David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News
We started last week just hoping to dodge a German constitutional bullet but by the time it was over, markets everywhere were surging after U.S. Fed Chairman Ben Bernanke (or Ben BernanQE as he is now more cleverly known) backed his liquidity truck up to the American low-rate punch bowl and filled it to the rim.
On Wednesday,Germany’s constitutional court ruled that its government does in fact have the legal authority to participate in the European Stability Mechanism (ESM) and to join the European Union’s fiscal compact.
Whew. While investors expected a favourable ruling on both fronts, if the court had ruled the other way, Europe’s bailout programs would have been turned on their heads and financial markets everywhere would have descended into chaos. Bullet dodged.
Then on Thursday, Ben Bernanke spoke the words that investors had been
waiting for, and then some.
First, he said the U.S. Fed would now embark on a third round of quantitative easing whereby it will effectively print new money to purchase $40 billion in mortgage-backed securities each month, while also continuing Operation Twist until the end of the year. (Reminder: Operation Twist is a Fed program that sells short-term Treasuries and uses the proceeds to buy long-term Treasuries in an effort to drive down long-term borrowing costs). In total, the Fed will purchase $85 billion worth of assets each month for the remainder of this year.
Second, just to make sure that the animal spirits of investors would be sufficiently whipped up, Mr. Bernanke also extended the Fed’s timeline for raising its near 0% policy rate from late 2014 to mid-2015.
Here were the key points made by the experts I read following the Fed announcement:
- The Fed’s commitment to buy $40 billion/month in mortgage-backed securities was open-ended, which means there is no timetable or limit on the potential size of QE3. Mr. Bernanke made it clear that the Fed would leave its economic stimulus programs in place “for a considerable time after economic activity strengthens.” This carefully worded phrase was designed to reassure Americans in the midst of building personal or business budgets that cheap rates will be around for the foreseeable future. To anyone reading between the lines, it also means that the Fed expects the U.S.economy to continue to struggle in the years ahead.
- The Fed has a dual mandate – to promote price stability and to help the economy reach full employment. Mr. Bernanke emphasized that it will take a “substantial” improvement in the employment situation before the Fed will change course, even at the expense of higher inflation.
But in spite of the Fed’s willingness to fight until it fires its last bullet, will these initiatives work as intended? I have my doubts. Here’s why:
- QE3 injects more liquidity into the U.S.economy but U.S.banks are already holding nearly $1.5 trillion in reserves and U.S. businesses currently have about $2 trillion in cash on their balance sheets. The U.S. economy doesn’t have a liquidity problem. It has a demand and growth problem because people don’t want to borrow to spend anymore. Printing money in that environment has about as much impact as pushing on a string.
- The Fed is hoping that QE3 will stimulate job creation but there is very little evidence that the former will cause the latter. Some experts argue that the rise in U.S. unemployment was not caused by cyclical changes in the economy but was instead triggered by structural changes in the economy that created a mismatch between skills and jobs (which would be more permanent in nature). If that is true, this type of stimulus won’t have much impact.
- More quantitative easing is actually a double whammy for U.S. consumers because it drives up commodity prices (like food and fuel) and drives down the U.S. dollar (making all imports more expensive). If U.S. consumers have to spend more on basic necessities they will have less to spend on discretionary purchases and that reduced demand will dampen economic growth. (Remember that U.S. consumer spending accounts for roughly 70% of total U.S. GDP.)
- Cheaper borrowing rates do nothing to help the millions of U.S. homeowners who are currently underwater and can’t refinance their mortgages no matter how low rates go.
- When investors sober up from their QE induced risk-on bender, the continuing steady-stream of downbeat economic reports will remind them soon enough that the U.S. economy, like so many others, has plenty of tough sledding ahead.
More to the point for my readers, what does this mean for Canadian mortgage rates?
For fixed-rate borrowers, we may see bond yields rise over the short term as investors shift out of safe-haven assets like GoC bonds and move to riskier assets like equities to catch the QE3 rally wave. If the momentum is sustained then we will see an increase in fixed-mortgage rates (since they are based on GoC bond yields) but if past is prologue, any effects on yields will be short-term in nature.
For variable-rate borrowers, I think today’s announcement makes it even more difficult for Bank of Canada (BoC) Governor Mark Carney to raise the overnight rate (on which variable-mortgage rates are based) for the foreseeable future. The Canadian dollar is already above par and if the gap between U.S. and Canadian interest rates widens further, the Loonie will continue to appreciate against the Greenback. That would hammer the already struggling Ontario and Quebec economies, which both have huge manufacturing sectors that depend heavily on exporting to U.S. markets.
(Dave’s Populist Rant: Excess liquidity and ultra-low borrowing rates fueled the U.S. credit crisis. While the profits ‘earned’ during the run-up were privatized, when the credit bubble burst the losses were socialized. The ensuing housing-market crash destroyed a huge swath of middle-class wealth and put millions of Americans underwater on their mortgages or forced them out of house and home altogether. The resulting low rates also reduced and in some cases eliminated the incomes of retirees who had saved diligently to provide for their future.
Now, when the Fed uses quantitative easing (money printing by another name) to push borrowing rates to even lower levels, this disproportionately benefits the rich who can still qualify for mortgage financing. Wealthy Americans are now using this almost free money to buy up foreclosed houses and rent them back to their previous owners while earning a handsome return in the process. Of course, with so much new demand for rental accommodation, average U.S. rents are up 9% on a year-over-year basis. Anybody else think the Willy Lomans of America are getting a raw deal in all of this?)
Government of Canada five-year bond yields were 6 basis points higher for the
week, closing at 1.48% on Friday and five-year fixed rates can still be found in
the 3% range.
Variable-rate mortgages may increase in popularity now that it seems more likely that the overnight rate will remain low for years to come. But they are still being offered in the prime minus .35% range (2.65% using today’s prime rate) and as such, I think a one-year fixed rate at 2.49% is a better way to take advantage of the savings offered at the short end of the yield curve.
The bottom line: While I think any spike in GoC bond yields that is caused by Ben Bernanke’s latest announcement will be short lived, anyone in the market for a fixed-rate mortgage should lock in a pre-approval ASAP. Better safe than sorry.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave
