The New Canadian Mortgage LandscapeDecember 5, 2016
Variable Mortgage Rates Grow More Appealing for CanadiansDecember 19, 2016
Last week the Bank of Canada (BoC) announced that it would leave its overnight rate unchanged, as was widely expected, and in its accompanying statement the Bank explained how current economic momentum, both at home and abroad, has contributed to its cautious overall view.
Here are the highlights from the BoC’s latest statement, along with my take on the implications for both our fixed and variable mortgage rates:
- “Global economic conditions have strengthened … However, uncertainty, which has been undermining business confidence and dampening investment in Canada’s major trading partners, remains undiminished”. In normal circumstances, when economic conditions improve it prompts businesses to invest in research and development, productivity enhancements and capacity expansion. This investment then spurs additional economic momentum in what becomes a virtual, self-reinforcing cycle. But U.S. businesses, much like their Canadian counterparts, have preferred to keep their powder dry since the start of the Great Recession, and that was before Donald Trump won the U.S. presidential election with a protectionist campaign platform. Now that President-elect Trump is threatening to rip up long-standing trade agreements, is it any wonder why businesses are reluctant to double down on any signs of positive economic momentum?
- “Following the election in the United States, there has been a rapid back-up in global bond yields, partly reflecting market anticipation of fiscal expansion in a US economy that is near full capacity. Canadian yields have risen significantly in this context.” There is still much debate about whether the U.S. economy is, in fact, approaching full capacity but that isn’t the key point for Canadian borrowers in the statement above. The most noteworthy observation is the BoC’s confirmation that the recent run-up in Government of Canada (GoC) bond yields that has pushed our fixed mortgage rates higher of late has been caused by the recent spike in U.S. bond yields, rather than by any material changes in our own economic momentum. And the key question that follows from this observation is whether Canadian bond yields will continue to move in lock step with their U.S. equivalents now that our economies are moving in very different directions (I explored this question in detail in this recent post).
- “In Canada … growth in the third quarter rebounded strongly, but more moderate growth is anticipated in the fourth quarter.” In other words, the BoC isn’t getting too excited about the 0.9% GDP growth we saw in Q3, which the Bank largely attributed to an increase in consumer spending that was “supported by the new Canada Child Benefit”.
- “Meanwhile, business investment and non-energy goods exports continue to disappoint.” We have a pretty good idea why business investment continues to disappoint (see first bullet above), but the lack of improvement in our non-energy goods exports is more puzzling. The Loonie has weakened against the Greenback for some time, and given that we sell the vast majority of our exports into U.S. markets, that exchange-rate weakening should have led to an increase in U.S. demand, but it hasn’t. One explanation is that while the Loonie has fallen against the Greenback, other competing currencies, like the Mexican peso, have fallen even further and in so doing, have sapped the momentum that would otherwise have accrued to our exporters. Furthermore, in a recent report, CIBC economist Benjamin Tal also noted that “70% of what we sell to the U.S. goes to their manufacturing sector” which is “struggling under the weight of a high (and rising) U.S. dollar”. Given that linkage, the export tailwind that was created by the Loonie’s fall is being largely offset by the export headwind that was created by the Greenback’s rise.
- “There have been ongoing gains in employment, but a significant amount of economic slack remains in Canada, in contrast to the United States.” This is clear confirmation that the Bank will not follow the U.S. Fed if it elects to raise its policy rate this week (in case we needed any).
- “Core inflation is close to 2 per cent because the effect of persistent economic slack is still being offset by that of past exchange rate depreciation, although the latter effect is dissipating.” In other words, the Bank is more worried about the downside risks to inflation and if those risks continue to rise, the Bank would eventually be expected to cut its overnight rate in response, giving it a dovish bias going forward.
In summary then, if you’re in the market for a mortgage in the near future it doesn’t look as if the BoC is going to raise its overnight rate for a long time yet, given its cautious assessment of economic momentum both at home and abroad. This is reassuring if you’re considering a variable-rate mortgage, because these rates are priced on the BoC’s policy rate, but that assumes that lenders will not arbitrarily raise their variable rates, as TD Canada Trust did recently. Furthermore, I wouldn’t get too excited about the prospect of a variable-rate cut because the last time two times the BoC cut its policy rate by 0.25%, lenders only passed on 0.15% discounts to borrowers, and there has been widespread speculation that lenders will pocket any further policy-rate discounts without passing any additional variable-rate savings on to borrowers.
If you’re in the market for a fixed-rate mortgage, then you’re probably in for a bumpier ride. Our fixed-rate mortgages are priced on GoC bond yields, which have been pulled higher by their U.S. equivalents of late. The growing divergence in momentum between the U.S. and Canadian economies should cause the correlation between our bond-yield movements to weaken but this will take time, and over the short-term, we should expect our fixed rates to rise if their U.S. counterparts do likewise.
Five-year GoC bond yields rose by seven basis points last week, closing at 1.09% on Friday. Five-year fixed-rate mortgages are available in the 2.49% to 2.69% range, with additional premiums now being added for refinances (+0.10%), rental properties (+0.25%) and extended amortizations (+0.10%). These new premiums are a result of regulatory changes and are explained here. Five-year fixed-rate pre-approvals are now offered at around 2.79%.
Five-year variable-rate mortgages are still available in the prime minus 0.30% to prime minus 0.40% range, which translates into rates of 2.30% to 2.40% using today’s prime rate of 2.70%.
The Bottom Line: The BoC maintained its dovish rate bias, which confirms that our variable rates are unlikely to be pushed higher by the Bank for some time yet. Conversely, if the BoC lowers its policy rate further, expect any additional discounts to be absorbed by lenders and not passed on to borrowers in the form of additional rate discounts. Meanwhile, our fixed mortgage rates will likely continue to be pulled along by their U.S. equivalents, at least until the correlation between our bond yields weakens (which it should, over time, given the growing divergence in the relative momentum of our economies).