Dave Larock in Interest Rate Update, Mortgages and Finances
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The U.S. Federal Reserve left its policy rate unchanged last week, as expected, but it surprised markets by removing two rate hikes from its Fed funds-rate forecast for 2016 and by adopting a much more dovish overall tone.
As a reminder, the Fed’s comments matter to anyone keeping an eye on Canadian mortgage rates because Government of Canada (GoC) bond yields have moved in virtual lock step with their U.S. equivalents since the start of the Great Recession in 2008. Our fixed-mortgage rates are based on GoC bond yields so the Fed’s comments and forecasts have direct impact on how much our fixed-rate borrowers pay for their loans. And given that the Bank of Canada (BoC) tends to move in the same direction as the Fed over time, the Fed’s longer-term rate forecasts and overall tone also act as a kind of distant-early-warning gauge for increases in the BoC’s overnight rate, which forms the basis for our variable mortgage rates.
Here are the highlights from the Fed’s latest statement (with my comments in italics):
- “Economic activity has been expanding at a moderate pace … household spending has been increasing at a moderate rate, and the household sector has improved further; however business fixed investment and net exports have been soft.” S. consumers are now spending some of the additional purchasing power, which they have gained through lower energy and import prices and which until recently they have channeled into increased saving instead. But unless a rise in consumer spending fuels an increase in business investment (which then leads to productivity enhancements) it only gives an economy a short-term sugar high. Meanwhile, the drop in net exports, while entirely expected in light of the surging Greenback, also costs the productive side of the U.S. economy some momentum.
- “A range of recent indicators, including strong job gains, points to additional strengthening of the labor market.” Fed Chair Yellen seemed to contradict this vote of confidence in U.S. labour-market progress later in her accompanying press conference when she said that she was surprised that tightening labour-market conditions had not corresponded with a faster rise in average incomes. Therefore, the debate still rages about why average U.S. incomes aren’t rising. Is it because:
1) U.S. job growth has been more about quantity than quality, and as such, cannot be counted as the “healthy” type, or
2) Average incomes are a lagging indicator and by the time they rise convincingly the Fed will have fallen too far behind the inflation curve and will have to raise rates more quickly than expected to catch up, or
3) Stagnant average incomes are the result of highly paid baby boomers leaving the workforce and being replaced by lower paid new entrants, a demographic shift that monetary policy can’t (and shouldn’t try) to counteract
- “Inflation picked up in recent months; however, it continued to run below the Committee's 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.” This dovish comment about inflation came as a surprise to many market watchers because there are compelling signs that U.S. inflation has picked up recently. For example, year-over-year growth of overall U.S. inflation, as measured by its Consumer Price Index (CPI), has accelerated from 0.20% in October 2015, to 1.4% in January 2016, so while it is still technically below the Fed’s long-term target rate of 2%, it has moved sharply higher of late. At the same time, U.S. core inflation, which strips out more volatile CPI inputs like food and energy, has grown steadily on a year-over-year basis from 1.9% in October 2015, to 2.3% in February 2016. Yet in its accompanying forecasts the Fed revised its projections for overall inflation downwards and left its projections for core inflation unchanged, despite its steady increase of late. The Fed’s latest comments on inflation have been interpreted as a signal that it will tolerate above-target inflation for as long as it takes for deflation fears to fully subside.
- The Fed reiterated that “global economic and financial developments continue to pose risks.” Its worry list is a long one, including:
1) Emerging-market instability risks caused by the surging U.S. dollar
2) The coming British referendum on exiting the European Union (EU)
3) Increasing odds that Italian banks will need bailouts on an unprecedented scale
4) At the same time, EU immigration policy disagreements making cooperation among member countries more difficult
5) Japan’s continued experimentation with unconventional monetary policy
6) The geopolitical impact of oil-price volatility
- The Fed shows each of its member’s predictions of where the fed funds rate is headed using a dot-plot forecast, and its latest version lowered the median dot-plot forecast for rate hikes in 2016 from four to two. Although the Fed’s dot-plot exercise has been derided as being out-of-whack with markets for some time, this latest reduction in the median number of rate hikes expected confirms that the Fed’s members have moved closer to the market’s view of where rates are headed.
The Fed’s monetary policy decisions are also influenced by the actions of other central banks, and it must account for the direction of monetary policy in the world’s other large economies. To that end, the recent decisions by the Bank of Japan, the European Central Bank and the People’s Bank of China to adopt increasingly accommodative monetary policies would likely magnify the potential headwinds that would act against U.S. economic momentum if the Fed chose to tighten its monetary policy while everyone else is loosening theirs. Against that backdrop, even standing pat is its own form of tightening.
Five-year GoC bond yields fell by ten basis points last week, closing at 0.71% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.59% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at rates as low as 2.69%.
Five-year variable-rate mortgages are available in the prime minus 0.30% to prime minus 0.40% range, which translates into rates of 2.40% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: The Fed surprised markets last week by adopting a more cautious policy-rate stance despite some recent improvements in the U.S. economic data, most notably a falling unemployment rate that now sits at a drum-tight 4.9%.
The Fed’s more dovish stance implies that it will tighten its policy rate more gradually than had been expected, which should put downward pressure on bond yields. On the other hand, the Fed also appears more willing to tolerate rising inflationary pressures, which should put upward pressure on bond yields. For now those competing forces appear to be roughly offsetting, which means that our GoC bond yields, which trade in lock step with their U.S. equivalents, and our fixed mortgage rates on which they are priced, should remain stable for the near future. That said, those forces remain in precarious balance, so stay tuned. Meanwhile, if you’re a variable-rate borrower, the Fed’s statements should not trigger any near-term changes to your rate.
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, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave
March 21, 2016
Mortgage |