Last week Bank of Canada (BoC) Governor Poloz called for more innovation in the Canadian mortgage market. He specifically targeted three key areas where innovation is needed, with longer-term mortgages topping his list.
In today’s post I’ll outline why longer-term mortgages have historically had limited appeal for both borrowers and lenders in Canada, and I’ll offer a suggestion to Governor Poloz on how he can facilitate a dramatic increase in the uptake of already available ten-year fixed-rate terms.
First, a confession.
While this didn’t come as a surprise to the Bank of Canada (BoC) or to mainstream economists, the contraction is nonetheless concerning because it marks the fourth time in the last six months that our GDP has shrunk. It also puts to rest any hope that the 0.3% month-over-month GDP growth we saw in January was a signal that our stalled economic momentum would recover more quickly than expected.
In its latest Monetary Policy Report (which I summarized here), the BoC predicted that our economy would return to its previous growth trajectory in the second half of 2019. The Bank lowered its estimate of our annual real GDP growth in 2019 from 1.7% to 1.2%, but it also held firm to its belief that our economy would return to “slightly above potential” after that and maintained its GDP growth forecasts of 2.1% in 2020 and 2.0% in 2021.
If the BoC’s most recent forecast is correct, we should expect that it will begin to consider additional rate hikes in early 2020. That would mean that variable mortgage rates wouldn’t rise until then but our fixed mortgage rates, which are priced of Government of Canada bond yields, would be expected to rise sooner in anticipation of the BoC’s move because longer-term bond yields are more sensitive to changes in our economic outlook.
Of course, that scenario is far from certain.
The Bank’s typical Monetary Policy Report (MPR) acknowledges that current conditions are weaker than expected but then makes the case that they are soon to improve. Wash, rinse, repeat.
The BoC’s hope for better days is not without some foundation. For example, low levels of unemployment can trigger a virtuous, self-reinforcing cycle where robust wage growth leads to increased consumer spending, which then spurs a rise in business investment that stimulates more job creation, etc.
Only things haven’t worked out that way.
Ultra-low unemployment hasn’t fuelled the kind of broad-based wage growth that our policy makers expected to see. We have had increased consumer spending, but it’s been fuelled by rising debt rather than rising incomes – and debt is really just future consumption brought forward. Business investment hasn’t materialized as hoped, and there is little evidence of any self-reinforcing cycle.
The Bank of Canada (BoC) is not expected to move its policy rate when it meets this Wednesday. The real question in the lead up to this meeting is whether the Bank will continue its shift to a more dovish outlook.
Against a steadily weakening economic backdrop, thus far the BoC has conceded only that its next rate hike will likely be delayed by what it views as a temporary “soft patch”. But if the Bank is now more concerned about slowing momentum, its accompanying Monetary Policy Report (MPR), which offers valuable insights into the BoC’s evolving economic view, should make that clear.
There is an especially interesting subtext this time around.
It stood at 1.82% on February 28 before plummeting to 1.40% on March 27. Lenders were initially slow to lower their five-year fixed rates, but they eventually dropped them from a range of 3.29% to 3.54% in late February to a range of 2.94% to 3.14% by late March.
Since that time, the five-year GoC bond yield has ricocheted back up, and by last Friday it closed all the way back at 1.64%. If the chart on the right were a roller coaster ride, it would come with a motion sickness warning.
In his speech in Iqaluit, Nunavut, Governor Poloz reiterated his view that our current slowdown will prove temporary. While current Government of Canada (GoC) bond-yield levels indicate that bond-market investors are more pessimistic, when the person with his hand on our policy-rate lever offers his views, we are wise to pay heed.
Here are the highlights from Governor Poloz’s most recent speech:
Their decline has been underpinned by softening domestic economic data, which have pushed down Government of Canada (GoC) bond yields, on which our fixed mortgage rates are priced. Our weakening economic backdrop has also made the Bank of Canada (BoC) more dovish about its plans to hike its overnight rate, on which our variable mortgage rates are priced.
While our own slowing economic momentum has been the primary driver of our falling bond yields and mortgage rates, changes in the U.S. Federal Reserve’s outlook are also contributing to their recent drop. That’s because we sell about 80% of our exports into U.S. markets, and on a comparative basis, our provinces trade more with their U.S. neighbours to the south than they do with each other.
Here is a summary of the recent U.S. developments that are helping to put downward pressure on our bond yields, and by association, our mortgage rates:
Last Thursday, our federal government released its 2019 budget, and it included several initiatives that were designed to improve housing affordability.
While on first pass this will be welcome news for home buyers and for many of our now somewhat beleaguered regional housing markets, the federal government has thus far left out many key details that are needed to assess the full impact of its main new initiative, the First Time Home Buyers Incentive (FTHBI) program.
Bluntly put, the announcement reminded me of a term paper that was written during an all-nighter the day before it was due (and my university roommates will confirm that I am somewhat of an expert on that topic).
In today’s post, I’ll outline what we know about the two most prominent initiatives that were announced last week, I’ll offer my take on how these changes are likely to impact our regional housing markets, and I’ll explain why these changes should concern existing home owners across the country.
Last October, the Bank of Canada (BoC) had just completed its fifth 0.25% policy-rate increase in a little over a year, and variable-rate mortgage borrowers, who before then had enjoyed more than seven years without a single rate hike, were having their conviction tested.
The BoC had just cautioned that if it was going to keep inflation close to its 2% target, it would need to continue raising its policy rate to its neutral-rate range of between 2.5% and 3.5%. (The neutral range is defined as the policy-rate level that neither stimulates nor restricts economic growth.)
Mainstream economists predicted that sharply higher rates were imminent and argued about whether three or four more rate hikes were likely in 2019. This spooked many variable-rate borrowers, and some of them rushed to lock in a fixed rate before variable rates rose even higher.
Regular readers of this blog might remember that all of this angst got my contrarian itch going. When the BoC raised its policy rate in October, I challenged its rationale, arguing that the Bank’s own forecasts of slowing GDP growth both at home and abroad made it unlikely that inflationary pressures would intensify. Then in November, in a post titled Fixed vs. Variable: Is the Five-Year Fixed-Rate Mortgage Now a No Brainer?, I argued in favour of variable mortgage rates and predicted that “the BoC’s actions will not match its words over the near term”.
Fast forward to today.
In its brief accompanying statement the Bank acknowledged that our current economic slowdown is now “more pronounced and widespread” than it had previously forecast.
On Thursday, Deputy BoC Governor Lynn Patterson offered more detailed insight into the key factors that are driving the Bank’s increasingly dovish assessment of our economic momentum.
Today’s post provides highlights from both of the BoC’s communications last week and offers my take on the two key questions that matter most to fixed- and variable-rate mortgage borrowers: When will the Bank move its policy rate next? And will its next move be up or down?
Let’s start with a look at the five key factors that led to the BoC’s dovish shift.
Up until now, the Bank has ascribed our slowing economic momentum in the second half of 2018 to falling oil prices and predicted that it would prove transitory. In its most recent Monetary Policy Report (MPR), which I summarized here, the BoC drew a sharp contrast between the economic momentum in our oil-producing and non-oil-producing provinces. But more recent data have blurred that line, and it is now much harder to make the case that the current slow down is just an oil-price story.
The Bank is not expected to change its policy rate, on which our variable mortgage rates are priced, when it meets this Wednesday. The real debate leading up to this meeting is whether the BoC will continue to talk about rates needing to move higher or concede that higher rates are no longer imminent.
– The Rolling Stones
Last week Bank of Canada (BoC) Governor Poloz made a speech that reminded me of those lyrics.
Bluntly put, he clearly wants to raise rates but he needs to keep inflation stable.
There are factors beyond Governor Poloz’s control that are preventing him from raising the BoC’s policy rate to a neutral-rate level, which is defined as the level that neither stimulates nor restricts economic growth.
He knows that if he ignores these factors and raises the policy rate too quickly, it will unleash deflationary forces that could push inflation well below the BoC’s 2% target.
If you’re keeping an eye on mortgage rates, Governor Poloz’s speech, titled “The Power – and Limitations – of Policy”, included valuable insights into where rates may be headed over the short and medium term. I will highlight these and offer my own accompanying commentary in today’s post.
Interestingly, even though the headline result came in much higher than the consensus estimate of 8,000, the bond market essentially shrugged off the news. I think that is in part because the underlying data weren’t actually that strong, but also because bond market investors don’t believe that last month’s surprising job-growth headline is likely to move the needle much at the Bank of Canada (BoC).
Before we look at the key details from the latest employment data, let’s first circle back to a recent speech made by Deputy BoC Governor Carolyn Wilkins on January 31, 2019 titled “A Look Under the Hood of Canada’s Job Market”. The speech provides a very recent BoC assessment of the health of our overall job market, and it provides insightful context for evaluating last month’s employment data.
Here are the highlights from Deputy Governor Wilkins’ speech:
Today’s post focuses on the U.S. Federal Reserve’s key monetary-policy shift last week, but before we get to that, let’s quickly review why the Fed’s actions matter to Canadian mortgage borrowers.
The Bank of Canada (BoC) decided not to raise its policy rate at its January meeting, but reiterated its belief that it would need to continue raising rates to keep inflation near its 2% target going forward. While the Bank emphasized that it would be heavily data dependent and would respond to key developments both at home and abroad, its decision to hold rates steady sounded like a grudging pause.
The BoC’s desire to bring its policy rate back into a neutral-rate range, where it neither stimulates nor restricts economic growth, makes sense. The Bank understands the potentially destabilizing systemic risks that have built up during the current period of ultra-low interest rates that began at the start of the Great Recession in 2008. Over that period, debt levels have risen to record highs, asset prices have soared, and investors have taken on increased levels of risk in their chase for adequate returns.
The BoC’s biggest challenge in returning its policy rate to its neutral range is that its rate decisions do not exist in a vacuum. It must also be mindful of the impact that outside forces are having on our economy.
This is especially true in the current environment because our economic momentum is no longer being fueled by debt-financed consumer spending, which has (rightly) been reined in by a combination of mortgage rule changes and BoC rate rises. Our policy makers are now hoping that rising export demand will combine with increased business investment to offset a policy-induced slowdown in consumer spending. So far, however, this transition has been slow to develop.
When the Bank of Canada (BoC) adopted a more dovish tone earlier this month, it explained that it would be “decidedly data dependent” going forward and that it would adjust its policy rate “to developments as they unfold”.
In particular, the Bank highlighted developments in three key areas that would determine “the appropriate pace of rate increases”: Canadian oil prices, Canadian house prices, and global trade policy (which, in banker speak, means the evolution of the U.S. /China trade conflict, the ratification of the new USMCA, and the continuation of U.S. tariffs on our aluminum and steel).
If we’re going to try to read the tea leaves to gauge the timing of the BoC’s next rate hike (and the Bank’s recent language confirmed its steadfast belief that its next move will be a hike), these are the areas to focus on. (It might seem a little early to conduct this exercise, but there has been some movement in key areas, and in an otherwise slow week for news impacting Canadian mortgage rates, now seems like a good time to outline these key determinants.)
In today’s post, we’ll check in on these three key areas.