Why the Spread Between Canadian Five-Year Fixed and Variable Mortgage Rates Is Set to WidenMarch 6, 2017
How Will Canadian Mortgage Rates Be Affected by the U.S. Federal Reserve’s Latest Rate Hike?March 20, 2017
The U.S. Federal Reserve has most investors convinced that it will raise its policy rate at its meeting this Wednesday (Fed futures prices are currently giving an 88.6% probability to a 0.25% Fed policy-rate rise).
When this happens, will U.S. bond yields rise? And will their Canadian equivalents and our mortgage rates get taken along for the ride?
Bond-market investors won’t be taken by surprise when the Fed raises on Wednesday because it has telegraphed its next rate move effectively. Left on its own, the Fed policy-rate hike might actually push U.S. bond yields lower because markets tend to buy the rumour and sell the fact. The real impetus for the next move in U.S. bond yields will come from the Fed’s accompanying statement.
Investors will be quick to react to any perceived change in the Fed’s expected policy-rate path and since bond yields around the world react to U.S. bond yield movements, there will be reverberations across the globe.
Bluntly put, if the Fed statement is interpreted as being increasingly hawkish about additional rate increases, expect Government of Canada (GoC) bond yields and our five-year fixed mortgage rates to move higher, at least initially, as investors shoot first and ask questions later.
That said, over the longer term, I continue to believe that the Fed will raise its policy rate more slowly than its rhetoric indicates. Here are five reasons why I say that:
- When the U.S. dollar rises, it has many of the same impacts on the U.S. economy as monetary-policy tightening by the Fed. I expect the Greenback to strengthen further as the Fed raises rates in a world where central bankers everywhere else are standing pat or lowering – and the more the Greenback rises, the less need there is for more Fed rate hikes.
- While overall U.S. inflation has risen of late, the factors pushing it higher are expected to be transitory. If this proves correct and the growth rate of overall U.S. inflation falls, helped in part by the rising U.S. dollar, there will be less urgency for the Fed to tighten monetary policy further.
- While the overall U.S unemployment rate is now below the Fed’s 5% target, thereby technically meeting its definition of “full employment”, other indicators imply that the U.S. labour market is still far from healthy. For example, the U-6 unemployment rate is less encouraging. It is a broader measure including those workers who are only marginally attached to the workforce (and are therefore considered “underemployed”) and those who have given up looking for work. It currently stands at 9.2%, which is still higher than it was at the start of the Great Recession in 2008. Most recently, while the headline U.S. employment data, for February, came in higher than expected, much of that upside surprise was attributed to warmer-than-expected weather and a rise in lower-skilled, lower-paying employment.
- The Fed may be accelerating its policy-tightening timetable in anticipation of a large-scale fiscal stimulus package from the Trump administration. If the U.S. federal government significantly increases its spending, that will put more upward pressure on inflation, but this is far from guaranteed. Any Trump-led stimulus package still has to pass through Congress and that will require co-operation from the Tea-Party wing of the Republican Party in the House of Representatives, which seems unlikely.
- While the short-term momentum arrow for interest rates is clearly pointing higher, longer-term trends, like aging demographics and the dampening effect that high debt levels have on economic growth rates, still imply that they will remain lower for longer.
While the week ahead could be an eventful one for our fixed mortgage rates, Canadian variable-rate borrowers can watch this week’s Fed drama safe in the knowledge that their rates aren’t likely to be moving in either direction for some time yet.
Our variable rates will move when the Bank of Canada (BoC) adjusts its policy rate, and the Bank is expected to keep a steady hand on its tiller regardless of any Fed-led changes in bond yields. In fact, the BoC will be happy to see a Fed policy-rate hike and more hawkish Fed policy-rate language because both should weaken the Loonie against the Greenback, and would thereby provide further stimulus to our underperforming export sector.
That said, if fixed mortgage rates rise the cost of converting from variable to fixed will increase – so variable-rate borrowers should still be paying attention to this week’s developments.
Five-year GoC bond yields rose ten basis points last week, closing at 1.27% on Friday. Five-year fixed-rate mortgages are available at rates as low as 2.44% for high-ratio buyers, and at rates as low as 2.49% for low-ratio buyers. If you are looking to refinance, you should be able to find five-year fixed rates in the 2.69% to 2.84% range, depending on the terms and conditions that are important to you.
Five-year variable-rate mortgages are available at rates as low as prime minus 0.80% (1.90% today) for high-ratio buyers, and at rates as low as prime minus 0.60% (2.10% today) for low-ratio buyers. If you are looking to refinance, you should be able to find five-year variable rates in the prime minus 0.45% range (2.25% today), depending on the terms and conditions that are important to you.
The Bottom Line: Investors won’t be surprised if the Fed raises its policy rate this week, but if it also sounds more hawkish in its accompanying press statement, U.S. bond yields should rise and their Canadian equivalents with them. If that happens, our fixed mortgage rates will increase. To protect against that risk, anyone who is in the market for a fixed-rate mortgage is well advised to lock in a pre-approval in the meantime. Forewarned is forearmed.