Inflationary Scenario

Quite a lot has happened in macro economic world since I wrote the ‘deflationary scenario’. While there are still quite a number of deflationary proponents holding there ground, the mainstream economists and pretty much all the central banks are getting perturbed over rising commodity prices. And for once, their words have some meaning as demonstrated by Bank of Canada holding interest rates steady, increasing the probability of rate increases in future. Just a couple of months ago such a scenario would have been unthinkable amidst all the talk of the global credit crunch.

Clearly, Central bankers in Canada, UK and the US are afraid of 1930s style deflation, but they are also not comfortable with the 1970s style stagflation. I guess they are stuck at a Morton’s fork point- raising rates will further worsen the housing market and create problems but keeping status quo will further raise prices making things much worse for them.

The implications will not be salubrious for the health of Alberta and Canadian real estate. Inventory is at highest levels ever seen, sales at levels close to the lowest levels for this time of the year. Meanwhile, new product is still coming to the market at a pace far faster than markets can absorb. Meanwhile, the nouveau landlords are learning some painful lessons on the 'joys of becoming a landlord.'

One of the scenarios that was often discussed on this blog was a disruption in the oil sands development in Alberta (environmental issues, commodity bubble bust etc) leading to a significant deterioration in the Alberta real estate market. The inflationary scenario, if it bears fruition, will lead to a direct impact on the real estate market. It could make properties that are ‘barely breaking even’, bleed cash profusely. As interest rates go up, a lot of speculators and double property holders who are somehow holding on to their properties in anticipation of a rebound of prices to Spring 2007 levels will likely capitulate.

Rising interest rates could expedite the widespread decline that has been so far avoided.

How likely do you think is a rise in interest rates?

Inflation or Deflation

The steep fall in commodity prices in last few days, especially for gold and oil was not entirely expected. At least by the inflationists. Is it possible that this is the beginning of the unwinding of the ‘great commodity bubble?’

The simple scenario could play out this way- If we get deflation instead of inflation, commodities are going to fall. It may take a while for them to unwind, but they will fall. How fast and how hard is difficult to say.

On the other hand, commodities will be a good play if inflation or inflation expectations remain high. This has been the primary reason for recent run up in gold, oil and other commodities.

Should the US enter a severe recession, the demand for oil is likely to fall quite a bit (the 3.2 per cent YOY fall is an example). The BRIC economies have been around for a long time and still consume less than the US.

What will happen to the real estate prices here if the only support Alberta prices have got disappears? The answer may not be pretty for some people. Especially those who are leveraged and have huge debts. We are in uncertain times, and no body really knows how things are going to unfold in the coming weeks and months.

What do you think is the oil price above which ‘nothing terrible’ will happen here? What is the threshold below which we could be in the same territory as the last bust?