While the Bank isn’t expected to increase its overnight rate, which our variable mortgage rates are priced on, market watchers will be looking for indications that it will raise at its next meeting on October 24. Right now, the futures market is assigning about a 75% probability that this will happen, but those odds have been coming down of late, and understandably so.
In Chinese astrology, 2018 is the year of the dog, and it will go down as the year of uncertainty for the BoC.
- The U.S. and Mexico have decided to bypass Canada during their NAFTA negotiations, and with our policy makers forced to the sidelines, trade uncertainty hangs over our collective heads like the sword of Damocles. At the same time, ongoing trade tensions between the U.S. and China threaten to unleash a broader, global trade war.
- Ill-advised U.S. tax cuts and aggressive stimulus spending (unsuitable during this phase of the business cycle) are stoking U.S. inflationary pressures, which have risen steadily on a year-over-year basis from 1.6% in June of 2017 all the way to 2.9% last month. Canada’s year-over-year inflation has soared even higher over that period, rising from 1.0% in June of 2017, to 3.0% last month.
- The UK is hurtling towards its Brexit deadline with no deal in place, Turkey’s economy teeters on the brink of collapse, and Italy’s newly formed government is promising to implement populist policies that will likely lead to a showdown with German policy makers. To add some perspective, consider that Turkey’s GDP is about five times the size of Greece’s GDP, and the Italian bond market is the third largest in the world.
- Last year’s theme of synchronized global growth has been tested thus far in 2018. Recent data show that the U.S. economy’s recent surge in economic momentum is slowing, as is China’s, which will have an indirect but material impact on commodity-based economies like ours. At the same time, the continued strength of the U.S. dollar has created a powerful headwind for many emerging market economies, which have had to raise interest rates to defend their currencies at a time when their economic momentum would otherwise not be calling for tighter monetary policy.
As summer turns to fall, Canadian mortgage borrowers will be trying to determine how the factors outlined above will affect rates. To that end, here are five key questions that we’ll be looking to answer in the months ahead:
To put that number in perspective, consider that our economy needs to create about 20,000 new jobs each month in order to keep up with the natural growth rate of its labour force. When our economy creates additional jobs above that threshold, it reduces the supply of unutilized labour and narrows our output gap.
(As a reminder, the output gap measures the gap between our economy’s current output and its maximum potential output. When the output gap closes, costs rise as resources, like labour, become scarcer. As that happens, the Bank of Canada (BoC) typically raises its policy rate to combat rising inflationary pressures.)
On first pass, last week’s banner jobs-number headline should have sent Government of Canada (GoC) bond yields soaring as investors priced in accelerating job growth and raised their bets that the BoC’s next rate hike would come sooner rather than later. But the details in the report were not nearly as encouraging, and the five-year GoC bond yield, which our five-year fixed mortgage rates are priced on, actually finished slightly lower on Friday.
Here is a look at the details in our July employment data that tempered the bond market’s enthusiasm:
- Canadian GDP Growth Surges in May
Last week Statistics Canada estimated that our GDP increased by 0.5% month-over-month in May, which was higher than the 0.3% reading the consensus had expected. Most interestingly, nineteen of the twenty sectors that are tracked by Stats Can showed a pick-up in activity over the month, which this National Bank report noted was the broadest dispersion of monthly growth that we have seen since 2004.
The Bank of Canada (BoC) predicted that our year-over-year second-quarter GDP growth would come in at 2.8% in its latest Monetary Policy Report, but the consensus raised its year-over-year forecast for that period 3.0% after the May GDP data were released. At the same time, the futures market increased the odds of a BoC rate hike in October from 65% to 72%.
It will be interesting to see if the Canadian economy can continue this impressive run of increasing growth. The May result was boosted by several temporary factors such as a tax-cut-induced surge in U.S. GDP growth, a bounce back from unseasonably cold temperatures in April, and the ramping up of Alberta oil-sands production following temporary shutdowns.
In the ensuing months, our current GDP momentum will have to overcome rising headwinds from the recently enacted mortgage rule changes, the BoC’s previous rate hikes, and relatedly, reduced consumer spending. Our labour market isn’t exactly rolling along any more either – our economy still hasn’t created a single net new job thus far in 2018.
That said, our May GDP result has market watchers betting that the next BoC rate rise will come sooner rather than later.
Last week we learned that U.S. GDP grew by 4.1% on an annualized basis in the second quarter. This was an impressive surge for the U.S. economy, which has averaged GDP growth of about 2.2% over the past nine years.
Most economists believe that the U.S. economy has no room left for non-inflationary growth. If they’re right and U.S. inflation continues to accelerate, Canada will import that inflation through its extensive trade with the U.S., and that could compel the Bank of Canada (BoC) to accelerate its rate-hike timetable.
So the key question for anyone keeping an eye on Canadian mortgage rates is “Will this rise in U.S. GDP growth be sustained?”
Many market watchers think not, for the following reasons:
Last Friday we learned that overall Canadian inflation, as measured by our Consumer Price Index (CPI), came in at 2.5% in June, and that result was higher than the consensus forecast of 2.4% for the month.
The reaction was predictable. Most mainstream economists speculated that the Bank of Canada (BoC) would raise its policy rate again in either September or October to rein in rising inflationary pressures.
Our inflation rate has certainly increased of late.
In January, our CPI rose by just 1.7%. But then rising inflationary pressures pushed it over the BoC’s target rate of 2% for each of the next five months. This extended period of above-target inflation is unfamiliar territory for our economy of late. It has spent most the past ten years looking up at that target (see chart).
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.