I’m off this week for March Break.
Check back next week for my latest take on the factors both at home and abroad that are affecting Canadian mortgage rates.
The only real question leading up to this meeting centred on the tone of the Bank’s accompanying statement. Would the BoC convey a hawkish bias out of concern for rising inflationary pressures and tightening labour market conditions, or would it sound more cautious in deference to increased trade uncertainty and the lagging effects of the three rate hikes it had recently made?
The answer to that question matters to anyone keeping an eye on Canadian mortgage rates because when the Bank increases its overnight rate, our variable mortgage rates rise in lock step. Meanwhile, our fixed mortgage rates are priced on Government of Canada (GoC) bond yields and they often fluctuate in response to changes in the BoC’s tone, even if no rate hike actually occurs.
In the lead up to this meeting, our mainstream economist consensus forecast called for two more BoC rate hikes this year (down from three at the start of the year). Regular readers of this blog will recall that I disagreed with that forecast and made the case that the Bank would prove much more cautious for the following five reasons:
Last Thursday, seemingly out of the blue, President Trump announced that the U.S. would impose a 25% tariff on imported steel and a 10% tariff on imported aluminum, adding that these new taxes may be applied as early as this week.
The U.S. President has a surprising amount of latitude on trade policy. In this case, Trump is arguing that the U.S. steel and aluminum industries are strategically important to the U.S. military. In theory, if foreign competition is allowed to starve out domestic production by dumping cheap steel and aluminum into U.S. markets, the U.S. industrial base may be degraded to the point where it cannot adequately supply the U.S. military in times of war.
Interestingly, the U.S. Department of Defense (DoD) quickly responded to Trump’s announcement by saying that “DoD does not believe that the findings in the reports [of harm to domestic steel and aluminum producers from foreign competition] impact the ability of DoD programs to acquire the steel or aluminum necessary to meet national defense requirements.” Furthermore, the DoD has expressed concern that the newly announced tariffs may do more harm than good to U.S. national security because they risk damaging relationships with long-standing U.S. allies.
Also, by increasing their costs, the tariffs will make many other U.S. industries more vulnerable to foreign competition.
While President Trump used national security concerns to justify the new tariffs, it is widely agreed that his real motivation was to throw protectionist red meat to his political base. Strangely though, while he has tended to focus on China when railing against unfair trade practices, the new tariffs will have a much more significant impact on its allies, including Canada and the EU.
This is where President Trump’s decision becomes increasingly confounding.
This debate should be of interest to both fixed and variable-rate mortgage borrowers because bank prime rates, which our variable-rate mortgages are priced on, move in lockstep with the Bank’s overnight rate, and our fixed mortgage rates typically rise in anticipation of additional overnight rate increases.
Overall inflation, as measured by the Consumer Price Index (CPI), came in at 1.7%. This was higher than the consensus forecast of 1.4% – but a decrease from 1.9% in December.
The consensus read of the latest inflation data, which showed only a modest uptick of one of the BoC’s key sub-measures of inflation (more on that below), was that this slight change is not likely to alter the Bank’s plan to raise its overnight rate at some point this summer. I continue to disagree with this view and believe that the Bank will once again prove more cautious than our mainstream economists are forecasting.
Why the Bank of Canada Will Be Cautious in 2018 (And It Isn’t Just Because of the January Employment Data)
Our economy lost 88,000 jobs in January and that marked our biggest one-month drop in nine years.
Investors reacted quickly, driving Government of Canada (GoC) bond yields lower on Friday and decreasing the odds of a Bank of Canada (BoC) rate hike in April from 58% to 50% (which is still way too high in my opinion, but more about that later).
The BoC has said that it will be heavily data dependent when determining its future monetary-policy path. If the latest employment report is an early signal that our surging employment momentum is now abating, this means that the Bank will delay additional rate rises.
As always, however, the market shoots first and asks questions later. It is worth remembering that Statistics Canada’s employment data are estimates that come with significant margins of error (to both the upside and downside). Bluntly put, the latest employment data, bad as they seemed, were not a game changer and the BoC isn’t going to blow up its existing plans over one lousy jobs report.
Here are the highlights, or in this case, the lowlights, from the January employment data:
Bond-market bears have been looking for signs that U.S. inflationary pressures are building and the latest employment data fuelled speculation that U.S. labour costs may finally be breaking out.
The five-year Government of Canada (GoC) bond yield rose in sympathy with its U.S. counterpart and if that upward momentum carries over into this week, we will see another round of increases to our five-year fixed mortgage rates.
Here are the highlights from the latest U.S. employment data that got the market’s attention:
The consensus continues to believe that the Bank of Canada (BoC) will raise its policy rate by another 0.50% to 0.75% in 2018 but for the reasons I outlined in last week’s post, I think that is unlikely.
(Long story short, I think the BoC wants to allow time for its three recent policy-rate hikes and the most recent mortgage rule changes to work their way into our economy. At the same time, the Bank doesn’t want to push the soaring Loonie any higher and doesn’t want to slow our economic momentum by too much when there is considerable uncertainty about the ongoing NAFTA negotiations.)
While there has been a lot written about the BoC’s expected policy-rate path in the year ahead, there has been very little coverage of another development that has the potential to have an even more significant impact on Canadian mortgage rates in 2018.
After years of monetary-policy interventions on an unprecedented scale, recent central bank actions make it likely that this will be the first year since the start of the Great Recession in 2008 that global liquidity is reduced.
To explain how and why this will impact our mortgage rates, let’s start with a brief review of our recent past.
Lender prime rates responded in predictable lock step and that meant that variable-rate borrowers had to absorb their third 0.25% rate increase in less than seven months, after enjoying seven years without any hikes.
Variable-rate borrowers are certainly having their courage tested of late, especially with the mainstream media making ominous predictions about more rate increases on the horizon. But will these warnings prove prescient?
After reading the BoC’s accompanying press statement, and more importantly, its latest Monetary Policy Report (MPR), I am sceptical. The latest rate hike was widely expected, but the Bank’s more dovish outlook was not (except by this blogger).
In the lead up to the BoC’s latest meeting, the consensus view from mainstream economists was that the Bank would hike its policy rate between three and four times in 2018. But in its latest MPR the BoC threw plenty of cold water on that forecast, and bluntly put, barring any unexpected surprises in the months ahead, more near-term rate hikes seem highly unlikely.
In today’s post I’ll provide the highlights from the BoC’s latest policy statement and MPR, along with my own observations, to explain why I hold that view.
In today’s post I offer my forecast for five-year variable rates in 2018. (FYI – You can read my forecast for five-year fixed rates here.)
Also, at the end of the post I offer my take on whether five-year fixed or variable rates are likely to offer the lowest cost over the next five years and, more importantly, my take on which is the better option for most borrowers in the current environment.
The Bank of Canada (BoC) raised its policy rate for the first time in more than seven years over the course of 2017, from 0.50% to 1.00%, and lender prime rates, which variable-rate mortgages are priced on, quickly followed.
At the time, the BoC explained that it was clawing back the two 0.25% emergency rate cuts that it had made in response to the global oil-price shock because it was satisfied that our economy had completed its adjustment to lower oil prices, and additional rate hikes did not seem imminent. But then inflationary pressures continued to build and by the time 2017 drew to a close, the BoC was once again sounding hawkish about near-term rate increases.
First off, I’d like to wish a very happy new year to my readers.
In today’s post I offer my forecast for five-year fixed rates in 2018, and next week, I’ll do the same for five-year variable rates.
Five-year fixed mortgage rates bottomed in the low 2% range in the first half of 2017 and by the end of the year they had climbed back up to around 3%. This marked the most significant proportional increase that we have seen in fixed rates since the start of the Great Recession.
In spite of that, a five-year fixed rate of 3% is still dirt cheap by any historical comparison and today the vast majority of Canadians can afford their mortgage payments. This reality is borne out by today’s overall mortgage default rate, which stands at its lowest level in decades.
But if rates continue to rise, affordability will deteriorate.
This year, in addition to thinking up soon-to-be-broken new year’s resolutions, many Canadians will be wondering, and worrying, about the impact that the next round of mortgage rule changes will have on our mortgage and housing markets as well as on our overall economic momentum.
Their concern is warranted.
The Office of the Superintendent of Financial Institutions (OSFI) is about to implement the most substantial mortgage rule changes to date. As of January 1, among other changes, conventional borrowers (who make down payments of 20% or more of the purchase price), will be required to qualify using a stress-test rate that is significantly higher than the actual rate they will be paying on their mortgage.
To put that in perspective, conventional borrowers make up about two-thirds of the total Canadian mortgage market. (You can read my detailed explanation of the coming rule changes here.)
In today’s post, in the spirit of another new year’s tradition, I’m going to poke my neck out further than usual and offer predictions on how I think the impacts from the coming mortgage rule changes will materialize in the new year. (Note: The only certainty with the following predictions is that when you combine them with $1.50 you can buy one cup of hot coffee.)
In its accompanying statement the Bank explained how developments both at home and abroad have influenced its overall economic view and today’s post will unpack this brief but detailed assessment by highlighting five key observations for anyone keeping an eye on Canadian mortgage rates:
Our pace of job creation matters to anyone keeping an eye on Canadian mortgage rates because over time, as the demand for labour increases, its cost should rise. And since labour costs are a significant component in the overall cost of most of the items and services that we buy, their relative movements can have a powerful impact on overall inflation (which can then lead to higher mortgage rates).
Bank of Canada (BoC) Governor Poloz recently stated his belief that our economy is hovering in what he calls an “inflationary sweet spot” where both our actual output and our maximum potential output are expanding. At the moment, this is giving our economy more room for non-inflationary growth, but a surge in employment demand could easily upset this delicate balance and compel the BoC to accelerate its rate-hike timetable.
The market’s reaction to the latest employment data was dramatic. Government of Canada (GoC) five-year bond yields surged higher by almost ten basis points, the Loonie registered its biggest one-day gain against the Greenback in almost two years, and the futures market increased the odds from 40% to 66% that the BoC will raise its policy rate in January.
On January 1, 2018, our regulators will implement a sixth round of mortgage rule changes as part of their ongoing attempts to slow our economy’s rate of mortgage debt accumulation. While I agree in principle with their instincts and with their earlier changes, I take issue with their most recent methodology.
For example, in a recent post I criticized the decision to use an average of the posted rates at the Big Six Banks to set the stress-test rate, because posted rates aren’t actually used for lending and because relying on rates from a sub-group of lenders effectively means that the regulator is delegating de facto control over consumer access to mainstream borrowing. I also questioned whether 4.99% was the right rate to use and called on our regulators to provide a more thorough rationale for their approach, basically arguing that the stress test should also be subject to a smell test, especially given its increased importance as a key Canadian benchmark rate.
While I think a deeper explanation is warranted in both cases, more pressingly, there are two specific aspects of the upcoming changes that are fundamentally flawed and need to be addressed prior to January 1.
Much of that data can seem quite technical at first glance, but the overall trends are easier to spot. For example, last week we learned that our overall inflation rate, as measured by the Consumer Price Index (CPI), fell from 1.6% in September to 1.4% in October. That’s at the bottom of the Bank of Canada’s (BoC) target band of 1% to 3%, and well below its official 2% target. Clearly, inflation still isn’t putting pressure on the Bank to raise its policy rate any time soon.
In a mortgage-rate context, that means that variable-rate borrowers aren’t likely to see their rates rise over the near term, as many pundits confidently predicted (and this blogger refuted) not long ago. At the same time, subdued inflation also takes pressure off Government of Canada (GoC) bond yields, which our fixed mortgage rates are priced on.
In today’s post, we’ll look at the latest inflation data, but before we do, we’ll examine recent BoC observations about current inflation and how the Bank is using monetary policy to manage inflationary risks through a period of heightened uncertainty. While the inflation data are important, the interpretation of that data by the BoC is arguably even more so.