Three Reasons Why I Think the Market Is Overestimating the Future Path For Canadian Mortgage Rates
July 24, 2017What Do Strong Job Growth and Weak Wage Growth Mean for Our Mortgage Rates?
August 8, 2017
The Canadian economy continues to defy expectations.
Last Friday we learned that Canadian GDP grew by 0.6% in May, three times the consensus estimate of 0.2% for the month. It now looks as if our second-quarter growth rate will come close to matching the 3.7% rate we saw in the first quarter (which led the G7 countries).
Last month’s growth surge was broad based, with increases recorded in fourteen of the twenty sectors tracked by Statistics Canada.
The Bank of Canada (BoC) has expressed increased confidence in the strength of our economic recovery, and the latest GDP result bolsters that view. It also raises the odds that the BoC will increase its policy rate by at least another 0.25% before the end of this year, thereby eliminating the 0.50% in emergency rate cuts that the Bank made in 2015 as oil prices plummeted.
Interestingly, while Government of Canada (GoC) bond yields initially surged higher on the news, they actually closed lower by end of day on Friday. While that may seem counterintuitive, because bond yields should rise if investors expect higher interest rates in future, here are some of the factors that may have contributed to that outcome:
- Our banner GDP result increased the odds that the BoC will raises rates again in the near future and the Loonie rose above 80 cents versus the Greenback in response. When the Loonie rises, it creates economic impacts that are similar to additional interest-rate increases, and that gives the BoC cause for an additional pause.
- The U.S. Federal Reserve took on a more dovish tone when it met last week. If the Fed delays additional rate hikes, that will exacerbate the impact of additional monetary-policy tightening by the BoC even more so because as our monetary paths diverge, the Loonie will soar higher still.
- Our newfound economic momentum comes in part from rising business investment in sectors that export to U.S. markets. If U.S. economic growth slows and increased demand for our exports doesn’t materialize, that business investment will dry up. And while it’s true that U.S. GDP came in at a solid 2.6% in the second quarter of this year, that growth was fuelled by an increase in consumer spending that was not underpinned by rising incomes. Average U.S. wage growth is barely keeping pace with inflation and if U.S. incomes don’t start rising faster, current U.S. economic momentum is unlikely to be sustained.
- Oil and gas extraction led our GDP growth last month, registering a 7.6% expansion as that sector continues to recover much of the momentum that was lost a year ago as the Alberta wildfires raged. The overall GDP number is based on a twelve-month average and last May’s artificially low input for the oil and gas extraction sector rolled out of the GDP calculation and was replaced with a more typical result from this May. That skewed the data somewhat.
- While GDP growth was strong across most of our economy, momentum in our real-estate sector slowed by 0.2% last month. Our regulators are probably relieved to see that result because our economy has over-relied on real-estate-based growth since the start of the Great Recession in 2008. But there is uncertainty about how far and how fast momentum in this sector is now slowing and about whether other newfound sources of momentum will be sustained if real estate momentum declines sharply.
Five-year GoC bond yields rose twelve basis points last week, closing at 1.64% on Friday. Five-year fixed-rate mortgages are still available at rates as low as 2.64%, and at rates as low as 2.79% for low-ratio buyers, depending on the size of their down payment and the purchase price of the property. Meanwhile, borrowers who are looking to refinance can find five-year fixed rates in the 3.04% to 3.09% range.
Five-year variable-rate mortgage discounts remain largely unchanged and are still available at rates as low as prime minus 0.90% (2.05% today) for high-ratio buyers, and at rates as low as prime minus 0.75% (2.20% today) for low-ratio buyers, again depending on the size of their down payment and the purchase price of the property. Borrowers who are looking to refinance should be able to find five-year variable rates around the prime minus 0.45% to 0.70% range, which works out to between 2.25% and 2.50% using today’s prime rate of 2.95%.
The Bottom Line: Our surging economic growth makes it increasingly likely that the BoC will raise its policy rate by another 0.25% in the coming months. That said, each time the BoC raises while the Fed stands pat, it lowers the odds of additional rate hikes, for the reasons outlined above. In summary then, while our fixed and variable mortgage rates may continue to rise in the near future, I believe that it is still unlikely that they will move materially higher over the medium term.