Monday Interest Rate Update

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

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Happy New Year indeed.

Markets are up, bond yields are rising and there is renewed optimism about
the green shoots of economic recovery in the air. (Yes Virginia, there is a
Santa Claus.)

The U.S. government swerved at the last minute to avoid the dreaded fiscal
cliff, the latest U.S. and Canadian employment data were once again solid and we
haven’t heard much out of Europe lately. Right? Well, before I start passing
around the “This Time It’s Real Recovery Kool-Aid” and warning about higher
mortgage rates, let’s first look back at some recent history.

Each of the last several years has begun with a wave of optimism that in
retrospect has been based largely on the hope that the global economic situation
was no longer deteriorating, with some decent data sprinkled on top for good
measure. It’s as if our collective consciousness now wakes up each January and
temporarily convinces many of us that everything will soon be back to normal,
only to have reality slowly reassert itself as the weeks roll by.

Are we really standing on the precipice of a legitimate economic rebound or
is all of this hoopla just another round of what has now become an annual rite
of winter?

If the recent past is prologue, by the time the snow melts we will once again
be reconciling ourselves to the fact that we are still at the end of a global,
decades-long debt super-cycle and that we have only just begun the long period
of deleveraging that must inevitably follow. The strong tailwind that debt
accumulation has provided for global economic growth for as long as many of us
can remember is now being converted into a strengthening headwind of debt
reduction – and this trend will govern, and limit, at least the western world’s
economic prospects for years to come.

Let’s revisit some of the recent headlines from a more discerning and
sceptical perspective:

The U.S. Fiscal Cliff

In August 2011, the U.S. Treasury needed Congress to raise its debt ceiling
limit so it could continue to borrow to finance U.S. federal government
spending. But with federal debt and deficit levels soaring to record highs each
month the debt ceiling issue became a political football and the threat of the
limit not being raised, and of a subsequent default by the U.S. federal
government, became increasingly real.

At the eleventh hour a compromise was reached, but only just. The
debt-ceiling limit was raised in conjunction with the passage of the Budget
Control Act and signed into law by U.S. President Barack Obama on August 2,
2011. This Act required Democrats and Republicans to approve a plan to balance
the U.S. federal budget (over time) by no later than December 31, 2012. In an
attempt to give both parties a powerful incentive to come to the negotiating
table the Act included draconian across-the-board tax increases and spending
cuts that would come into effect if no compromise were reached by the deadline.
This became known as the “fiscal cliff”.

There were 516 days between the passage of the Budget Control Act and the
fiscal cliff deadline and with only three hours to spare, the U.S. Congress
passed the American Tax Payer Relief Act. Everyone breathed a sigh of relief as
the threat of fiscal-cliff chaos appeared to have been avoided and the stock
market rallied while bonds sold off. But is the U.S. economy really out of the

The fiscal cliff may have been the focus of attention but it was merely a
symptom, not the cause, of what ails the U.S. economy. The real problem is that
the U.S. federal government simply cannot continue to tax and spend at anything
close to current levels.

Consider the following:

  • The U.S. Congressional Budget Office (CBO) estimated that the fiscal cliff
    would cut spending by approximately $671 billion in 2013 and that this would
    reduce GDP by approximately 4.2% over the same period (plunging the U.S. into
  • The just finalized American Tax Payer Relief Act prevented the U.S. economy
    from going over the fiscal cliff but still comes with tax increases and spending
    cuts that are estimated to reduce U.S. GDP by 1.4% in 2013. For an economy that
    is barely growing, this could still tip the U.S. economy into recession.
  • If Congress doesn’t come up with an alternative proposal to reduce spending
    by March 1, 2013, the U.S. Budget Control Act will trigger automatic spending
    cuts of $110 billion/year for the next nine years. Think of this as a “fiscal
    ledge” instead of a cliff, but remember that these cuts will come on top of the
    tax increases and spending cuts already being implemented under the American Tax
    Payer Relief Act.
  • Around March of this year, the U.S. Treasury will once again hit its debt
    ceiling. After the most recent elections, President Obama believes that he has a
    mandate to increase taxes on the rich to fund entitlement programs. Meanwhile,
    the newly elected Republicans believe they have a mandate to drastically reduce
    spending and avoid any increase in taxes. The debt ceiling issue is bound to get
    contentious and when it does, it will become obvious that the recent fiscal
    cliff compromise was not a solution but merely another swift kick of the can
    down the road.
  • Just how unsustainable is the U.S. federal budget? The U.S. CBO projects
    that at current levels of spending and taxation, by 2025 the U.S. federal
    government will need every dime of its total revenue to cover just the cost of
    its entitlement spending programs and its debt-servicing payments (and that’s at
    today’s interest rates). And what would it take to fix the projected imbalances?
    The IMF recently estimated that it would take an immediate and permanent 35
    percent increase in all U.S. federal taxes and a 35 percent cut in all federal
    benefit programs for the U.S. federal government to meet its long-term
    obligations. Anyone want to bet on a smooth transition between here and

The Canadian and U.S. Employment

The U.S. economy added 155,000 new jobs in December and full-time employment
increased by 200,000, with previous employment reports also revised upwards by
another 14,000. While this latest result was slightly above trend (as compared
to the current six-month average), 155,000 new jobs barely keeps up with U.S.
population growth and, on a related note, average incomes increased by only
0.3%. With the modest new tax increases and spending cuts soon to be
implemented, and more the horizon as far as the eye can see, it will be a real
challenge for the U.S. economy just to maintain today’s mediocre levels of job

The Canadian employment data for December provided much more of an upside
surprise, showing another 39,800 new jobs (41,200 new full-time jobs) for the
month, on top of 59,300 new jobs in November. This surprised our economists
because it runs counter to most of our other recent economic data which have
implied slowing economic momentum. The disconnect between our jobs reports and
our other economic data can only be a temporary phenomenon - sooner or later our
jobs data will have to converge with other measures, like GDP growth, and so far
there is broad agreement that the jobs data is the outlier.

Mortgage borrowers who are worried that another strong jobs report might put
upward pressure on labour costs (thus fueling higher inflation that will then
lead to increased mortgage rates) can take comfort in the fact that wage growth
has actually been moderating, despite a tightening labour market. While
continued job-creation strength will eventually push labour costs higher, we
aren’t seeing evidence of this so far.


This post has already run long so today I will be brief on the Europe file.
Suffice it to say that we will be talking again about the euro zone’s problems
soon enough. Spain still needs a bailout, Greece needs another haircut (or two)
and France, whose economy has mysteriously defied gravity for much longer than
most economists have expected, will have its day of reckoning in the not too
distant future. Stay tuned.

Five-year Government of Canada (GoC) bond yields have risen ten basis points
since my last post on December 17th and closed at 1.47% last Friday.
Several lenders increased their five-year fixed-mortgage rates last Friday and
while sub-3% rates are still available, anyone who has a fixed-rate mortgage
negotiation on the horizon should be locking in as soon as possible.

Variable-rate mortgage discounts can still be found in the prime minus 0.40%
range (which works out to 2.60% using today’s prime rate). While that’s only a
shade below equivalent five-year fixed rates, if you believe that the Bank of
Canada (BoC) will be compelled by global events (particularly the U.S. Federal
Reserve’s monetary policy) to keep rates low for years to come, then today’s
variable rate presents an attractive option. The key, if you choose to go this
route, is to either keep a close eye on economic events that affect
variable-mortgage rates on an ongoing basis, or to partner with an experienced
mortgage planner who will do this for you.

The bottom line: I think the optimism that is pushing bond yields
higher at the moment will be short lived, mainly for the three reasons listed
above. That said, if you need to negotiate (or re-negotiate) mortgage financing
in the not-too-distant future, you are well advised to lock in today’s rates as
soon as possible to protect yourself against any further short-term spikes in
bond yields.

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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