Variable-Rate Mortgage Simulation: A Detailed Look at the Risk/Reward Trade-OffJuly 22, 2013
Why CMHC’s Latest Move is Good for Variable-Rate BorrowersAugust 12, 2013
That is good news for Canadians who are in the market for a fixed-rate mortgage because the Fed’s QE programs are artificially suppressing U.S. bond yields, which have had about a 90% correlation with their equivalent Government of Canada (GoC) bond yields over the past five years. The ultra-low fixed-rate party in both countries is expected to continue for at least as long as the U.S. Fed keeps buying up a staggering $85 billion in U.S. government debt each month.
Meanwhile, Canadian variable-rate mortgage borrowers will also be happy if the Fed takes longer than previously expected to taper its QE programs because U.S. and Canadian monetary policies are just as tightly linked as our government bond yields have been.
The Fed will not raise its short-term policy rate, which currently sits at 0%, until it completely unwinds its QE programs. This makes it highly unlikely that the Bank of Canada (BoC) will raise its overnight rate, which is equivalent to the U.S. Fed’s policy rate, any time before then. The BoC’s overnight rate currently sits at 1%, compared to the U.S. Fed policy rate of 0%, and this discrepancy has pushed the Loonie higher against the Greenback. Any additional increases to the BoC’s overnight rate would cause the Loonie to surge higher still, heaping more suffering on our already beleaguered exporters. Since our variable-mortgage rates move in lock step with the BoC’s overnight rate, this suggests that future variable-rate increases should still be a long way off.
Here is the key phrase from the Fed’s accompanying press release that is music to the ears of every Canadian variable-rate mortgage holder (italics mine):
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program [QE] ends and the economic recovery strengthens.
On a related note, the latest U.S. non-farm payroll report was issued last Friday and it reinforced the view that the U.S. employment market is still taking a long time to heal, in spite of the Fed’s massive and unprecedented efforts.
The U.S. economy added 162,000 new jobs last month, which is barely more than the number of new jobs it needs to create each month just to keep pace with U.S. population growth. There were also small, downward revisions to the jobs data from the prior two months, meaning that some of the job-growth momentum that recently had investors so excited had been overstated. At the same time, both average earnings and average hours worked fell slightly in July, leaving U.S. consumers with a little less spending power to deploy as well.
While the U.S. unemployment rate fell to 7.4%, the lowest it has been in four years, this was primarily because discouraged workers pulled themselves out of the labour market and decided to stop looking for work altogether. The U.S. participation rate, which measures the percentage of Americans who are either working or actively looking for work, remains near its all-time historical low. This is important because the Fed has made it clear that it will only reduce its stimulus programs if there is “healthy” improvement in the U.S. employment rate. A drop in the unemployment rate that is caused by an increase in the number of discouraged workers certainly doesn’t meet that criterion.
GoC five-year bond yields rose a modest three basis points last week, closing at 1.75% on Friday. Five-year fixed rates are still offered in the 3.29% to 3.39% range but borrowers who know where to look can do better.
Five-year variable-rate discounts are available at rates as low as prime minus .60% range (which works out to 2.40% using today’s prime rate). As the competition for variable-rate business continues to heat up, borrowers are well advised to pay attention to the important differences in the terms and conditions offered by different lenders. For example, variable-rate mortgages can be compounded either monthly or semi-annually, and understanding that devilish little detail can save you money over time.
The Bottom Line: When the U.S. Federal Reserve suggested last month that it might start tapering its QE programs as early as September, U.S. and Canadian bond yields surged higher. Since then, however, the Fed has taken every opportunity to soften this view, and in its post-meeting press release last week, the Fed reiterated its renewed, more cautious approach to the timing of its eventual monetary stimulus withdrawal. As such, I think our fixed-mortgage rates will stay at or near today’s ultra-low levels until the Fed starts talking seriously about tapering again, and for the reasons outlined above, I think our variable rates will remain at today’s levels for a long time after that.