What the U.S. Federal Reserve’s Current Economic View Means for Canadian Mortgage RatesJune 22, 2015
The Greeks Say No. Will Their Creditors Echo That Sentiment?July 6, 2015
This is the day that Greece is required to repay a loan of €1.5 billion to the International Monetary Fund (IMF). After failing to agree to the reforms required by its creditors for another extension of its existing repayment terms, the country must either pay up, which it can’t, or default. In anticipation of this default, the European Central Bank (ECB) has just cut off Greece’s access to further funds from its Emergency Liquidity Assistance (ELA) facility, which had pumped an estimated €1 billion into Greek banks since the start of this year and had basically kept Greece’s financial system afloat during that period.
In anticipation of the coming chaos, the Greek government has just told the banks to stay closed until July 7. In the meantime, they will hold a national referendum on July 5 to ask voters to decide whether to accept new bailout terms from its creditors and to agree to the additional austerity measures that will accompany them or to default and turn their backs on the euro zone.
After overplaying his hand, this was really the only choice Greece’s Prime Minister Tsipras had left. He mistakenly believed that the threat of a Greek default would keep Greece’s creditors at the negotiating table but that belief was based on an outdated reality. When Greece received its first bailout related to the current crisis in May 2010, much of the debt was held by non-Greek European banks and there was real danger that a Greek default would spread contagion to the many other vulnerable euro-zone countries, and in so doing, trigger a chain of events that might ultimately lead to the euro zone’s collapse.
But a lot has changed since then.
In 2010, Spanish and Italian banks lent huge sums to Greece. With their economies struggling, their bond yields spiking, and their own insolvency fears mounting, neither Spain nor Italy (to say nothing of Portugal and Ireland) looked strong enough to withstand a broadside from a Greek debt default . Since then, however, most of Greece’s estimated €320 billion in outstanding debt has been offloaded to state-sponsored actors, like the IMF, central banks, and the European Financial Stability Facility (EFSF), which is backed by the ECB. In addition, the euro zone now has more safeguards in place to provide liquidity in times of crisis, such as the ELA facility, which is no longer being made available to Greece.
The euro zone’s leaders have used the last five years to plan for this inevitable day. How could they not, when Greece’s debt-to-GDP ratio has climbed all the way to 180% and is still rising? For Greece to have any chance of repaying its debt, it would need GDP growth of at least 3% to 5% over many years, which is a far cry from the huge GDP declines that it has seen since its debt crisis began to unfold in late 2009. What the euro zone’s leaders needed to do back in 2010 was to stall for time in order to bolster weaknesses in the euro zone’s financial defenses for the day when Greece did eventually (and inevitably) default.
The euro-zone leaders played their hand well. With their defenses now better positioned, the risk of a Greek default now appears to be outweighed by the risk that granting Greece too many concessions would undermine future negotiations with other crisis-ridden euro-zone countries. Ironically, it appears that a Greek default might actually be seen to have some value to the euro zone’s leadership by providing a cautionary example to other would be euro-zone credit defaulters of the domestic chaos that awaits any failure to comply with bailout demands.
Which brings us back to Greek Prime Minister Tsipras, who himself provides a cautionary example of how campaigning and governing are entirely different challenges, especially in such difficult times. Having realized all too late that the threat of a Greek default would not force his creditors to accept whatever terms he would offer (as he promised during his election campaign), he is now caught between the proverbial devil and the deep blue sea.
The majority of Greek citizens do not want to leave the euro zone, which would be likely in the event of a full-scale debt default. Nor do they want to agree to more of the austerity measures demanded by Greece’s creditors. Prime Minister Tsipras now knows that he must accede to more austerity measures to avoid his country’s economic collapse, but he built his entire election campaign around rejecting the existing austerity measures that were in place at the time. How can he now agree to even more of them? Rather than make a tough call that would surely cost him his office, Mr. Tsipras wants to use the coming referendum to ask his voters to give him a mandate for his next move. I still think that it will be his last move of any consequence, regardless of how his citizens vote, because he badly misjudged his bargaining position and, frankly, he wilfully misled his voters about the real choices before them.
So what does all this mean for Canadian mortgage rates? While the euro zone is now better positioned to withstand a Greek default, I expect that we will still see a rise in investor demand for safe-haven assets. If past is prologue, this should increase short-term demand for Government of Canada (GoC) bonds, and thereby push their yields lower. It would take a fairly significant drop in GoC rates from current levels to fuel further fixed-mortgage rate cuts, but at the very least, a spike in the demand for GoC bonds should help keep these fixed-mortgage rates at current levels for as long as there is uncertainty about the repercussions of a Greek default.
Five-year GoC bond yields rose by eleven basis points last week, closing at 1.03% on Friday. Five-year fixed-rate mortgages are offered in the 2.49% to 2.59% range and five-year fixed-rate pre-approvals are available at rates as low as 2.69%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range depending on the terms and conditions that are important to you.
The Bottom Line: While it will be hard to predict the exact moment when Greece will officially default, that outcome now appears imminent. Despite the careful planning by the euro zone’s leaders to minimize contagion effects, uncertainty over the effects of a Greek debt default along with fears of potential instability caused by a Greek exit from the euro zone should fuel increased demand for safe-haven assets like GoC bonds. These developments should help keep a lid on GoC bond yields, and by association, our fixed mortgage rates, for some time to come.