Uncertainty Reigns at The Bank of CanadaJanuary 23, 2017
The U.S. Federal Reserve Maintains a Cautious Approach to Future Rate HikesFebruary 6, 2017
Last week President Trump announced a series of controversial immigration measures that touched off waves of condemnation both at home and abroad. The implementation of these new measures served as confirmation, and a warning, that President Trump plans to follow through on the promises he made on the campaign trail, even in the face of overwhelming opposition. Say what you will about President Trump – he is doing what he said he would as candidate Trump.
This is a concerning development for America’s main trading partners, who until last week might have held out some hope that President Trump’s protectionist trade rhetoric would eventually be tempered by the light of cold, hard economic reality. But we now find ourselves in a world where every traditional, evidence-based warning by economic experts about the damage that trade barriers will inflict on the U.S. economy is met with “alternative facts” that are free from any burden of proof (or reality).
To cite a few examples:
- It is true that manufacturing jobs have been in decline across the western world for a generation. But this deterioration is mostly due to technological advances. Interestingly, the U.S. economy has actually added about one million new manufacturing jobs since 2010 while countries like China and Canada have seen a steady decline in these jobs over the same period. Ironically, many of those recently created U.S. manufacturing jobs are in export-based industries that will suffer if U.S. actions lead to trade wars, but that explanation just doesn’t cut it with the Trump base. It is easier for President Trump to just repeat the simple message that countries like China are stealing U.S. jobs and then wait for the applause.
- Trade barriers will raise the cost of U.S. imports and result in higher prices for U.S. consumers. Americans with the lowest incomes will be most affected, but I have no doubt that Steve Bannon, one of President Trump’s key strategists, will redirect the angst that will rise from this increased suffering toward whomever President Trump happens to have in his sights at that time.
- Pew Research Centre estimates that there has been a net migration of Mexicans out of the U.S. and back to Mexico since the start of the Great Recession in 2008. This has largely been attributed to the economic benefits that the North American Free Trade Agreement (NAFTA) has brought to Mexico. Ironically, if President Trump tears up NAFTA and starts a trade war with his southern neighbour, his actions are likely to reverse the existing flow of migration between Mexico and the U.S. as economic opportunities in Mexico diminish.
Sadly, while the other branches of the U.S. government can provide checks and balances to some of President Trump’s more controversial policies, he has a largely free hand over trade. As such, if he wants to end trade agreements, as he has already done with the Trans-Pacific Partnership (TPP), and threatened to do with NAFTA, the rest of the world will be left to pick up the pieces.
All of this sets up an interesting test for both the U.S. dollar and U.S. treasuries.
Until now, global instability has increased demand for safe-haven assets and in every modern crisis, that has pushed the U.S. dollar higher and U.S. treasury yields lower. This pattern has held even when the crisis is of America’s making, with the U.S. tech bubble of 2000 and the U.S. financial crisis of 2008 providing two recent examples.
But will the world continue to view American-backed assets in the same light with President Trump at the helm? Or will his radical and destabilizing approaches to governance undermine the greenback’s status as the world reserve currency? We should remember that Trump has mentioned strategic debt default as one ways to solve the U.S. debt problem when on the campaign trail – and he has repeatedly used this technique in his personal business affairs.
Against this backdrop, it is now fair to at least ponder the future status of the U.S. dollar as the world’s reserve currency.
Over the short term, the new U.S. immigration crisis should put downward pressure on U.S. bond yields, assuming that investors believe that it raises instability risks and that, for now, U.S. treasuries still top the list of safe-haven assets that investors turn to in such times. Given the tight correlation between Government of Canada (GoC) bond yields and their U.S. equivalents, that should also exert some downward pressure on our fixed mortgage rates.
Over the longer term, while President Trump’s actions cater to his base of electoral support, they also hurt U.S. credibility and undermine the world’s confidence in the American guarantee, in all of its forms.
For my part, I am hopeful that President Trump will expend so much political capital on the immigration file that he won’t have much left to win support on new, equally controversial policies in other areas. Of course, that assumes that political capital still matters in the post-truth we suddenly find ourselves in.
Five-year GoC bond yields fell by one basis point last week, closing at 1.14% on Friday. Five-year fixed-rate mortgages are available at rates anywhere from 2.59% to 2.94%, with rates at the lower end of that range offered on loans that are eligible for some form of default insurance, and rates at the higher end of that range offered on loans that are not eligible. (If you want to learn whether you and your loan are eligible for default insurance , check out Part One and Part Two of my recent posts on this topic.) Five-year fixed-rate pre-approvals are now offered at around 2.94%.
Five-year variable-rate mortgages are still available in the prime minus 0.35% to prime minus 0.60% range, which translates into rates of 2.25% to 2.10% using today’s prime rate of 2.70%.
The Bottom Line: If past is prologue, expect GoC bond yields to fall this week in sympathy with their U.S. counterparts as the new U.S. immigration crisis raises instability risks, and with them, the demand for safe-haven assets. If that happens, it will exert downward pressure on our fixed-mortgage rates and rate drops may be in the offing – at least in the short term.