Is There a Prime-rate Cut In Our Future?
January 28, 2013Latest Canadian Employment Data Falls Into Line
February 11, 2013
Bond yields rose again last week in response to new economic data. As is so often the case, beauty was in the eye of beholder.
First, we learned that U.S. GDP fell by 0.1% in Q4, 2012, which was well below the consensus estimate of 1.5% GDP growth for the quarter. Despite this, investors shrugged off the result and took solace in the report’s details, which showed household incomes, consumer spending, house prices and capital spending all rising in the quarter. The sharp slowdown in headline GDP was largely attributed to the effects of super storm Sandy and an unusually large cut in military spending.
While optimists argued that the report showed strong fundamentals that would carry momentum into the first quarter of 2013, those who are governed by a more cautious view of the U.S. economy interpreted the data differently:
- U.S. household incomes rose by 6.8% for the quarter but this result was skewed because a large number of companies brought bonuses forward into Q4 to avoid the higher taxes that begin to take effect in 2013. While consumer spending rose by 2.2%, this modest increase was probably also impacted by the temporary rise in incomes.
- House prices and new-home construction were higher overall during the quarter but the most recent monthly housing data, for December, showed declines across the board. As such, any housing-related momentum enjoyed early in Q4, 2012 appears to have been lost heading into Q1, 2013. The U.S. housing recovery is still being led by investors with strong balance sheets who are plowing resources into multi-unit housing and to a lesser extent, distressed single-family homes. The ever-important first-time buyer remains on the sidelines, awash in record levels of student debt (with accompanying record student-debt default rates to boot).
- Overall U.S. GDP was impacted by a sharp slowdown in government spending, which was estimated to have reduced the quarter’s headline number by 1.3%. When this and other ‘temporary’ factors were smoothed out of the numbers, market watchers adjusted GDP growth for the quarter to about 2.2%. While this compares favourably with the -0.1% GDP headline result, to put even a .2% GDP growth in a long-term perspective, most analysts believe that GDP growth will have to stay above 3% for a sustained period to create the kind of job growth that the U.S. Fed wants to see before altering its ultra-accommodative monetary policy.
On Friday the latest U.S. employment report was released (for January). It showed 157,000 new jobs being created for the month and revised the November and December reports upwards by 127,000. Despite these numbers, the unemployment rate actually rose from 7.80% to 7.90% because of an increase in the participation rate (more unemployed people starting actively looking for work during the month).
While stock markets rallied after the report was released, it’s not clear whether that was because investors interpreted the data as positive for the U.S. economic recovery or because a higher unemployment rate extends the timeline for the U.S. Fed’s quantitative easing programs.
As a reminder, the U.S. Fed has said that it will continue its ultra-loose monetary policy until the unemployment rate reaches 6.50%. In one of my recent posts I put that target in perspective: If the U.S. participation rate improves by 1% over the next two and a half years, which is a reasonable assumption when you consider that it currently sits at an abnormally low level, the U.S. economy will need to average 238,000 new jobs a month over that same period to hit 6.5% by mid-2015. That longer-term view explains why I think that any enthusiasm tied to the latest U.S. employment report will be short lived.
Finally, last week Statistics Canada released our November GDP data and this was an upside surprise, showing 0.30% growth for the month. This strong result correlates well with the robust employment reports we have seen lately, because until now they have not been supported by other economic data. Nonetheless, reaction to the strong November GDP data was tempered by recognition of the powerful headwinds still acting against our economic momentum, such as continued reductions in household and government spending, slowing real estate markets and weakening export demand.
Five-year Government of Canada (GoC) bond yields were eight basis points higher for the week, closing at 1.54% on Friday. While these bond yields have now risen above what has become their well-established trading range of 1.35% to 1.50%, lenders have not yet increased their five-year fixed rates in response. This may be because they believe that the current yield spike will be temporary but it may also be the first sign of more aggressive spring-market rate competition. We’ll find out soon enough but in the meantime, borrowers who are in the market for a fixed-rate mortgage should lock in today’s sub-3% rates while they still can.
Five-year variable rates are offered in the prime minus 0.40% range (which works out to 2.60% using today’s prime rate). While the spread between five-year fixed and variable rates is fairly narrow using recent historical comparisons, as I wrote last week, even the Bank of Canada’s latest economic forecasts and accompanying commentary suggest that the prime rate isn’t likely to rise until late 2014. In fact, I even speculated in last Monday’s post that there may be a rate cut in our future if household credit growth continues to moderate.
The bottom line: The U.S. and Canadian economic data that was released last week sparked a sell-off in five-year GoC in bonds that pushed yields higher. If this trend continues it may trigger a short-term rise in fixed-mortgage rates that borrowers who are currently in the market should guard themselves against. On a longer-term basis however, for the reasons listed above, I don’t think any of the latest data marks a material change in the broader economic trends in either country. My opinion, therefore, is that last week’s bond-yield spike should be only short term in nature.