What Permanent QE Would Mean for Canadian Mortgage RatesOctober 7, 2013
The Bank of Canada Finally Drops Its Rate-Tightening BiasOctober 28, 2013
While the U.S. Congress finally passed a bill to reopen the government and raise the U.S Treasury’s debt ceiling, it only gave the U.S. government enough money to stay open until January 15, 2014, and only gave the Treasury enough breathing room to keep borrowing until February 7, 2014.
Instead of being a lasting resolution, this latest development was just a pause in the action, like the time keeper’s bell going off in the middle round of an eighteen-round fight. Republicans and Democrats merely returned to their corners, where they now wait to be called out for their next round of budgetary brinkmanship.
As I watched this all play out, I wondered why U.S. politicians seemed so willing to push both the U.S. and world economies to the brink, and why they aren’t more concerned about voter backlash.
I found the answer in a recent Economist article that gave a detailed account of a somewhat obscure term called “gerrymandering”. This is the process by which politicians redraw their electoral districts to make them more reliably Republican or Democratic. Gerrymandering creates safer seats for each party but it also makes the primaries, rather than the general election, the real testing ground for candidates. Instead of trying to appeal to independents and middle-of-the-road voters in each party, many U.S. politicians now focus instead on pandering to their more radical, grass-roots party members.
This practice of gerrymandering has radicalized U.S. politics and led directly to the rise of the Tea Party, the group which has hijacked the last several rounds of U.S. budget and debt-ceiling negotiations. There are many Tea Party members who seem to think that forcing the U.S. government into default is a better option than allowing Obamacare to be implemented. Then again, I suppose that, technically speaking, a U.S. default would be one way to defund Obamacare, in an inmates-running-the-asylum sort of way.
Now let’s get to the question that I try to answer each week: What does all of this mean for Canadian mortgage rates?
The U.S. Fed can’t feel any better about U.S. fiscal policy after last week’s resolution because the U.S. economy has less than 90 days until its next budget and debt-ceiling deadlines loom. The Fed has long said that it is using its massive monetary-stimulus programs and accommodative forward guidance, in part, as ways to counteract the negative economic momentum caused by ongoing U.S. fiscal-policy uncertainty. Since there is still plenty of that to go around, I don’t think last week’s resolution accelerates the Fed’s timetable for tapering. In fact, I think the only sure bet is that the Fed won’t even think about tapering until the next round of fiscal brinkmanship has run its course early next year.
As I wrote in my last post, this matters to Canadian mortgage borrowers because U.S. and Canadian monetary policies are very tightly linked, essentially because we are each other’s largest trading partner and because our economies are so integrated through free trade. This means that the Bank of Canada (BoC) cannot raise its short-term policy rate (which we call the “overnight rate”) if the U.S. Fed doesn’t raise its equivalent federal funds rate (which we call the “target rate”). The Fed has repeatedly said that it will not even consider raising its target rate until it has completely unwound its quantitative easing (QE), and this most recent short-term resolution to the U.S. budget and debt-ceiling crisis should now push its timetable for tapering QE even farther into the future.
So while the rest of the world is cursing the practice of gerrymandering and the rise of the U.S. Tea Party movement, perhaps Canadian borrowers should count the continuation of their rock-bottom mortgage rates as a silver lining in the otherwise dark economic clouds they have formed.
Five-year Government of Canada (GoC) bond yields fell by six points last week, closing at 1.83% on Friday. Lenders have started to slowly reduce their five-year fixed rates in response, and these terms can now be found in the 3.54% to 3.49% range. As competition for this business heats up, pay special attention to the terms and conditions in your mortgage contract. It is especially important to make sure you understand the different ways that lenders calculate fixed-rate mortgage penalties, because the wording in your lender’s penalty clause can easily make a difference of many thousands of dollars if you ever need to break your contract early.
Five-year variable rates are still offered in the prime minus 0.50% range (which works out to 2.50% using today’s prime rate of 3.00%). While it looks increasingly likely that variable rates will stay low for an extended period, variable-rate borrowers should not get complacent. Instead, I advise my variable-rate clients to bank the interest-rate saving they enjoy today by using it to pay off their mortgage balance more quickly. This will knock years off of your amortization period and get you used to making higher payments. That way, when rates eventually rise, you will have made the adjustment to higher payments long ago.
The Bottom Line: Last week the U.S. Congress managed to stave off its latest budget and debt-ceiling crisis for a few more months. The short-term nature of this reprieve makes it unlikely that the Fed will begin tapering its QE programs until longer-term solutions can be worked out. That will take at least until the start of next year, but probably much longer, and that means that our fixed- and variable-mortgage rates should stay at their ultra-low levels for some time yet.