This is primarily being caused by higher Government of Canada (GoC) five-year bond yields, and as best as I can tell, yields are moving higher because investors are more optimistic about the strength of the U.S. recovery and are less concerned about euro-zone crisis risks. I believe this short-term trend is only a contrary blip in my long-term view of where mortgage rates are headed, but the current momentum in our five-year GoC bond yields should not be ignored by anyone planning to buy a house this spring.
Predicting the future of mortgage rates is a tough job at the best of times, but the longer you look into the future, the better chance you have of being right more often than wrong. With that in mind, here is a detailed explanation of why I think today’s market optimism (and the consequent rising interest rates) will be short lived:
The U.S. Situation
- While U.S. consumer spending has rebounded, the U.S. savings rate has been dropping. If consumers were spending more because they were earning more, that would indeed be a positive sign. But when increased spending comes from decreased savings, the economic benefits are transitory and on balance, the long-term impact is negative. The drop in the U.S. savings rate accounted for $150 billion in additional consumer spending in the second half of 2011 and without that boost, U.S. consumer spending would have actually contracted.
- Gas prices dropped precipitously in the second half of 2011 and the overall economic benefit from that cost savings was about $80 billion. That savings was equivalent to the average U.S. consumer getting a 4% pay raise for the year (David Rosenberg). Gas prices are expected to increase in 2012 (substantially so if the Iran situation escalates), and that will convert a strong tailwind in 2011 to a powerful headwind in 2012.
- U.S. unemployment levels have edged down recently but the official U.S. unemployment number only counts people who are actively looking for work. If unemployed workers who have given up looking for work were also counted, the unemployment rate would be closer to 16% (versus today’s official rate of about 8%).
- While the last U.S. jobs report showed 243,000 new jobs being created, many of those were in lower-paying industries. If average U.S. income levels fall, overall consumption has to adjust. When you consider that consumer spending accounts for about 70% of the overall U.S. economy, the long-term impact of this trend starts to come into focus.
- The U.S. recovery, tepid as it has been, has coincided with massive federal-government stimulus and unprecedented action by the U.S. Federal Reserve. If the U.S. economy were to experience another slowdown (entirely possible when you consider that U.S. economic activity has historically had a 70% correlation with European economic activity), the U.S. government and the U.S. Fed will have far less ammunition to fight it off.
There are many other points that I would make to support my view that the U.S. economy is not doing as well as many believe (recent data skewed by abnormally warm winter weather, U.S. economic growth being driven by a steep rise in inventories, the looming impact of huge public spending cutbacks), but I will save those points for my next Quarterly Mortgage Market Update.
The Euro-Zone Situation
- Even though Greece will receive its next bailout, the austerity reforms that accompany it will have to be implemented in the midst of a grinding recession with a national election coming in the spring. While investors react positively when one week is better than the last, on an overall basis Greece’s long-term prospects remain terrible.
- Portugal’s economic path over the last year has closely tracked Greece’s previous path. If this trend continues, Portugal will be Greece 2.0. The markets seem to be discounting the risk of a Portuguese default. For now.
- Italy has to refinance an average of more than $5 billion in debt per week throughout 2012. If the euro-zone crisis escalates and bond yields spike, Italy will feel the effects immediately and the danger of another Italian debt spiral could reappear in short order.
- Spain’s economy is in worse shape than many thought. Even if Spain had a 0% interest rate on all of its debt, the country would still be spending more than it is taking in. When you add in a realistic interest rate to Spain’s sputtering economy and its deep and prolonged housing slump, it’s not hard to imagine investors running from Spanish debt like it’s a Pamplona bull.
- The European Central Bank (ECB) bought time when it made $600 billion in loans to European banks last December, but no one knows what the long-term impacts of this emergency measure will be. If all those loans did was postpone the death of zombie banks, the ECB’s short-term relief will have come at the expense of long-term growth (see Japan, 1991 to present).
These points don’t cover some recent troubling signs from Germany’s economy, the danger that French banks are in more trouble than is widely believed, or whether or not a populist revolt against German-led austerity measures will undermine the euro zone’s latest efforts when the politicians who agreed to them face re-election. I don’t want to sound all doom and gloom here. My goal is simply to justify my belief that the wave of market optimism that is driving fixed-mortgage rates higher will be tempered by some cold hard reality over time.
Five-year Government of Canada bond yields were up 5 basis points for the week and closed at 1.45% on Friday. Several lenders have raised their five-year fixed rates and while you can still find a five-year rate at a shade over 3%, market rates are back in the 3.39% to 3.49% range.
Variable-rate mortgage holders are not affected by short-term changes in GoC bond yields. Variable rates are based on the Bank of Canada’s (BoC) overnight rate, and BoC Governor Mark Carney is not likely to increase the overnight rate if he sees a short-term run up in GoC band yields that isn’t supported by a material change to our long-term outlook.
The bottom line: While fixed-term mortgage rates will probably head higher over the short-term, I think this rise will be based more on short-lived optimism and not on any meaningful change in the global economic picture. If we avoid a tail-risk event that drives all rates higher with a systemic shock, I think our ultra-low mortgage rates will be around for a while yet.
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
February 21, 2012Mortgage |