The world’s most powerful central banker has confirmed that U.S. interest rates are on the way up — and if history is any guide, Canadian rates are going up with them.
Federal Reserve Chair Jerome Powell was optimistic about U.S. jobs, growth and the benign effect of current trade disputes, but one of his comments could be read as an unintentional but ominous warning about the Canadian housing market.
And while high asset prices remain a risk, he said, Powell was stubbornly optimistic in the face of questions from the financial press, pointing to signs the U.S. economy is going through one of its best periods in modern history.
As expected by nearly everyone, the Fed raised rates by a quarter of a percentage point to 2.25 per cent. Not only that, Fed documents released yesterday show the committee that makes the rate decisions is expecting another quarter point rise this year and three more in 2019.
The unexpected warning for Canadian housing came in what was intended as a reassuring response to a question about the danger of a U.S. asset bubble.
“If you look at asset prices, it is true that assets are at the upper reach of their historical ranges,” Powell said.
He’s confident that relatively well-off shareholders could deal with any drop in stock prices. And U.S. consumers in general are relatively safe because their most dangerous asset, housing, was part of a bubble that popped more than a decade ago.
U.S. housing, he said, remains more affordable than before the financial crisis in 2007.
But in his reassuring words for U.S. consumers, he dropped a grim warning for Canadians whose house prices have continued to rise sharply since the financial crisis.
“Really, what hurts is if consumers are borrowing heavily and doing so … against an asset that can fall in value,” he said. “That’s a really serious matter, when you have a housing bubble and highly leveraged consumers and housing values fall.
“We know that’s a really bad situation.”
Unfortunately for Canadians and folks in many other countries around the world affected by the U.S. rate rise, Powell made it very clear that his only concern is U.S. domestic policy. His message was effectively: countries that have large loans denominated in U.S. dollars will have to figure out how to deal with it.
However, the gradual nature of U.S. rate rises and the transparency of what the Fed is thinking will help most international borrowers plan ahead. And Powell said that while it is the job of the U.S. Treasury, not the central bank, to manage the currency, a rising U.S. dollar caused by rising rates would inevitably allow countries to sell more to the U.S.
Independent from Trump
That message might not have been what U.S. President Donald Trump, currently waging a trade war with China and trade disputes with many other countries, including Canada, wanted to hear. As one reporter at the news conference pointed out, Trump had already expressed displeasure with Powell’s rate hike.
But on that point, the U.S. central banker was explicit in asserting his independence from Trump, explaining that the Federal Reserve has a mandate from Congress to maintain monetary stability and that nothing would divert it from that path.
Powell did say that regional Fed meetings with business leaders around the country show they are worried about the potential impact of tariffs.
“We’ve been hearing a rising chorus of concerns from businesses all over the country about disruption of supply chains, materials cost increases and loss of markets,” Powell said.
But so far, he said, the economic effects are not showing up in economic indicators.
With this latest increase, the spread between Canadian and U.S. interest rates has grown to three quarters of a per cent. Over the past 20 years, that kind of divergence has only happened when the two economies were affected by very different economic circumstances.
Two notable examples would be during the dot-com crash of the early 2000s, which had a bigger impact on the U.S., and in the years following the Great Recession, when high oil prices sustained the Canadian economy then crashed in 2014, requiring two Canadian quarter point cuts to nudge the economy through a bad time.
When Bank of Canada governor Stephen Poloz decides whether to raise rates next month, he will be watching for whether the Canadian economy is suffering in a way that the U.S. economy isn’t.
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