Monday Morning Interest Rate Update (March 19, 2012)

David Larock in Mortgages and Finance, Home Buying

Five-year Government of Canada (GoC) bond yields continued to surge higher last week so expect a fresh round of headlines predicting that the end of low mortgage rates is nigh.

While there is no denying that fixed-mortgage rates are heading up in the short term (I reviewed every client pre-approval in my pipeline late last week in preparation), today I will give you three reasons why I think the run up may be transitory.

Spring Market Demand

Canadian bond yields tend to spike in the spring each year and mortgage lenders and investors play a significant role in this annual trend. Many lenders increase their hedging in anticipation of a surge in spring-market mortgage demand (and sell GoC bonds short to do this), and institutional investors sell GoC bonds to ready their balance sheets for purchasing the increased supply of Canada Mortgage Bonds that inevitably follows.   

Here is an estimated breakdown of the spring market yield run-ups in five-year GoC bonds over the last five years: March 22 to May 30, 2007: +55 basis points, March 11 to June 9, 2008: +36 basis points, April 1 to June 16, 2009: +81 basis points, March 10 to April 23, 2010: +37 basis points, March 11 to April 11, 2011 (estimated): +50 basis points, March 6 to March 16, 2012: + 31 basis points.

In four of those five years (with 2009 being the exception) the end of the spring market run-up represented the peak for bond yields for the year.

Warm Winter Weather

David Rosenberg recently made some excellent points about the pervasive influence that an unseasonably mild winter can have on economic data. Here is his look at theU.S.data that have investor bulls so excited, with a warm weather perspective added (in the two examples, the effect on Canadian data would be similar):

• Consumer spending has rebounded but a material part of that uptick can be attributed to U.S. households spending $30 billion less on their heating bills. The impact of this temporary savings stimulus will fade as we enter the low-heating cost part of the year at the same time that higher gas prices must be absorbed into consumer budgets.   
• Recent U.S.job reports have been encouraging but the January and February data are always adjusted for ‘seasonality’, which is a technique used to smooth out the impact of cold, snowy weather on the numbers each year. This year’s data were still smoothed in the normal way, despite the fact that winter did not have its usual impact. Rosenbergestimates that the warm weather bounce accounted for about 40% of the job creation in both months, and when he adjusts February’s raw employment data to account for this, he gets a decrease of 400,000 jobs instead of the 227,000 increase that was so enthusiastically received by the market.  (One wonders what Canada’s moribund job data would have looked like using the same adjustment!)

The spring data are less affected by seasonal smoothing so we’ll get a truer picture of economic momentum in the coming months.

Global Economic Uncertainty

The euro zone’s Long-Term Refinancing Operation (LTRO) bought the region some time by shifting over $1 trillion in debt onto the European Central Bank’s balance sheet, but the region still seems headed for a deep economic slump. Investors are less fearful that the euro zone will suffer a complete financial meltdown but I think default risks in Greece, Portugal and most worryingly Spain will dampen some of their new-found optimism soon enough.

Also, while a more detailed analysis will have to wait until my next Quarterly Market Update, I think fears of economic slowdown in China have yet to be fully discounted by investors.  (Questions stemming from its record trade deficit in February provide the most recent example – that is not a misprint). 

The short-term spike in our GoC bond yields means that the much ballyhooed fixed-rate mortgage specials currently on offer might be withdrawn at any moment. Only a few lenders are including four-month pre-approvals as part of their rate specials, so be sure to ask about that feature (and the other fine print) before making your choice.

Variable-rate mortgage holders will note that the bond market is now betting on a Bank of Canada overnight-rate increase by the end of this year, as opposed to the rate cut they were pricing in not too long ago. We’ll keep our eye on this going forward but keep in mind that bond futures traders can be a fickle bunch.  

The bottom line: GoC bond yields have decreased whenever fears about overall market risk have intensified. I don’t think we’re done with the fear stage of the global economic recovery and if the warm winter weather has the market getting ahead of itself, increases in fixed-mortgage rates may be short lived.  

Of course, even if I’m right, that will be cold comfort for anyone needing a mortgage in the meantime, so if you’re actively looking for financing, lock in today’s fixed rates while you still can.

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