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Fixed Rates Move Up and Variable Rates Look Better By Comparison (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

Five-year fixed-mortgage rates moved higher last week as lenders continued to respond to the recent run up in Government of Canada (GoC) bond yields, which have risen from a low of 1.13% on May 1, 2013 to a high of 1.63% on June 12, 2013.

Fixed-mortgage rates have been at ultra-low levels for a long time, so it’s not surprising that the vast majority of borrowers have been opting for the comfort and familiarity of the ‘banker’s favourite’ five-year fixed term (here is a post I wrote that explains why I call it that). But after the recent increases to five-year fixed rates, I think there is an increasingly compelling case to be made for the variable rate instead.

Here are five reasons why I think the five-year variable rate is worth a fresh look:

1. For much of the past year, the spread between five-year fixed and variable rates was less than 0.25%, which meant that it would take only one increase by the Bank of Canada (BoC) to make five-year variable-rate mortgages more expensive than their fixed-rate alternatives. After the latest round of fixed-rate increases, this spread is now greater than 0.50%, which gives variable-rate borrowers a wider ‘margin of safety’ between variable and fixed rates.
2. If you’ve recently agreed to purchase a home or have a renewal coming up, you need a mortgage at a specific future date. If the vagaries of bond-market investors happen to push up five-year GoC bond yields at the same time that you need a mortgage, opting for a five-year fixed rate locks in that short-term yield spike for the next five years. Conversely, variable rates don’t move until the BoC raises its overnight rate and this happens much less frequently, and on a more measured and considered basis.
3. When borrowers dismiss the variable-rate option, the most common justification I hear is that they’re worried they won’t be able to afford future rate increases. Most of these same borrowers are surprised to learn that they can only qualify for a variable-rate mortgage if they prove that they can afford a doubling of rates over the next five years. That’s because lenders now qualify variable-rate applicants using the BoC’s Mortgage Qualifying Rate (MQR) which currently sits at 5.14% (here is a post I wrote that explains the MQR in detail). If you can pass the MQR’s stringent test, then you should feel confident that you can afford substantial, and even unlikely, future rate increases. Variable-rate mortgages also come with the option to convert to an equivalent fixed rate term at any time with no penalty. While the conversion rates offered by different lenders can vary widely, this free lock-in option gives you the ability to eliminate further variable-rate risk.

A Look Behind Canada’s Near Record-Breaking Employment Report (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

Last Friday the latest Canadian employment report was released by Statistics Canada and it smashed expectations. Not surprisingly, bond yields shot higher on the news and lenders increased their five-year fixed-mortgage rates shortly thereafter.

Let’s start by taking a look at the highlights from the latest employment report that got everyone so excited:

• Our economy added a total of 95,000 new jobs in May. This is the second highest single-month result in the last thirty-five years (the highest was 95,100 new jobs in August, 2002).
• Ontario accounted for roughly half of the new jobs with more than 50,000 new positions created.
• The private sector accounted for almost all of the new jobs, adding 94,600 net new positions.
• 76,700 of the new jobs were full-time positions.

The immediate investor response to this employment report was predictable. Markets are made at the margin and an employment report that comes in ten times higher than the consensus forecast can certainly be expected to push bond yields higher over the short term.

Investors were quick to speculate that a surge in our monthly employment data may be a signal that our labour market is entering a tightening phase. Since there is an 80%+ correlation between rising labour costs and rising inflation, higher interest rates won’t be far behind if this tightening trend comes to fruition. But does this sudden spike in employment signal the onset of higher inflation or is it just a one-off blip?

As I read about the details in the report, I began to suspect the latter. Here are the factors that led me to that conclusion:

Are Higher Mortgage Rates on the Way? (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

When the Bank of Canada (BoC) met for the last time before Governor Carney leaves for the Bank of England, it did not change its interest-rate bias as I had speculated that it might in last week’s post. In fact, the BoC’s commentary was a little more general and more vague than usual.

In the end, the Bank favoured a steady-as-she-goes approach as it begins to transition from outgoing Governor Carney to incoming Governor Stephen Poloz. With that in mind, I think it’s unlikely that Governor Poloz will make any significant changes to the Bank’s monetary policy right off the bat - so it now looks like the BoC’s upward interest-rate bias will be with us for a while yet.

The big story relating to Canadian mortgage rates last week was the continued surge in our five-year Government of Canada (GoC) bond yields, which have risen 33 basis points over the past month (from 1.15% on May 1, 2013 to 1.48% at close of business last Friday). To put that current yield level in perspective, over the past 12 months the five-year GoC bond yield has remained below 1.50% on all but a handful of days and we haven’t breached the 1.50% threshold since mid-February.

Marginal changes in bond yields are caused by many factors but I think the largest single influence on this recent GoC bond-yield run up has been a reduction in the fear premium that investors are willing to pay for AAA-rated assets that guarantee a return of capital. Fears of a systemic shock to the world economy, often referred to as a “tail-risk event”, have been on the wane of late. As a result, large institutional investors in search of greater returns have been rotating their massive portfolios out of ultra-safe, ultra low-rate government bonds and back into equity markets.

This selling pressure has pushed GoC bond yields up and we are now left to wonder whether this trend is just a temporary blip or the first signal that a long-term rise in our bond yields, and by association our fixed-mortgage rates, has now begun.

While there is no way to know for sure, if it’s true that the recent run up in five-year GoC bond yields is being primarily driven by diminished tail-risk fears then I don’t think we’ve seen the last of sub-1.50% yields.

Here is a look at the most pressing concerns that still surround the world’s four largest economies. These are the main reasons why I think that fear will push greed back out of the market’s driver’s seat before too long:

A Closer Look at Toronto’s Condo Market

John Pasalis in Toronto Real Estate News and Condo Buying

If you’re a condo buyer in Toronto it’s certainly tough to make sense of what’s really happening in the market. In the same day one can read a story about the condo market being on solid ground thanks largely to the strong demand for condo rentals followed by a story about the condo boom coming apart at the seams.

I thought it would be worthwhile to expand on a post I wrote last month on the condo market, this time taking a closer look at actual numbers to give readers a better picture of what has actually been happening in Toronto’s condo market over the past year.

While most mainstream media outlets focus on reporting changes in sales and average prices there’s actually a more important metric that gives us a more accurate picture of how balanced the market is. The sales-to-inventory ratio is one of the key metrics we use when analyzing the market because it takes both supply and demand into account giving us a more accurate picture of how balanced the market is.

To see how this works, imagine that 500 condos sold in April and at the end of the month there were 1,000 condos available for sale. In this case the ratio of sales (500) to inventory (1000) would be 50%. This level of balance between supply and demand is roughly what we are seeing in Toronto’s freehold market. There are not enough homes coming on the market for sale to meet the demand from buyers. This is why we are still seeing a lot of bidding wars for Toronto houses.

Now imagine in May sales dropped to 100 and there were still 1000 condos available for sale at the end of the month. In this scenario the ratio of sales (100) to inventory (1000) would be 10%. This level of balance between supply and demand is similar to what we are seeing in many US cities. Weak demand relative to the number of properties available for sale.

The market is considered to be balanced when the sales-to-inventory ratio is between 15%-25%. Anything above 25% favours sellers and below 15% is a buyer’s market.

The chart below shows the sales-to-inventory ratio for detached houses and condo apartments in the Greater Toronto Area.

Our Latest CPI Data Suggests That it’s Back to the Revising Board for the BoC ... Again (Tuesday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

Anyone keeping an eye on Canadian mortgage rates should pay close attention to the Consumer Price Index (CPI) which is released monthly by Statistics Canada. The CPI tells us whether average prices have increased or decreased over the past twelve months, and over time, changes in the CPI influence Bank of Canada (BoC) monetary policy more than any other economic measurement.

Before looking at the details in the latest CPI (released last Friday), let’s highlight a few phrases from the BoC’s oft repeated inflation-control strategy, which it includes at the front of each Monetary Policy Report (MPR).

• At the heart of its inflation-control strategy, the BoC believes that “that the best way to foster confidence in the value of money and to contribute to sustained economic growth, employment gains and improved living standards is by keeping inflation low, stable and predictable”.
• Further to that point, the BoC’s inflation-targeting approach is symmetric, meaning “that the Bank is equally concerned about inflation rising above or falling below the 2 per cent target”.

As you will see in a moment, that last phrase is critical in the current context. If the BoC’s monetary policy actions are primarily governed by the goal of steering inflation towards 2% over time, then current CPI trends clearly imply that the BoC’s next move in its overnight rate should be a decrease, rather than the increase it has repeatedly warned us about.

A Review of Our Latest Employment Report with Implications for Canadian Mortgage Rates (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

Anyone keeping an eye on Canadian mortgage rates should pay special attention to our Labour Force Survey (commonly referred to as our ‘employment report’), which is released by Statistics Canada each month.

The Survey gives us a bevy of useful information about whether and where our economy is adding jobs, whether average incomes are rising or falling, and whether the average worker is putting in more or less hours of work each month. Together, these factors combine to give us valuable insight into where our overall economic momentum is headed.  

Here are the data from the latest report, which was released last Friday, with some thoughts on its implications for Canadian mortgage rates:

• Our economy added 12,500 new jobs overall last month, almost bang on the 12,400 new jobs that we have averaged over the last six months. The federal government has hinted that over the near term the Bank of Canada (BoC) will lean its monetary policy more towards job creation than tight inflation control and the April employment data shouldn’t give them any cause to alter that approach.   
• The public sector added 34,200 new jobs in April. In other words, full-time government hiring was the only reason we added jobs over the past month. That’s an unsustainable trend that can’t be relied upon in this age of austerity-themed government budgets.
• The private sector lost 20,000 jobs in April and has now shed 105,400 jobs over the past two months. In fact, this sector has grown by only 0.1% over the past year so our current private-sector hiring slump is actually very well entrenched. This is a big concern because private-sector job growth and GDP growth go hand-in-hand, making it unlikely that we will see any real change in our overall economic momentum until private-sector hiring looks very different than it does today.

Has the Bank of Canada Discovered Life on Mars? (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

The Bank of Canada (BoC) left its overnight rate unchanged last week, as expected.

The Bank also released its latest Monetary Policy Report (MPR), which I read with great interest because it gives us the BoC’s views on the state of the world’s economies and includes projections for where the Bank sees foreign and domestic economic momentum headed over the next several years.

In a perfect world, the MPR would offer an unbiased assessment but bluntly put, that has not been the case for some time now. The BoC remains primarily concerned about our elevated household debt levels and continues to warn Canadian consumers about higher future interest rates. The Bank’s hope is that this form of ‘moral suasion’ will help counteract the natural effect that its ultra-low interest-rate policy is having on household borrowing. If successful, the BoC would be able to continue stimulating the rest of our small, open economy, which is needed in light of current global economic conditions, without fueling a household credit bubble as a by-product.

The challenge that the BoC has today when drafting its MPRs is that it must support its higher interest-rate warning with forecasts to match. This is where the tangled web that tries to connect the Bank’s warning to the hard economic data can be most plainly seen.

A pattern has emerged in the last several MPRs where the Bank downgrades its current data and near-term forecasts, unable to deny that our near-term economic momentum is slowing, but then offers more optimistic medium-term projections as an offset. This is a clever way of massaging the data because it allows the Bank to use a distant pickup in economic momentum as a way of continuing to justify its threat of higher interest rates, even while we are clearly still in the midst of an economic slump. Then, later, as the future unfolds and that momentum doesn’t materialize, the BoC simply adjusts its projections downward as they move nearer to the present day and makes new medium-term projections to fit as needed. Wash, rinse, repeat (and hope no one notices).

Toronto's Condo Market - Bubble or Balanced?

John Pasalis in Toronto Real Estate News and Condo Buying

Ever since the federal government reduced the maximum amortization on insured mortgages in Canada back in July 2012 we have seen a 17% decline in sales. For home buyers it’s been tough to make sense of what’s really happening in the market because different segments of the market (price range, location, housing type) have been behaving quite differently.

To make things even worse, home buyers have to find some way of separating fact from fiction in the daily news stories they read about Toronto’s housing market.

One news story this week titled “Is Canada’s condo boom coming apart at the seams?” stood out for being very misleading and clearly there to alarm rather than educate readers.

In it the writer highlights “some major flashing red lights” with the condo boom in some of Canada’s largest cities. His key concerns and observations with Toronto’s condo market:

In March, active condo listings for sale on the MLS rose 8 per cent over last year to hit a record high for the month. At the same time, condo sales slumped 18 per cent. Compounding this growing supply-demand imbalance is the 55,000 new condo units currently under construction in the city, the majority of which are set to hit the market through the rest of the year and into 2014.

First of all, suggesting that 55,000 condo units are going to be completed over the next 20 months is nothing more than a bubble theorist’s wishful thinking. Yes, industry data does show that nearly 55,000 condos are scheduled for completion by 2014 and only 5,000 units in 2015 and a mere 1,000 units in 2016. But we all know that a condominium’s scheduled completion date is very different from their actual completion date. I have three clients who just took possession of a condo this month that was scheduled to be completed in 2011. Many of the projects scheduled for completion in 2014 are no doubt going to be delayed and their closings will be pushed out to 2015 and even 2016.

How Japan's New All-in Monetary Policy Will Affect Canadian Mortgage Rates (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

Since the start of the Great Recession, Government of Canada (GoC) bond yields have been consistently pushed lower by wave after wave of troubling economic news from beyond our borders.

GoC bonds are part of a shrinking pool of available safe-haven assets and as economic fear and uncertainty have increased, so has the premium that international bond-market investors are willing to pay for those assets. Since our ever popular fixed-mortgage rates move in close relation to GoC bond yields, this fear premium has created a significant interest-cost saving for the majority of Canadian mortgage borrowers.Today, Japan is most responsible for recent increases in investor uncertainty. The Bank of Japan (BoJ) recently announced a new monetary stimulus package that would make even U.S. Federal Reserve Chairman Ben Bernanke blush (the same man who some have come to call Ben BernanQE). To put the latest announcement in perspective, consider that the BoJ’s balance sheet expansion will be equivalent to 30% of Japanese GDP over the next two years, as compared to the U.S. Fed’s expansion of 15% of U.S. GDP over the last five years. This is a radical and unprecedented shift from what had previously been a conservative central bank, and the impacts are already being felt around the globe.

The political pressure to do something of consequence in Japan was understandable. Thirteen years of essentially 0% policy rates have done nothing to reflate Japan’s low-growth economy and the BoJ has long been criticized for not providing enough monetary policy stimulus along the way. Recently elected Japanese Prime Minister Shinzo Abe was swept into office largely on a promise to right that perceived wrong and he has not disappointed his supporters, quickly appointing a new and compliant BoJ Governor, Haruhiko Kuroda, to do his bidding. But while Prime Minister Abe has won short-term political approval, he will ultimately be judged by the longer-term success or failure of his actions - and the ultimate outcome of these actions is far from assured.

March Employment Numbers Push CDN Bond Yields Down But U.S. Stagflation Threat Rising (Monday Interest Rate Update)

Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News

Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.

The latest Canadian and U.S. employment reports were released last Friday and the data in both came in well below expectations.  

U.S. and Canadian employment data should always be counted among the most important economic indicators for anyone keeping an eye on where Canadian mortgage rates are headed. In normal times, this is primarily because rising labour costs have an 80%+ correlation with rising inflation which then leads to higher mortgage rates. But in today’s world, the employment data in both countries take on an even greater significance. Here’s why:

• The U.S. Federal Reserve has stated that it will continue its current quantitative easing programs until U.S. unemployment reaches 6.50%, provided that U.S. inflation does not exceed 2.50%. (This unconventional and unprecedented level of monetary stimulus adds $85 billion to the U.S. Fed’s already bloated balance sheet each month.)
• Canadian Federal Finance Minister Jim Flaherty has said that the Bank of Canada’s near-term monetary-policy objectives should also be focused primarily on job growth. He introduced the term “flexible-inflation targeting” when explaining that short-term interest rates should be allowed to remain at ultra-low levels, even if that means letting the Consumer Price Index (CPI) temporarily rise beyond its 1% to 3% target range over the short term. Our recent inflation data don’t indicate that we will exceed this target any time soon, but Mr. Flaherty’s comments on the subject confirm that Canada’s near-term monetary-policy objectives are also focused on employment growth above all else.

Now that we have reaffirmed the importance of the employment data in both Canada and the U.S., let’s take a closer look at what was in the latest reports and draw out some of the implications: