after today's employment report, we would still look out for signs that at least the bottom of the range will hold. For the shortest term, only a strong snapback rally back above 1.0420 today would provide an immediate bullish signal. As a side note, the housing starts data was relatively in-line with expectations. The last several months of data suggest that the Canadian housing construction boom has topped out and could even be in decline. Some analysts, Gluskin Sheff's David Rosenberg (also a Canadian) the most prominent among them, suggests that virtually all of Canada's GDP improvement since the crisis has come from the housing boom in Canada brought about by the BoC's lower of rates to 0.25% from 4.5%. (It's almost like an echo boom of Greenspan's housing boom touched off by the 2001-03 lowering of rates to 1.00%).

The next very important date for USDCAD comes July 20, when the BoC is out with a rate announcement. The conventional wisdom now is that Carney will have to hike despite his very persistent attempts to warn of . Are we going to see a repeat of 2002-03, when the Bank of Canada hiked prematurely, even while the Fed was still lowering its target rate? Then in 2004, the BoC lowered rates back to the lows just as the Fed had primed the market for rate hikes. The pattern this time around could be something similar - perhaps a hike to 1.00% in the coming months just as the Fed is forced to launch a massive new QE program, which would be quickly followed by a BoC retreat back to 0.25% as the Canadian fundamentals deteriorate while the housing bubble comes unwound. It's a scenario worth consideration.

Chart: US Nonfarm Payrolls vs. Canada Employment Change

We averaged two months' worth of data at a time for the following chart, which shows how the Canadian data never really escapes the orbit of the US nonfarm payrolls. Considering signs of a strong deceleration in the US and possible weakening in Canada as well, the Canada employment change for July might even come in at a negative level, considering its strong tendency to mean revert on month to month basis.

UK data

The shockingly bad UK trade balance for May should really give the market a bit of pause. This is a really bad number and reminds us of the risks of the further risks of imbalance if the pound is to strengthen too much. Remember the old argument that the UK financial sector was the be-all and end-all of the pound. This was the case as the global financial crisis unfolded. More recently, gauging the currency has been more about weighing the risks of owning UK sovereign debt vs. the EuroZone, etc.... But good old fashioned current account fundamentals must be a consideration once in a while, and by this measure, we have a severe failure going on, particularly in light of the pound's pronounced weakness over the last couple of years. For at least the short term, then, GBPUSD looks overpriced and could test below 1.5000, particularly if the market ever decides to throw the greenback a bone. Also weighing on the pound were strongly negative monthly PPI Output readings that support the BoE's thesis that inflation will remain contained in the UK. A heavily deflationary new budget, hike to the VAT, public wage and hiring freezes, and relatively strong GBP vs. the Euro over the last several months should also serve to push the coming few CPI readings back lower as well.

US Consumer Credit

A number that perhaps slipped under the radar for many late yesterday was the May US Consumer Credit number, which showed a very strong contraction of over -9B vs. -2.3B expected and a shocking downward revision of the April number from +1B to almost -15B. This is extremely strong evidence of the deleveraging US consumer and adds to the fear that contraction in end demand together with an end to the inventory rebuilding cycle are strongly increasing the odds of a double dip in the economy.

Looking ahead

Treasuries tried to start the day on a stronger note in the US. If they can get a rally going again, it would put pressure on the JPY crosses after the merciless squeeze on risk-averse long JPY positions over the last couple of days. Next week we have key US treasury auctions that will gauge the market's appetite for more US public debt. The action gets under way already on Monday with an auction of 3-year notes, followed by 10-year and 30-year auctions on Tuesday and Wednesday, respectively. The German Bund looks relatively bid as well, which could help spell the top for the EURUSD and EURJPY rallies here, though we still need to see a strong move back through 1.2500 in EURUSD, for example, for better technical confirmation. For EURJPY, the rally has been supported by the move higher in rates in Europe, but the rally in German 2-year yields, for example, is beginning to look overdone.

So now we sit back and watch how the machines and algorithms trade the US equity market into the weekend.

Stay careful out there and have a great weekend.

Economic Data Highlights

• US May Consumer Credit out at -9.1B vs. -2.3B expected
• China Q2 Business Climate Index rose to 135.9 vs. 132.9 in Q1
• China Q2 Entrepreneur Index fell to 133 vs. 135.5 in Q1
• Sweden May Industrial Production rose 2.3% MoM and 12.4% YoY
• Sweden May Industrial Orders rose 2.1% MoM and 20.4% YoY
• Norway Jun. CPI fell -0.1% MoM and rose +1.9% YoY vs. -0.1%/+1.7% expected, respectively
• Norway Jun. Underlying CPI rose +0.2% MoM and +1.3% YoY vs. +0.1%/+1.2% expected, respectively
• UK May Visible Trade Balance out at -£8062 vs. £7000 expected and £7411 in Apr.
• UK Jun. PPI Input out at -0.2% MoM and +10.7% YoY vs. -0.4%/+10.2% expected, respectively
• UK Jun. PPI Output out at -0.3% MoM and +5.1% YoY vs. +0.1%/+5.7% expected, respectively
• UK Jun. PPI Output Core out at -0.3% MoM and +4.8% YoY vs. +0.1%/+5.1% expected, respectively
• Canada Jun. Net Change in Employment out at 93.2k vs. 20k expected and 24.7k in May
• Canada Jun. Unemployment Rate dropped to 7.9% vs. 8.1% expected and 8.1% in May
• Canada Jun. Housing Starts out at 189.3k vs. 190.3k expected and 195.3k in May

Upcoming Economic Calendar Highlights (all times GMT)

• US May Wholesale Inventories (1400)
• China Jun. Trade Balance (Sat, July 10)
• New Zealand Jun. QV House Prices (Sun 1200)
• Japan Jun. Domestic CGPI (Sun 2350)
• Australia May Home Loans (Mon 0130)
• Australia May Investment Lending/Value of Loans (Mon 0130)