Mortgage Rates. What Now?
We’re at one of those points in the economic cycle where mortgage rates get especially confusing.
On the one hand, we see the Bank of Canada confirming that it has no plans to raise short-term interest rates for several months (maybe several quarters). And on the other hand, we have bond traders pushing up long-term interest rates to two-year highs.
That's got many wondering:
a) which side is most reflective of the long-term trend, and
b) how mortgage shoppers should position themselves?
The Gatekeepers of Rates
First off, here’s one basic point to reinforce. Two primary entities control the direction of mortgage rates in this country:
- The Bank of Canada (BoC)
- Whose monetary policies directly impact short-term rates (like variable and 1-year fixed terms)
- The bond market
- Where bond yield movements influence longer-term rates (like 5- and 10-year fixed terms)
What the BoC is Saying
The Bank of Canada sets interest rates based on where it believes inflation is headed 18-24 months from now. Yesterday, the Bank conveyed three key points in that regard:
- It acknowledged what everyone knows, that “Inflation in Canada remains subdued…” (Inflation control is the BoC’s core mandate, and the overwhelming reason it changes interest rates.)
- As long as inflation remains in check, and there is “significant slack” in the economy, and household debt doesn’t come to a boil, current rates will “remain appropriate.”
- Rate increases, once they finally arrive, will likely be “gradual” and just big enough to keep inflation at the BoC’s 2% inflation target. (Those with memories of the early 80’s can probably safely discard of fears of 300 bps rate hikes in the next few years.)
What the Bond Market is Saying
The bond that everyone in our industry watches is the 5-year “government of Canada” (GoC). Its yield jumped 10 basis points Thursday to 2.16%, a brand new 2-year high.
Traders have been selling bonds and pushing up long-term rates for four reasons, among others*:
- Positive economic momentum continues down south, which many feel could accelerate our GDP and spark inflation concerns
- A reinvigorated Canadian housing market (at least temporarily so)
- Canada’s weakening loonie (which makes holding Canadian bonds less attractive)
- Continued outflows from global bond markets (the multi-decade bond bull market is deflating, at least somewhat)
* Bond prices and yields have an inverse relationship. If one goes up, the other goes down, and vice versa.
What Analysts are Saying
- “The BoC continues to reference language that has us believing they are on hold into 2015”
— Derek Holt, Scotiabank Economics
- “…We are still looking at a very long period of inactivity by the Bank [of Canada], and may well be talking about four years of unchanged rates a year from now"
—Doug Porter, BMO Capital Markets via CBC
- “…This is a central bank that…is happy to sit on the sidelines and wait for substantial proof [that]…(economic) acceleration is underway before raising rates”
—Avery Shenfeld, CIBC World Markets via Calgary Herald
- “(The central bank’s statement) gives us comfort in our view the policy rate will remain where it is for the next 15 to 18 months, even 24 months”
—Terrence Connelly, Contingent Macro Advisors via Montreal Gazette
Most of Canada’s market prognosticators envision the next BoC rate increase in late 2014. That roughly coincides with financial market bets, where OIS traders are pricing in the next hike by September 2014.
In the words of CAAMP economist Will Dunning, however, "...Frankly, forecasting does not work." Take these projections with a wad of skepticism.
What it Boils Down To
Despite the technical damage currently being done to the bond market, there’s a cold reality in today’s rate environment:
- Economic growth and inflation are significantly underperforming expectations and the BoC isn’t about to raise rates until that situation reverses
- The recent long-term rate increases act as economic brakes, reducing the need for further rate hikes
- All it takes is one global crisis to reverse the upswing in yields (a low probability but still a possibility)
- Absolutely nothing at this point suggests a persistent growth rate much above 2%. So long as GDP is stuck in a ~2% rut, inflation will likely remain at or below that range. With that backdrop, future rate increases could be moderate (e.g. limited to 1-2 percentage points) and/or be short-term in duration.
A well-qualified risk tolerant borrower (e.g. someone with 20%+ equity, great credit, strong provable income, and 10+ years paid down on their mortgage) would do well to consider a short-to-medium term mortgage if the rate savings were big enough compared to 4- and 5-year terms.
For example, if the best 5-year fixed was 3.59%, and the best 1-year fixed was 2.49%, that’s a spread of 110 basis points. This is enough to absorb 175 basis points of rate increases, spread out over the next 48 months—making the 1-year term a reasonable gamble for sound borrowers.
If your financial circumstances aren’t so robust, 4- and 5-year fixed terms remain at just a stone’s throw (80-basis points or less) from their record lows. Those are rates that people would have begged and stole for back in 2000
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