Monetary policy provides a powerful tool for our central bankers to use during tough times.
Lowering short-term policy rates helps to stimulate economic growth, and central-bank balance sheets can be used for myriad purposes, which include restoring market liquidity and influencing or even outright manipulating longer-term bond yields and borrowing rates. But, human nature being what it is, over time, that blessing became a curse. The ability to do something seems to have made our central bankers forget that sometimes the best option is to do nothing.
The US Federal Reserve raised its policy rate by another 0.75% last week, and, as I predicted in last week’s post, it also surprised financial markets with a very hawkish warning that more monetary-policy tightening is both needed and imminent.
Let’s start with a quick look at the highlights from the Fed’s latest communications before considering the implications for Canadian mortgage rates:
The bond futures market is pricing in a 0.75% hike on Wednesday, with two more 0.50% increases expected in October and November.
Those bets were raised after the release of last week’s US inflation data. While it showed that headline inflation fell in August, from 8.5% to 8.3% on a year-over-year basis, that was less of a decline than the market had expected. More concerningly, US core inflation, which strips out the most volatile prices like food and energy, increased from 5.9% in July to 6.3% in August.
As in Canada, US inflation is broadening out even as the overall headline number starts to decline. But right now, the Fed is in a tougher spot than the Bank of Canada (BoC).
The Bank of Canada (BoC) raised its policy rate by 0.75% last Wednesday, and that means our variable-rate mortgages and home-equity lines-of-credit will increase by the same amount in short order.
The increase was in line with the consensus forecast, and as such, the Government of Canada (GoC) bond yields which our fixed mortgage rates are priced on held steady.
At least for now.
All eyes will be on the Bank of Canada (BoC) when it meets this week.
The Bank is expected to hike its policy rate by between 0.50% and 0.75%, and variable mortgage rates will be raised by the same amount shortly thereafter.
Our fixed mortgage rates, which move in the same direction as Government of Canada (GoC) bond yields, won’t be directly affected by the BoC’s policy-rate change, but they could be indirectly impacted if the Bank’s accompanying statement has a tone that is different from what is anticipated.
Our bond markets and our central banks are not on the same page right now.
Both the US Federal Reserve (the Fed) and the Bank of Canada (BoC) are adamant that they will continue raising their policy rates until inflation and inflation expectations are brought to heel, and they have recently hinted that this will require more hikes than the market is currently pricing in.
Our central bankers concede that this will create economic pain, but they believe that pain will pale in comparison to the pain that will occur if inflation is left unchecked – and they continue to predict that they can pull off a soft-landing for our economies while all of this transpires.
Last week we received the latest Canada and US employment data for July, and it confirmed that our two labour markets continued along diverging trajectories last month. (US employment rose by 528,000 while Canadian employment fell by 31,000.)
Jobs data have increased importance now because ongoing labour shortages on both sides of the 49th parallel have fueled a steady rise in labour costs. To wit, the average wage in both countries has now risen by 5.2% year-over-year.
Both the Bank of Canada (BoC) and the US Federal Reserve (Fed) are concerned that rising labour costs will broaden inflation pressures, even as many of the prices that drove our initial inflation surge begin to moderate. If that happens, both central banks will have to keep raising their policy rates, even as headline inflation starts to decline from its current eye-popping levels.
Here’s how the latest US and Canadian employment data may impact Canadians who are currently in the market for a fixed or variable mortgage.
The Canadian economy is in the midst of being weaned off record levels of fiscal spending and the lowest borrowing rates on record. We are currently experiencing the highest inflation and the lowest unemployment rates in more than forty years as well as record high overall debt levels and house prices (at least for now).
Although this unusual current backdrop makes forecasting where rates are headed even more difficult than usual, there are some key signposts that can help us find our way.
In today’s post I’ll focus on three of those signposts and explain how they inform my outlook for Canadian fixed and variable mortgage rates.
In the meantime, here are links to three of my most popular recent posts:
Five Thoughts on the Bank of Canada’s Jumbo Rate Hike – The Bank of Canada (BoC) hiked by 1.00% on July 13 and in this post I provide highlights from, and my take on, the Bank’s accompanying communications that were used to justify its jumbo-sized hike.
Straight Talk From Our Central Bankers – In this post I imagine what BoC Governor Macklem and US Federal Reserve Chair Jerome Powell would write in an unvarnished, no holds barred op-ed offering their candid assessments of the current economic situation and what they plan to do about it.
New Mortgage-Rule Changes: HELOCs & Reverse Mortgages – This post outlines the two recent mortgage-rule changes that were announced by our banking regulator and offers my take on a rising risk that it failed to address.
The Bank of Canada (BoC) surprised markets last week with a super-sized 1.00% rate hike. Its policy rate now stands at 2.50%, a substantial increase from its 0.25% level in March.
Variable mortgage rates will rise by the same amount in short order, and that will increase each variable-rate borrower’s payment by approximately $53/month for every $100,000 in principal outstanding (assuming a 25-yr amortization).
The BoC justified its larger-than-expected move by predicting that a front-loaded jumbo increase now would decrease the total amount of tightening needed to bring inflation to heel and thereby increase the odds of a soft-landing for our economy.
Right now, the BoC’s policy rate stands at 1.50%, which is below its estimated neutral-rate range of 2.25% to 3.25%.
(The neutral-rate range is the rate level that neither stimulates nor reduces target inflation when the economy is operating at full capacity.)
The BoC is in a hurry to raise rates and course correct.
Last week was quiet for mortgage-rate news (whew!), so this week I’ll turn my attention to the latest update from our federal banking regulator, the Office of the Superintendent of Financial Institutions (OSFI).
Last Wednesday, OSFI announced the following changes, which will take effect at the end of 2023:
Statistics Canada confirmed that our overall Consumer Price Index (CPI) surged higher again last month, up from 6.8% in April to 7.7% in May on a year-over-year (YoY) basis. That marked its highest level in nearly forty years.
The single largest contributor to last month’s CPI spike was gasoline, which rose by 12% month-over-month (MoM), and have now risen by a whopping 48% YoY. (If we excluded gasoline, our overall CPI would have risen from 5.8% in April to 6.3% in May.)
Let’s try something different this week.
Instead of reporting on rate hikes and soaring bond yields, let’s imagine that Bank of Canada (BoC) Governor Macklem and US Federal Reserve Chair Jerome Powell decided to sit down to write an unvarnished, no holds barred op-ed offering their candid assessments of the current economic situation, what they plan to do about runaway inflation, and how they think it will all play out.
Here is what I think they would write …
Last week we received the latest US inflation and Canadian employment data, and the Bank of Canada (BoC) issued its latest Financial System Review with an accompanying press conference from BoC Governor Macklem.
In today’s post I offer quick hits on each and make my admittedly contrarian case for inflation and interest rates falling back more quickly than most market watchers expect.