Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News
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Over the past several years, bad economic news from the world’s
largest economies has meant good news for Canadian mortgage rates.
When
several euro-zone countries tottered on the brink of default, investors
responded by pouring their money into Government of Canada (GoC) bonds,
driving down these yields, on which our fixed-rate mortgages are based.
When
the U.S. Federal Reserve announced that it would initiate quantitative
easing (QE) programs to stimulate economic growth, investors once again
sought out GoC bonds. And why not? They offered higher yields than
equivalent U.S. treasuries; our federal government has the cleanest
balance sheet in the G7; our federal deficit is manageable (and
shrinking); and the printing presses at our central bank remain idle.
Then an eerie calm ensued.
Europe
quieted down in time for the German election … but the euro-zone’s
leaders didn’t use the lull to fix the structural problems that led to
the initial financial crisis. That makes their next crisis all but
inevitable.
The U.S. Fed’s stimulus programs have prolonged the
U.S. economy’s slow-growth momentum … but every new dollar printed
produces a diminishing benefit while fears about the U.S. Fed’s
unprecedented balance sheet expansion continue to grow.
Japan’s
three-pronged approach to pulling its economy out of its
two-decades-long slump finally got its GDP ticking upwards … but this
seems to have only temporarily drowned out that other ticking sound that
can be heard from Japan. That would be the ticking of its colossally
large debt-bomb.
Not surprisingly, as investor fears of sovereign
default and stock market crashes began to fade, investors started
rotating out of safe-haven bonds. In Canada, this caused GoC bond yields
to rise and our mortgage rates quickly followed. On June 3, I wrote this post
that explained why our mortgage rates were increasing and I made the
case that this run-up would not last. I closed with this prediction:
I
think this [bond yield] run up has been primarily caused by the growing
belief among investors that the world economy’s tail-risk threats are
subsiding but, in my view, the world’s largest economies continue to
face significant challenges. For that reason, I think our bond yields
will head lower again, and that history is likely to show that this was
really just a brief period of calm before the next storm.
Markets
are governed by only two primary forces: fear and greed. When fear
takes the driver’s seat, investors care more about return of their capital than they do about the return on their capital.
Well, fasten your seat belts folks because, once again, fear is about to take the wheel.
While
there are numerous simmering threats to our fragile global economic
momentum that could boil over, none will tip investors back into
full-blown fear mode faster than a sovereign-debt default. Both the U.S.
and the euro zone are again flirting with this risk. To wit:
- In the U.S., House Republicans have refused to approve a
much-needed spending bill unless both the President and the Democrat-controlled
Senate agree to suspend funding for Obamacare. Fat chance of that, and anyway, this
is just the warm-up fight. The real battle will be over the U.S. debt-ceiling
limit, which needs to be raised by the middle of October to keep federal
programs running. If the debt limit isn’t raised, U.S. GDP growth will stall
and many experts think the U.S. economy could be tipped back into recession
within a month. Once again, it appears that the threat of a U.S. debt default will
be used as a political football in an ideological debate where at least some of
the players involved seem willing to run the U.S. economy into the ground to
make their point. If they do, the rest of the world will be forced to pay a
steep price at an inopportune time. Very few countries have enough dry powder
left in their fiscal and monetary policy arsenals to stave off the global
damage that a U.S. default, or even the serious threat of one, would cause. - Angela
Merkel won re-election, and just in time, because Greece needs another
bailout and Portugal is queuing up behind it at the German cash window.
While Chancellor Merkel’s party won a near record 41.5% of the vote, her
traditional coalition partner in parliament failed at the polls and
that raises the prospect that the Chancellor will have less reliable
support from the new coalition partners she must assemble to produce her
majority. That support will be tested soon enough because the euro
zone’s imperilled countries can’t wait much longer for their next
bailout packages.
The U.S. threat is more immediate, but
most observers still agree with Winston Churchill that Americans
eventually do the right thing “after they have exhausted all the other
possibilities”. That said, does anyone doubt that many House Republicans
are determined to either repeal Obamacare or die trying?
The euro zone’s ongoing bail-out and default dance will probably be slower to get going again but for the reasons I listed in this post last year, I think the worst is yet to come. The euro zone’s march back into crisis mode has “inexorable” written all over it.
This
is not to say that I think Canadian bond yields will move straight down
from here. The U.S. Fed may have decided not to taper its QE programs
at its most recent meeting but the spectre of this development still
hangs over bond markets like the sword of Damocles. Early indicators
suggest that the U.S. employment report for September, which is due out
later this week, may be stronger than expected. If we see a surprisingly
strong report, investors could recalibrate their taper timing
projections and bond yields could once again surge higher. Over the
coming weeks and months, however, I think that the sound and fury
surrounding the taper will be drowned out by the more powerful and
systemically important euro-zone and U.S. sovereign default risks.
Five-year
Government of Canada (GoC) bond yields were twelve basis points lower
for the week, closing at 1.88% on Friday. We have now seen a twenty-four
basis point drop in the five-year GoC bond yield over the last two
weeks but despite this, most lenders have not yet dropped their
five-year fixed rates. While this delay is disappointing for fixed-rate
borrowers, it is not altogether surprising. To borrow a well-known
description of stock-price movements, mortgage rates also tend to take
the elevator on the way up and the stairs on the way down.
Five-year
variable rates are available in the prime minus 0.50% range, which
works out to 2.50% using today’s prime rate of 3.00%. If you find any
reasons why the Bank of Canada will raise its overnight rate (on which
our variable rates are based) for the foreseeable future, would you
please let me know? I keep looking for hints in the economic data but I
still can’t find any.
The Bottom Line: In the short term, I
think the latest round of U.S. budget brinkmanship will heighten
uncertainty and push GoC bond yields lower. Over the longer term, I
expect the slowly rekindling euro-zone crisis to eventually take the
fear baton from Uncle Sam. Both developments mean that we should see
lower fixed-mortgage rates on the horizon.
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
