Thursday, 27 February, 2020

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The US Federal Reserve Has Canadian Real Estate Back In Bubble Territory | Better Dwelling


Canadian real estate buyers are still feeling exuberant about the market. The US Federal Reserve Bank of Dallas‘ (Dallas Fed) exuberance indicator shows expectations are still high in Q3 2019. The index measures explosive price growth, that’s detached from fundamentals. Expectations are much lower than they were in 2017, but are still above critical levels.

Exuberance Index

The exuberance index is the tool the US Federal Reserve developed to track housing bubbles. The indicator measures buying behavior in contrast to income developments, and looks for explosive dynamics. That’s what econo-nerds call unusually fast rising prices. A rapid increase in price is usually due to emotion, which is a detachment from fundamentals.

Emotional premiums tend to not stick around very long, since they’re volatile. Events such as policy, recession, or employment can quickly deflate expectations. As a result, when buyers are grounded in reality by one of these events, the premiums can disappear. This is more commonly referred to as a correction or crash, depending on how fast it happens.

Efthymios Pavlidis and the Dallas Fed developed an index to track exuberance. They publish two sets of numbers – an exuberance indicator, and a threshold value. If the indicator rises above the 95% critical threshold value, buyers are acting exuberant. If the indicator stays above the threshold for more than 5 quarters, the market is said to be exuberant. It’s complicated, but not at the same time.

Canadian Real Estate Buyer Exuberance Is Back

Canadian real estate buyer expectations have cooled down, but they’re still elevated. The Dallas Fed has buyers in Q3 2019 at a level 3.1% lower than the previous quarter. The most recent quarter is also reading 12.6% lower than the same quarter last year. The only quarter lower in the past few years, was in the beginning of last year – when the market was cooling down. That was very brief.

Canadian Real Estate Buyer Exuberance

An index of exuberance Canadian real estate buyers are demonstrating, in relation to pricing fundamentals.

Source: Federal Reserve Bank of Dallas, Better Dwelling.

Exuberance is much lower than it was at the recent peak, but it’s still very high. The indicator has fallen 63.2% from the most recent peak in Q2 2017. If you consider the Q1 2019 drop below the threshold a blip, this is the 19th quarter of exuberance. Remember, the market is declared exuberant after 5 consecutive months above.

Confused? That’s because the Canadian real estate market is very confusing right now. After twelve consecutive months of rapid price acceleration, expectations lowered for a quarter. Literally 4 days after that quarter ended, Canada announced a policy reigniting enthusiasm. The size of the program is small, but the message is big – the government will try to bolster prices. If 12 quarters of exuberance set the prices they’re willing to try and preserve, what’s another few quarters?

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