Canadian housing should stay afloat in 2014; Don't expect a crash

What’s in store for Canadian house prices in 2014? It’s hard to predict the exact increase or decrease, but I believe one thing can be said: the housing market should again avoid the crash that has been long predicted by a number of observers.
Sure, house prices have outrun household incomes to reach levels of overvaluation that put Canada at the top of international valuation rankings. But as I have discussed over the past two years, it’s difficult to see a hard landing when central bankers are going all out to pump up the economy, incomes and jobs—factors that increase the demand for owned accommodation.
Let’s begin with the U.S. Federal Reserve, whose actions have a substantial impact on Canada due to the close integration of U.S. and Canadian economies. The Fed currently is printing massive amounts of money to buy bonds (QE3) in an economy that has lots of spare capacity and low inflation. The result, if history is a guide, should be a strong pick-up in the U.S. economy with a spill-over into Canada
Meanwhile, the Bank of Canada has cancelled plans to raise its overnight lending rate, and is allowing the Canadian dollar to tumble. This is a dramatic easing since it slashes the prices of Canadian goods and services sold in foreign markets. Along with a ramping up of U.S. economic growth, it should give a boost to the Canadian economy through a jump in exports (with the usual lags).
As 2014 begins, there are few signs of stress in the Canadian house market. The national inventory of unsold housing is at a six-month supply and the sales-to-listing ratio is just over 1.5: both are at levels that indicate a balanced market. Plus, according to the latest annual report from the Canadian Mortgage and Housing Corp., only 0.31% of residential mortgages are three or more months in arrears, versus the average of 0.41% from 1990 to 2010.
True, the Fed plans to wind down its bond purchases and let long-term bond yields rise in 2014, as long as the U.S. economy is still expanding at a healthy clip. Some fear the impact of these interest-rate increases on the Canadian housing market, but income and job growth should have an offsetting impact.
What could be of concern is if inflationary pressures get out of hand and the Fed sought to cool things off by raising its overnight lending rate to the point where short-term lending rates exceeded long-term rates (known as “inversion of the yield curve”). Since commercial and other banks borrow short and lend long, they wouldn’t be able to make a profit on their lending operations; the flow of credit to businesses would dry up and trigger a recession.
But the Fed has pledged not to raise its overnight rate until mid-2015. And then it would take at least another year of steady increases to bring about inversion of the yield curve. Or possibly even longer: the 425-basis-point hike in the Fed’s overnight rate that preceded the 2008 U.S. housing bust was phased in over two years.
Moreover, U.S. and Canadian policymakers now have the experience of the 2008 U.S. housing crash hanging over them. It wouldn’t be surprising if they adopted more of a preventative approach to dealing with overheating in the economy. Instead of letting the economy rip and then slam on the brakes, central banks may tap them sooner and more often to avoid creating the runaway momentum that requires inversion of the yield curve.
Even if U.S. and Canadian economies do reach the overheated phase and short-term rates are driven above long-term rates, it’s not a foregone conclusion the denouement will be a U.S.-style housing crash in Canada. There are a number of reasons for this. For example, the oligopolistic financial system in Canada is a stronger one than the fragmented, competitive U.S. system, and the Canadian mortgage market displays far less of the excesses that plagued the U.S. mortgage market in the mid-2000s