Bank of Canada Says Home Prices Overvalued as Much as 30%; Warns of Liquidity Risk in Corporate Bond

By Greg Quinn Dec 10, 2014 1:15 PM ET

Canada’s housing prices are overvalued by as much as 30 percent, the central bank said in its latest assessment of a financial risk that’s built up over years of rising prices and low interest rates.

Home prices are 10 percent to 30 percent above where the bank’s model suggests they should be, according to the Ottawa-based bank’s Financial System Review. Today’s report is the first time the central bank has published such a direct calculation of housing overvaluation.

Governor Stephen Poloz reiterated near-record consumer debts and high housing prices pose an “elevated” risk to the domestic financial system, adding the bank still believes a housing crash will be avoided. Today’s strains differ from housing downturns in 1982 and 1991, when interest rates were rising and the economy was slowing, Poloz said, adding that consumers now should be supported by low rates and signs of stronger growth.

“The rise in house prices has been much more gradual and, in the context of a broadening recovery, the unwinding of household imbalances should be gradual as well,” Poloz told reporters. “That is why we continue to expect a soft landing in the housing market, but it is conditional on continued strengthening in the economy.”

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http://www.bloomberg.com/news/2014-12-10/bank-of-canada-sees-elevated-risk-from-home-prices.html

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Bank of Canada Warns of Liquidity Risk in Corporate Bonds

By Ari Altstedter Dec 10, 2014 1:12 PM ET

Canadian corporate bond investors may be underestimating the difficulty of selling their holdings in a market downturn, leaving them open to greater losses, the Bank of Canada said.

Rising holdings of corporate bonds in mutual and exchange-traded funds could exacerbate price swings if the funds are forced to sell in a rout, the central bank said in its semi-annual Financial System Review. Some market participants also believe dealers are reducing market-making activity, or acting as the middleman between trades, which may make it harder to unwind large positions.

“A potential deterioration of liquidity in Canadian corporate bond markets may not be fully priced in,” according to the report. “Market trends suggest that more sizable price swings might be observed in the future than previously, should investors seek to simultaneously unwind large positions.”

The greater role of ETFs and mutual funds in the market could cause “price dislocations” if investors cash out and funds are forced to sell underlying corporate bond holdings at lower prices, the report said.

“Liquidity in Canadian corporate bond markets could deteriorate quickly and significantly during episodes of future financial distress,” the central bank said.

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http://www.bloomberg.com/news/2014-12-10/bank-of-canada-warns-of-liquidity-risk-in-corporate-bonds.html