The Bank of Canada (BoC) raised its overnight rate by 0.25% last Wednesday and it now stands at 1.5%. The move was widely expected, and Canadian lenders quickly increased their variable mortgage rates in response.
This marked the fourth BoC rate hike over the past twelve months, matching the U.S. Federal Reserve’s policy-rate increases over the same period. That is somewhat surprising given the significant differences in our current economic trajectories and the fact that our federal government has raised taxes at the same time that the U.S. federal government has cut theirs substantially.
Yet here we are.
The BoC’s recent guidance left little doubt about its immediate plans, so the only real question was whether additional near-term rate hikes were also likely. To that end, the Bank’s accompanying statement was deemed to be a little more hawkish than the consensus had expected, and that put upward pressure on the Government of Canada (GoC) five-year bond yield, which our five-year fixed-rate mortgage rates are priced on. But that run-up was short lived and the five-year GoC bond yield actually ended the week slightly lower.
In today’s post, I’ll offer my take on the highlights from both the BoC’s latest policy statement and the release of its latest Monetary Policy Report (MPR), which provides us with the Bank’s assessment of current economic conditions at home and abroad and includes forecasts for key economic data. Now that the Bank has decided to offer less guidance going forward, its MPR forecasts have increased importance as benchmarks that will confirm whether our economy Is evolving as expected, and if not, whether additional policy-rate moves may be required. I’ll summarize the Bank’s key forecasts and observations and offer my related comments in italics.
It is widely expected that the Bank of Canada (BoC) will raise its overnight rate by another 0.25% when it meets this week, and if it does, lenders will pass that increase on to variable-rate mortgage borrowers in short order.
The Bank signaled its plans when it made its most recent policy announcement on May 30, and it has appeared largely unmoved by the U.S.- initiated trade war that began almost immediately afterward or by the steady string of weaker-than-expected economic data that we have seen since. With the Bank’s next rate hike now a seemingly foregone conclusion after BoC Governor Poloz’s speech last week, the most important question remaining to be answered is whether additional rate hikes are looming on the near horizon.
Variable-rate borrowers who are expecting the Bank to offer clear reassurances in that regard are likely to be disappointed.
In its most recent policy statement released on May 30, the Bank of Canada (BoC) gave every indication that it would raise its overnight rate, which our variable mortgage rates are priced on, at its next meeting on July 11. But right afterwards, U.S. President Trump started a trade war with Canada (among other countries), and we were hit with a steady string of mostly weaker-than-expected economic data.
These events fueled speculation that the BoC might not actually follow through with a rate-hike next week and piqued everybody’s interest in BoC Governor Poloz’s speech to the Greater Victoria Chamber of Commerce, which he delivered last Wednesday. Market watchers expected Governor Poloz to use this forum to confirm whether recent events had changed the Bank’s near-term plans.
Governor Poloz began his speech by chronicling the evolution of transparency in Canadian central banking and extolling the benefits that it has brought to our economy. But then he made the case that forward guidance, a key recent element of that transparency, had actually diminished the Bank’s effectiveness, and he explained why the BoC wants to phase it out altogether.
This was a somewhat surprising acknowledgement and one that seemed more significant than whether or not the Bank will move its policy rate at its next meeting (which I’ll get to in a minute).
Here are the highlights from Governor Poloz’s speech:
When the Bank released its most recent policy statement in early June, it might as well have hung out a neon sign that said, “We’re hiking rates at our next meeting in July”.
Then Murphy’s law kicked in and just about every ensuing economic development from that point forward served to undermine the Bank’s intent. To wit:
The idea of a trade war with the U.S. seemed ridiculous until very recently. Then again, so too did the idea that Canadian steel (or Canadian anything) poses any sort of threat to U.S. national security.
And yet here we are.
As our leaders contemplate retaliatory tariffs against President Trump, the U.S. Bully-in-Chief, we must now imagine a world where Canada and the U.S. no longer trade freely with each other, and for readers of this blog, contemplate how that development is likely to affect Canadian mortgage rates.
First, a quick recap.
Last Friday Statistics Canada confirmed that our economy lost an estimated 7,500 jobs in May, which was a much worse result than the 23,500 job gain the consensus had been expecting.
Last month’s drop marked our second monthly decline in a row (we lost 1,100 jobs in April), and we have now lost a total of 48,900 jobs over the first five months of 2018. The robust job-growth momentum that we enjoyed in 2017 continues to recede in our economy’s rear-view mirror.
The question that follows for anyone keeping their eye on mortgage rates is: How will this impact the recent warning from the Bank of Canada (BoC) that it plans to raise rates again in the near future?
To answer, let’s start by reviewing five highlights from our latest employment report:
The Bank of Canada (BoC) held its policy rate steady last week but warned in its accompanying statement that our next rate hike is not far off.
The futures market is now pricing in about 80% odds that the BoC will increase its overnight rate by 0.25% at its next meeting on July 11. Variable-rate mortgages are priced off of the overnight rate, so if that happens, our variable rates will increase by the same amount.
In today’s post I’ll provide highlights from the BoC’s latest statement with my related comments in italics, and then offer my take on how this latest news impacts the appeal of the variable-rate mortgage option.
In my two most recent posts I made the case for why I think today’s variable mortgage rates will prove cheaper than their fixed-rate equivalents over the next five years, and then I ran three different simulations for variable rates over that period – one where the variable rate saves you money, one where fixed and variable rates break even, and another where the fixed rate wins out.
As the variable-rate mortgage wars rage on, savvy borrowers are well advised to look carefully at the terms and conditions in their mortgage contract because two mortgages with the same headline rate can come with very different associated costs. To help in that regard, today’s post highlights five important questions to ask when evaluating variable-rate mortgage products.
In last week’s post I made the case for five-year variable rates over their fixed-rate equivalents, based on my current view of where our economy is headed.
Today, I’ll simulate three different scenarios for variable rates over the next five years – one where the variable rate saves you money, one where fixed and variable rates break even, and another where the fixed rate wins out. You can then decide for yourself which rate path seems most likely for the years ahead.
Let’s start with a quick outline of the assumptions that I used to run the numbers:
- Purchase price: $600,000
- Mortgage amount: $480,000
- Amortization period: 25 years
- Five-year variable rate: 2.45% (today’s prime rate minus 1.00%)
- Initial variable-rate monthly payment: $2,138
- Five-year fixed rate: 3.39%
- Fixed-rate monthly payment: $2,369
In each simulation we’ll compare the total interest cost of the fixed and variable-rate options, with one additional wrinkle.
Five-year fixed-mortgage rates continued their upward march last week as the five-year Government of Canada (GoC) bond yield they are priced on hit its highest level in seven years. Meanwhile, five-year variable-rate discounts deepened, further widening the gap between five-year fixed and variable rates.
Over the past few years my advice has generally favoured five-year fixed over five-year variable rates. Not because I thought that variable rates were going to the moon as some pundits have unendingly warned, but because the gap between fixed and variable rates was small enough that the cost of uncertainty outweighed the potential reward for most borrowers.
Today, the inherent uncertainty in variable rates remains, but its increased potential saving may now be worth the risk. (Five-year variable rates have offered a discount of about 0.50% when compared with their fixed-rate equivalents over the past several years, and that discount has now widened to 0.75% or more.)
My view isn’t based just on the fact that the fixed/variable rate-gap is widening. It is also underpinned by the different ways that the bond market and the Bank of Canada (BoC) are responding to the current rise in inflationary pressures.
There is no new post this week but I will be back up and running next Monday as usual.
In the meantime, here are links to my five most popular posts thus far in 2018:
Last week TD Canada Trust raised its five-year posted rate from 5.14% to 5.59%, and shortly thereafter, Royal Bank and National Bank increased their five-year posted rates from 5.14% to 5.34%. Other major banks are expected to follow shortly.
At first glance these increases may seem innocuous to mortgage borrowers because bank posted rates are not typically used for lending. (For comparison, today’s actual market five-year fixed rates are offered in the low to mid-three percent range.) But the posted rates from the Big Six banks are now used by our regulators to determine how much we can borrow, and as their importance grows, their use should be subject to more scrutiny.
Although posted rates have been around for a long time, they are somewhat mysterious because borrowers don’t pay them and these rates don’t move consistently in response to market forces. With nothing to anchor them, they can be moved up or down arbitrarily at each bank’s whim.
The Bank of Canada (BoC) left its overnight rate unchanged last week, as most market watchers expected. The Bank also released its latest quarterly Monetary Policy Report (MPR), which provides us with the Bank’s assessment of the current economic conditions at home and abroad and includes forecasts for key economic data.
The overall tone of the BoC’s latest MPR sounded cautiously optimistic – cautious over the short term but more optimistic over the longer term. Bluntly put, I think the Bank’s latest assessment makes it less likely to raise rates in the near term, but also reconfirms its belief that a rate hike will eventually be its next move.
In last week’s post I outlined five key questions for the BoC’s latest meeting and in this week’s post, I answer them using highlights from the Bank’s latest policy statement and MPR (with my accompanying comments in italics).
The Bank of Canada (BoC) meets this Wednesday, and while most market watchers aren’t expecting the Bank to raise its overnight rate at this meeting there is still the possibility that its accompanying commentary could push Government of Canada (GoC) bond yields higher, along with the fixed mortgage rates that are priced on them.
The BoC will also release its latest quarterly Monetary Policy Report (MPR). The MPR provides us with the Bank’s latest assessment of the current economic conditions at home and abroad and includes forecasts for key economic data.
Simply put, if you’re trying to figure out where fixed and variable mortgage rates may be headed, Wednesday will be an important day.
With that in mind, here are five key questions that I’ll be looking for the BoC to answer:
What the Canadian Bond Market’s Surprising Reaction to Last Week’s Employment Data Means for Our Mortgage Rates
While the headline result came as a surprise, the much bigger surprise, at least to me, was the bond market’s reaction.
Over the past year, bond-market investors have become increasingly confident that our job market’s momentum will compel the Bank of Canada (BoC) to raise its overnight rate. This view was maintained even after our economy lost 88,000 jobs in January, reversing much of the late surge that we saw at the end of 2017. Only two weeks ago our bond futures market was assigning an 80% probability that the BoC would raise its policy rate in May, despite cautious recent commentary from the Bank itself.
Against that backdrop, when I read that our economy added 32,300 new jobs last month, I expected to see the five-year Government of Canada (GoC) bond yield surging higher in response. But when I clicked over to check, it wasn’t following suit.
To my surprise, the five-year GoC bond yield closed lower for the day on Friday, and at the same time the bond-futures market had dropped the probability of a BoC rate rise in May to 40%.
What had caused bond-market investors, who are known to shoot first and ask questions later, to react bearishly to such a bullish headline?