Canadian Housing Market December Recap: Will Inflation Reignite by Following Fed’s Monetary Policies?

Montreal, QC | Catherine Zibo/

Written by Breck Hapner

Should the Bank of Canada (BOC) follow the U.S. Federal Reserve if quantitative tightening policies to control inflation are relaxed? The BOC could potentially find itself in a vulnerable position with the Consumer Price Index (CPI) remaining sticky, being forced to choose between supporting the economy and the potential risk of rekindling Canada’s inflation rate, which could further harm the Canadian housing market.

Are Inflation & Interest Rates Coming Under Control?

That being said, according to a December 16th Fortune article, it appears that inflation is under control, interest rates are coming down, and many believe that the economy is heading toward a soft landing. 

As detailed in a December 14th MarketWatch report, this sentiment prevailed in the markets following the December 13th speech by the U.S. Federal Reserve Chair Jerome Powell, who said monetary policy would gradually loosen, although inflation was still a chief concern.  

Vancouver, BC | Mike Benna

U.S. Treasury & Canadian Bond Markets React

Indeed, following the perceived victory over inflation, the bond markets took off, with yields on U.S. treasuries falling (in the dropdown next to “Advanced Charting,” click on “3M” to see December 11th–13th graph data).  Similarly, yields on Canadian five-year government bonds followed suit, hitting lows not seen since May of 2023 (in the dropdown, click on “1Y” to compare graph data for May and December 2023).

Yet, despite a December 16th Financial Post report discussing the timing and extent of rate cuts, especially those expected from the BOC, as detailed in a December 18th Financial Post article, others are pointing to potentially more significant moves coming out of the U.S. in 2024. 

Fed to Address Issues with Balance Sheet?

According to a December 15th BNN Bloomberg report, one of these issues includes the shrinking of the Fed’s balance sheet. Another problem, as pointed out by a December 11th Yahoo Finance Business Insider article, is U.S. debt problems. And probably the most worrying issue, cited in a December 14th Financial Post article, is the potential for a recession. 

All of these concerns could have a more significant impact on Canada’s economy than a simple rate decision here or there.

Considering what we’ve witnessed throughout the year, developments originating in the United States—such as the banking crisis, struggles over the debt ceiling, treasury auctions on Wall Street, worries about Fed mortgage rate hikes, and treasury refunding issues—tend to have a greater impact on the Canadian economy than Canada’s own developments. 

Toronto, ON | Ashim D’Silva

Understanding Economic Dynamics Affecting the Canadian Housing Market

It is important to understand these developments to comprehend the dynamics the Canadian housing market will face in 2024. Some essential linchpins include the market-soaring Fed announcement, the Fed’s strategy concerning its balance sheet amid U.S. debt problems, and how these issues could affect the Canadian economy throughout 2024.

Fed Intends to Cut Rates by 75 Basis Points

According to a December 13th Financial Times report, the Federal Reserve announced its intention to cut rates by 75 basis points. The markets and others took this to mean that 150 basis points in rate cuts were coming in 2024. A December 15th article from The Globe and Mail inferred that the BOC would also be delivering these anticipated rate cuts in 2024, noting that the cuts could potentially save the mortgage market.

Is the Fed Continuing Quantitative Tightening?

According to a December 13th American Banker article, few considered the potentially more important message coming out of the Fed chair: While the Fed may indeed consider rate cuts, they are currently continuing with quantitative tightening. For reference, as cited in a March 16th, 2020, CNBC report, recall the quantitative easing the Fed conducted during the pandemic. The Fed purchased U.S. treasury bonds and mortgage-backed securities from banks, injecting trillions of dollars into the U.S. banking system. To visualize this, in the Federal Reserve Bank of St. Louis (FRED) date box, type in “2014-01-02” to “2023-07-01”. Hover the cursor to see Q4 2019 at $18,645,727.167 to Q1 2022 at $23,973,282.493.

It’s worth noting that the BOC also engaged in similar activities. In the BOC weekly assets and liabilities chart, slide the bottom cursor under the main graph to cover the period from 1990 through 2020. On the left, select “Treasury Bills,” “Government of Canada Bonds,” “Real Return Bonds,” and “Canada Mortgage Bonds” to see that upwards of $450 billion in bonds were bought from Canadian banks.

So, during COVID, central banks globally, including the Fed and the BOC, bought trillions of dollars’ worth of government bonds and mortgage-backed securities, effectively injecting printed money into the financial system. The Fed and the BOC currently hold these bonds on their books and can do whatever they want with the money.

Halifax, NS | Junior Jacques

Is the Fed Engaged in Quantitative Easing?

Fast forward to the present. As of a March 30th Reuters article, the Fed is engaging in almost the opposite, quantitative tightening, trying to pull those funds out of the economy and reduce the amount of money in circulation. According to an October 29th CNN Business report, the Fed is using its multi-trillion-dollar balance sheet to reduce inflation.

So, the central banks injected printed money into the banking system through quantitative easing, which contributed to inflation. Now, the Fed and the BOC are engaged in quantitative tightening to remove that money from the system. It seems incredible that the Fed and the BOC have found a way to address inflation by reducing the money supply. However, according to a September 12th TD Economics report, very few proclaimed to know, until it was too late, that increasing the money supply would cause inflation to balloon out of control.

What Happens During the Bond Sale Process?

Regardless, the Fed/BOC isn’t exactly doing the opposite of quantitative easing by selling their bonds. According to a December 27th Investopedia article, the Fed can reduce its balance sheet “by electing not to reinvest some or all of the principal repaid when securities mature.” So, when a U.S. or Canadian bond matures, the government owes the holder of that bond (in this case, the Fed or BOC) all of the money due on that bond, including accrued interest. During quantitative tightening, the Fed/BOC allows themselves to be repaid, and they don’t use that money to purchase another bond.

In essence, the money paid to the Fed/BOC ceases to exist; it disappears. But the problem lies in that the U.S. and Canadian governments have to obtain that money from somewhere to repay the Fed/BOC. The government, which was once borrowing money from the Fed/BOC using the banks as an intermediary, now has to find another lender in order to repay the Federal Reserve.

Stephenville, NL | Erik Mclean

Is Money in the System Drying Up?

And this is the heart of the problem in the U.S.: According to a December 19th Business Insider article, the amount of money in the system is drying up. When the Federal Reserve printed $4 trillion to purchase those bonds, the banks had to do something with the money. Much of it ended up in what is called a reverse repo facility—a Federal Reserve account where banks and money markets can place their funds and receive interest from the money printer.

Reverse Repo Facility Woes?

But, according to a September 12th MarketWatch article, yields on short-term government debt have reached over 5%, leading to a considerable outflow of funds from the reverse repo facility. These funds have been used to buy U.S. government debt. According to a December 16th article from The Economic Times, with quantitative tightening and growing issuance of U.S. debt, the funds in the reverse repo facility, which is still draining, will have dried up by May or June, according to Barclays.

At that point, once that facility has been drained, there will be one last buyer—a final source of funds to acquire U.S. debt. Currently, U.S. banks still have about $3.5 trillion in reserve at the Fed. However, as mentioned in a December 13th Bloomberg report, even Fed Chair Powell acknowledged during his press conference that these reserves would start to fall once the reverse repo facility is completely drained.

Growing Deficit and Market Instability Concerns

So, during 2020 and 2021, the Federal Reserve printed a substantial amount of money, which has been sitting in the accounts at the Fed, on reserve, and in the reverse repo facility. But these funds are continuing to dry up as they fund U.S. fiscal borrowing needs. According to a September 11th MarketWatch article, significant borrowing needs are coming in 2024, with the U.S. expected to renew $7.6 trillion of existing debt and estimates of $1.8 trillion in new borrowing. As mentioned on page 239 of the White House Federal Borrowing and Debt report, “The deficit is projected to grow to $1,846 billion in 2024, and debt held by the public is projected to grow to $27,783 billion, or 102.0 percent of GDP.”

So, the U.S. will seek slightly over $10 trillion in new money from the market at a time when the debt is already at its highest level since World War II. According to a December 4th article from the Council on Foreign Relations, “The sheer volume of accumulating deficits, alongside a long-running lack of political will to raise revenue or cut spending, has renewed debate over the peril posed by the national debt.”

As we have seen, demand for that debt might be diminishing, and it is not just domestic demand that could be dwindling. According to a Dec. 18th South China Morning Post article, calls are growing in China for an orderly reduction in the holdings of that debt.

Will the Fed Step in to Act as Lender of Last Resort?

So, all the printed cash from 2020 and 2021 is evaporating, international holders of U.S. debt are becoming less willing to buy that debt, and the only remaining alternative is the Federal Reserve. According to a December 12th Reuters article, there is growing anxiety on Wall Street regarding when the Federal Reserve will need to step in, putting an end to quantitative tightening and buying new bonds when the old bonds are paid off. This would position the Federal Reserve as the lender of last resort for the U.S. government.

Quantitative Easing Comes to the Short-Term Rescue

Sound familiar? According to an October 8th, 2019, article from The New York Times, the Fed had to restart quantitative easing (QE), purchasing what was initially planned to be $400 billion worth of bonds per year. Although the Fed insisted it wasn’t engaged in QE, it was apparent that the Fed’s interventions in the market were having a huge effect on the stock market, which was then hitting record highs. The expansion of the Fed’s balance sheet was done to loosen financial conditions and spur growth.

We don’t really know what the effects of the non-QE would have been, as it only lasted four to five months and about half a trillion dollars before COVID hit, and the Fed added another three-to-four trillion dollars for good measure. And behold, rampant inflation.

Saanich, BC | Mike Benna

This Situation Has Happened Before

The last time this happened was four years ago. According to a September 23rd, 2019, article from The New York Times, the Federal Reserve was trying to reduce its balance sheet through quantitative tightening. As outlined in a September 18th, 2019, CNN Business article, overnight money market rates spiked due to insufficient liquidity and cash in the banking system. According to a February 27th, 2020, report from the Board of Governors of the Federal Reserve System, this situation “exhibited significant volatility, amid a large drop in reserves due to the corporate tax date and increases in net Treasury issuance.”

Why Does All This Affect Canada?

So, what is the effect on Canada and the Canadian housing market? What happens to the Canadian economy if the U.S. starts printing money again?

Canada Keeps Interest Rates Nominal to Avoid Inflation

Here is the key part: In 2019, when the Fed turned on its money printer, Canada did not. In fact, according to an October 30th, 2019, CBC News article, the BOC held rates at 1.75%. And, as mentioned in an October 31st, 2019, CBC News article, BOC Governor Stephen Poloz expressed concern that lower interest rates “could spur a new round of Canadian borrowing and mortgage-funded bidding wars at the wrong time” in the real estate market.

Newfoundland and Labrador | Erik Mclean

Does Canada Have to Cut Rates Because the Fed Does?

In fact, even when the Fed was printing money, Canada maintained the highest policy rate among major advanced economies, even after the Federal Reserve cut rates. So, does the BOC have to cut rates because the Fed did? Should the BOC follow suit and risk reaccelerating inflation that would further damage the current housing market? 

Canadian Economy on the Brink?

With growing U.S. debt problems set to hit a $1.8 trillion deficit in 2024, having to borrow $10 trillion from the market with minimal demand at current rates, the Federal Reserve may indeed have to step in, and the BOC could find itself in a bit of a bind. 

Does the BOC loosen to follow the Fed and risk re-inflation of the Canadian market, or does the BOC keep policy tight with higher interest rates, pushing up Canadian currency levels and possibly hurting the economy?

What is the endgame for the Canadian housing market? 

Choosing between following the Fed, loosening monetary policy, and reigniting Canada’s inflationary faucet is a looming challenge and could very well be one of the main dynamics going into 2024. This situation could play out in any number of ways in the Canadian real estate market.

Peggys Cove, NS | Justin Hu

In our January recap, HAVEN will take a further look at the numbers: how Canada’s housing market is reacting to prevailing economic factors influencing real estate.