Trump effect blamed as mortgage rates rise and bonds tumble: Don Pittis

If all theother banks join RBC and TD andmortgage rates rise further,popping a Canadian house price bubble, thatmight seem a high price to pay for a lesson in worldfinance.

But Canadians contemplatingthe effect of risingrates on real estate are now getting an exceptional insight intowhy the so-called "bond vigilantes" are angry at president-elect Donald Trump.

Theyare also getting a ringside seat on the interconnectedness of global financial policy that creates winnersbut leaves many losers suffering the consequences.

A lot of Canadianstruly understand the real estate market. Many others talk as if they do.Interest rates, short- versuslong-term mortgages andwhether current house prices are real or a bubble are the stuff of modern bar chatter.

• Royal Bank hikes mortgage rates

Canadians work hard to understand because they realizehouse pricesmatter to their own finances. That's how the bond market matters to the world.

Think about the pain of a sharp fall in house prices. It hurts the borrowers. It hurts the lenders. And it hurts the entire marketplace where the business is being conducted.

Pulling the trigger

Slowing house prices and fallingbondprices have the same trigger.

If we look back 15 years or so, interest rates were much higher. Amortgage would cost you between seven and eightper cent.

In a story explaining the RBC rate change yesterday my colleague Pete Evans showed that paying off a $300,000 mortgage that cost $1,360permonth before the rate hike would cost about $1,400 permonth after.

But back when mortgage rates were eight per cent,paying off that same $300,000 mortgage would have costabout $1,000 more per month about $2,300. The lifetime cost of that loan would also be much higher.

Clearly one of the effects of falling interest rates over the last 15 years was that it gave potential homebuyers access to more borrowed money.

As interest rates fell, quite reasonably, banksdecided people who could afford to pay an eight per cent loan on $300,000 could afford to borrow much more at three per cent.

And all that extra money in the market allowed house prices to rise.

When almost everyone borrows to buy a house, the true cost of a house in any year is the carrying cost on the money you borrow. So as the carrying cost fell, the nominal asset valueof the houserose.

That is the same thing that happens in the bond market. There are various online calculators to help you do the math. The asset price of abond thatwas earning eight per cent a few years ago will go up and up as interest rates fall.

But of course in bonds and in houses, everything changes once interest rates change direction.

Change at the Fed

Trump's promise to spend $1 trillionand cut taxes has bond (and mortgage) markets worried that Federal Reserve Chair Janet Yellenmust begin to raiseinterest rates.

• Bond explainer

Just as eight per cent bonds get more valuable as rates decline, bonds that pay half a per centfall in value as interest rates rise.

Feed some numbers into abondcalculator to see how it works. Remember many bonds have a 30-year termand interest rates have been 0.25 per centand less.

There are many ways that house markets and bond markets are different. Bonds work on a hair trigger, traded in huge blocks on international markets.

Bond markets anticipate future rate rises, as they are doing now.

The house market, where units are traded one by one, mostly by amateurs, is slower to react.

For most Canadians, houses are not principally investment assets. They are a place to live and raise families.

Canadians may find the housing marketmore familiar, but in many ways it's more complexthan the bondmarket.

Housing markets are fractured, dependent on human values and decisions that don't fit into bondtables.

But everything else being equal, rising interest rates wouldeventually have the same effect on houses that it has already had on bonds. Higher rates make existing assets fall in value. In both cases there will belarge effects on the wider economy as asset values disappear.

If that happens in the property market, Canadians will not like the feeling.

The president-elect may not care how Canadians feel. But the global bond industry with its traditional headquarters in the U.S. has enormous clout in Washington.

Trump's plan to pump $1 trillion into theU.S. economy will further tighten atight job market, increase wages and could wellstimulate private sectorinvestment.

But with $1 trillion already lost in the bond market,Trump will have to use all his skills as abrash, hard-nosed entrepreneur to turn his stimulusplan from talk into action.

Follow Don on Twitter @don_pittis

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