Monday Morning Interest Rate Update (May 14, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

Rate Sheet (May 14, 2012)Last week’s big news came from our latest employment report, which showed that the Canadian economy added 58,000 new jobs in April – a multiple of the 10,000 or so jobs that most analysts were expecting. Better still, if we add this impressive result to the 82,000 new jobs that were created in March we get the best two-month run for job creation that our economy has seen in more than thirty years.

The nature of the jobs was also encouraging, with 85,800 new private sector jobs more than offsetting 19,200 fewer public sector jobs for the month. As our various levels of government continue to shrink their budgets and reduce the size of their labour forces, we will need our private sector to drive job creation for the foreseeable future.

(As an aside, the April report included an interesting comparison between the Canadian and U.S. employment rates, which are normally calculated using different methodologies. The report rejigs the Canadian employment data using the U.S. formula and the resulting “apples-to-apples” comparison puts our employment rate at 62.6% versus the overall U.S. employment rate of 58.4%. That’s a significant gap that helps explain why Canada has now replaced all of the jobs it lost in the 2008-09 recession while the U.S. economy is still more than 5 million jobs short of its pre-recession peak.)

Bond market investors who bet on the future direction of our short-term rates reacted to the second positive Canadian jobs report in a row by pricing in the 100% probability of a .25% increase in the Bank of Canada (BoC) controlled overnight rate by December of 2012 (Reminder: variable-mortgage rates are based off of the BoC’s overnight rate).

But that enthusiasm has not yet spilled over into our longer-term Government of Canada (GoC) bond yields, which barely moved on Friday (Reminder: five-year fixed-mortgage rates are based off of GoC five-year bond yields).

While short-term bond traders are a notoriously fickle bunch, investors who trade the longer end of the rate curve tend to adjust their views more gradually. Here are some thoughts on why they are still taking a wait-and-see approach to the possibility of higher rates:

  • The Canadian economy saw six months of moribund job growth before the robust March and April rebound. Our combined job growth over the last eight months now puts us in line with our long-term average growth rate.
  • While the job creation data was strong, growth in average incomes is still barely keeping pace with inflation and this means that the purchasing power of the average Canadian is largely unchanged.
  • The upbeat hiring numbers stand out against a backdrop of otherwise less-than-impressive economic data. Our current GDP growth rate is cause for the greatest concern - we are well below the 2.5% level that the BoC was forecasting when it predicted that our economy would return to full capacity in early 2013 and consensus estimates for first-quarter GDP growth are now in the 1.3% to 1.6% range. If the economy doesn’t start growing faster, our recent jobs momentum won’t be sustained.
  • Much was made of last week’s CIBC report showing that year-over-year household credit growth has now slowed to 5% (its lowest level since late 2001). Given that Governor Carney has referred to our rising debt levels as the “biggest risk” to our economy, reduced rates of borrowing should make it less likely that he will raise the BoC’s overnight rate as an emergency response to reign in rampant borrowing. Also, while less borrowing reduces the risk of a debt bubble, it also lowers demand and acts as a headwind against both future job creation and economic growth.
  • Many investors are expecting more bad news from the euro zone where Greece can’t form a pro-bailout government and Spanish ten-year bond yields are back within a sniff of 6%, and from the U.S., where the strength of their economic recovery is still very much up for debate.

We’ll get our next key data point this Friday when Statistics Canada releases its latest Consumer Price Index (CPI). While the market expects the April CPI to show slowing price inflation, which would make short-term rate increases less likely at the margin, BoC Governor Mark Carney made some pre-emptive comments last week to temper any overly-enthusiastic reactions to the report.

He warned that “inflation can be allowed to run below target for a longer period than usual if tighter policy is warranted”. In other words, he was reminding the market that below-target inflation will not stop him from raising rates to keep other risks in check, like rising household debt levels.

Five-year GoC bond yields were down 2 basis points for the week, notwithstanding a mild Friday rally in response to the latest jobs data. Five-year fixed rates are still offered in the 3.29% range for conventional borrowers who have down payments of at least 20% of the value of their property. High-ratio borrowers who have down payments of less than 20% can now find five-year fixed rates as low as 3.14%. While on first blush that looks like the less you put down the better your rate, when the cost of mandatory high-ratio default insurance is factored in, borrowers who put down less than 20% still pay more in the end.

I still don’t think today’s variable-rate mortgages are compelling with their very small discounts off prime and I explained that view in this recent Rob Carrick interview as part of his Let’s Talk Investing series.

The bottom line: On their own, the recent strong job reports suggest that higher mortgage rates may be on the way, but so far there hasn’t been a lot of other supporting data to bolster this view. That said, we’ll keep watching the tea leaves for any signs that make Mr. Carney’s words more likely to turn into action.

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 ( and on his own blog Email Dave

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