April 3, 2013

Dynamic changes in the home and auto sectors

The economy is nothing if not dynamic. The two most expensive items most of us purchase are a home and a car. Changes in the supply-demand conditions underlying those markets are almost always underway, with implications for affordability and availability that warrant monitoring.

Let’s start with the housing market in North America. U.S. new home construction is finally moving sharply higher, pulling some material costs in its slipstream. Lumber prices in particular are on an upward incline, both in the U.S. and, because we ship so much product south (obstacles under the softwood lumber agreement notwithstanding), in Canada as well.

The Bank of Canada (BOC) compiles monthly commodity price index series. In the forestry sector, prices have risen to a new all-time high (see accompanying chart).

The latest lumber products price index information from Statistics Canada confirms this assertion. The relevant information appears in the Industrial Products Price Index (IPPI) series.

In January 2013, the IPPI’s lumber and forest products composite index was +9.0% year-over-year. But that broad series doesn’t hone in on housing enough. More important for new home construction costs are softwood lumber prices.

In the IPPI series, Ontario January softwood lumber prices were up by nearly a third (+30.5%) year-over-year. In Quebec, they were 19.4% higher.

The advances in the Atlantic Region (+15.0%), Prairies (+17.9%) and B.C. (+17.2%) may not have been as out-sized, but they were still substantial.

While material costs are on the rise, there are other dynamics influencing affordability in Canada’s new housing market — and mainly in a different direction.

Opposite to what is happening south of the border, Canadian new home starts are expected to decline this year. That alone indicates a cooling in residential real estate prices.

One side effect is that lending institutions are worried about the volume of their mortgage business. To fight the decline, the Bank of Montreal (BoM) has launched what is being called a mortgage war. BoM has dropped its five-year fixed mortgage rate below the 3.00% barrier to 2.99%.

This isn’t the first time BoM has taken the lead in dropping mortgage rates. In recent memory, it stepped up twice before. In both instances, the federal Finance Minister, Jim Flaherty, spoke up quickly to warn potential borrowers about the dangers of leaping into an ownership commitment. His moral suasion was also successful in causing BoM to reverse its decision.

Rates will eventually rise and many families that are comfortable with current monthly payments may find themselves struggling. To forestall this problem, Ottawa has tightened the rules for mortgage approvals. Perhaps most restrictive, the amortization period under which a mortgage is eligible for government insurance (payable to the lending agency) has been lowered to 25 years.

Circumstances are a little different this time around, however. The overall demand level for both new and existing housing has weakened. And the mathematics governing the five-year mortgage rate is not as far off track as one might think.

The charge for a five-year fixed mortgage is usually set 150 basis points (or 1.50 percentage points) above the government’s five-year bond rate. Since the latter currently sits at 1.38%, there is justification for a 2.88% mortgage rate, even lower than what BoM is offering.

This brings me to the auto sector and some key changes underway internationally. Production in Canada has turned more precarious. Mexico is supplying the U.S. with far more cars than we are.

General Motors announced just before Christmas that production of Camaros would be moved from its Oshawa plant, where 4,000 people are employed, to Michigan. Ostensibly, the company wants to consolidate output of several of its rear-wheel-drive models at the same site.

Not surprisingly, there’s speculation that labour costs may be cheaper across the border. Michigan has just enacted right-to-work legislation. Workers will no longer have to join a union or pay dues. It should be noted that GM does continue to operate union plants in several other states with right-to-work provisions.

The autoworkers in the U.S. have accepted a drastically lower wage tier for new hires. The hourly rate gap remains permanent even as rookies gain seniority. In Canada, the wage shortfall for freshman workers is gradually eliminated over many years.

Production modifications in the North American auto sector are hardly new. There were wrenching adjustments several years ago and the climate has largely settled down since then.

What’s happening here is a pale shadow of what’s transpiring in Europe where workers’ rights are enshrined in legislation. There have been several recent instances of managers being held hostage by workers disgruntled about plant closings or other cost-cutting measures.

In Europe, there is often union representation on governing boards. Hence, executives can have their salary increases held up or contract extensions denied

Analysts have estimated that from five to ten plants must be closed in Europe to restore profitability to the sector. The industry’s capacity utilization rate is expected to range from 60% to 65% this year. The jobs of at least 20,000 workers are in jeopardy.

In Canada, the transportation equipment sector (which is largely comprised of automakers) has a current plant usage rate that’s over 90%.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com

Forestry commodities price index
(as calculated by the Bank of Canada)

The forestry commodities price index includes pulp, lumber and newsprint.

Data source: Bank of Canada. Chart: Reed Construction Data - CanaData.

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