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The U.S. Federal Reserve left its policy rate unchanged last week, as expected.
In its accompanying statement the Fed also offered a generally positive view of the current state of the U.S. economy, but that said, its latest assessment did not read like a warning that materially higher rates were imminent (as an increasing number of market watchers have been predicting).
The Fed’s latest commentary matters to anyone keeping an eye on Canadian fixed mortgage rates because our bond yields have moved in virtual lock step with their U.S. equivalents since the start of the Great Recession. While our economies now appear to be progressing along very different trajectories, for as long as the current bond yield correlations hold, if U.S. interest rates rise, Canadian rates will get taken along for the ride.
Here are five highlights from the Fed’s latest statement, with my comments added:
- “The labor market has continued to strengthen and … economic activity has continued to expand at a moderate pace.” The recent improvements in the U.S. economic data have corresponded with a rise in inventory investment, so while the data have been positive, we need to see some follow through in future sales data before we can accurately assess the sustainability of this current uptick in momentum. To provide one example of where the subsequent data may tell a different story, consider that the recent rise in U.S. car sales has come at the expense of aggressive price discounting and razor thin selling spreads.
- “Job gains remained solid and the unemployment rate stayed near its recent low.“ Looking at the most recent U.S. employment data, which were released last Friday after the Fed’s announcement, we see encouraging headline job growth (227,000 new jobs created in January versus the 180,000 that were expected) but a drop in average wage growth (2.5% In January versus 2.8% in December). This drop in average wage growth implies that there is still slack in the U.S. labour market and that should make the Fed more cautious about the timing of future policy-rate hikes.
- “Household spending has continued to rise moderately while business fixed investment has remained soft.” Further to the point above, the rise in household spending won’t be sustained if average wage growth stagnates. Meanwhile, the lack of business fixed investment remains a concern because it’s not as though companies don’t have funds available to invest. But is anyone surprised that U.S. businesses remain cautious in the current U.S. political environment?
- “Inflation increased in recent quarters but is still below the Committee's 2 percent longer-run objective.” In a recent speech, Fed Chair Yellen attributed the recent uptick in the U.S. inflation data to “the waning effects of earlier movements in the dollar, not upward pressure from resource utilization”. Put more simply, she attributes the recent rise in inflation to temporary factors, and that is significant because the continued lack of significant U.S. inflationary pressure allows the Fed to continue to focus on the health of the U.S. labour market when determining the timing of future policy-rate increases.
- “The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate … [but] the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.” While the Fed has made no secret of its desire to normalize its policy rate, it continues to emphasize a cautious, data-driven approach that could keep rates lower for longer than the growing legion of bond-market bears have been forecasting. To that end, the bond futures market pushed out its bet on the timing of the Fed’s next policy-rate increase from May to June after its latest statement was released last week.
Five-year Government of Canada bond yields fell three basis points last week, closing at 1.11% 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: The Fed’s latest statement threw some cold water on the idea that U.S. interest rates may be headed sharply higher this year. While it acknowledged some recent improvement in the economic data, the Fed did not sound overly concerned about inflationary pressures and continued to emphasize a cautious overall approach that should help keep Canadian mortgage rates at or near their current levels for the foreseeable future.
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