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QE3 – Nothing To See Here Folks

toronto mortgage ratesMarket bulls hoped that when U.S. Fed Chairman Ben Bernanke finally gave investors the quantitative easing juice they had long been waiting for it would ignite a furious equity-market rally that would reinvigorate the U.S. economy. At the same time, investment capital was expected to flee the safety of low-risk sovereign debt, like Government of Canada (GoC) bonds, and flow into riskier assets as investors sought out higher yields.

That was the theory anyway. Reality has so far proven much different. Instead of triggering the next bull market run, the ensuing rally was more of the blink-and-you’ll-miss-it variety.

Today’s key question then is why? Here are five possible explanations:

A theory about what the U.S. Fed might really be up to. America suffers from political gridlock at a time when urgent action is needed. While Grover Norquist’s Tax-pledge Republicans will fight to their last bullet to prevent any taxes increases, it’s hard to imagine how the U.S. can address its long term funding challenges without them. While letting the higher-inflation Genie out of the bottle is fraught with risks, if Mr. Bernanke can push inflation higher he will give the economy much needed help in several areas, specifically, by driving down the value of the Greenback (making U.S. exports more competitive) and by increasing nominal government revenues while U.S. debt levels remain fixed (making U.S. debt relatively less expensive). Higher inflation is just a tax by any other name and given the fact that it touches almost every part of the U.S. economy isn’t using higher inflation as a policy tool really just another way to create the mother-of-all-consumption taxes?     

To be clear, I don’t think rampant inflation is around the corner because the excess liquidity that is created by quantitative easing has its strongest impact on inflation when economies are operating at full capacity, not when they have huge amounts of excess capacity (as the U.S. economy does now). But central bankers are known for taking the long-term view and if Mr. Bernanke believes that the current U.S. political gridlock is firmly entrenched then might he see higher inflation as a non-political revenue solution to America’s most pressing problem?

Five-year GoC Canada bond yields fell 9 basis points last week, closing at 1.29% on Friday. Lenders continue to drop rates and as such, a market five-year fixed-rate mortgage can readily be found at or below 3%.

My best five-year variable-rate mortgage is now available at prime minus .40% (2.60%) which is the lowest it has been for some time. While this rate looks tempting at first glance, Bank of Canada (BoC) Governor Mark Carney still considers household borrowing rates to be the greatest domestic threat to our economy. Given that, I expect him to remain staunchly opposed to lowering the BoC’s overnight rate any further. With that in mind, I still think a diligently managed strategy of rolling over a one-year fixed rate (my best one-year is currently at 2.49%) will probably prove a cheaper option for anyone looking to save on interest cost at the short end of the yield curve.

The bottom line: The post-Q3 market reaction confirms what many have long believed – that there is no magic stimulus bullet that will turn the U.S. economy around in short order. Instead, we are in the middle innings of a grinding game of deleveraging. Against that backdrop, government bonds in fiscally prudent countries like Canada will continue to be in demand and that should continue to keep GoC bond yields, and by association our mortgage rates, at ultra-low levels for the foreseeable future.

David Larock is an independent full-time mortgage broker and industry insider who helps Canadians from coast to coast. If you are purchasing, refinancing or renewing your mortgage, contact Dave or apply for a Mortgage Check-up to obtain the best available rates and terms.