Bond-market yields yo-yoed last week, with more subdued comments from the Bank
of Canada (BoC) pushing them down last Wednesday before strong employment
reports from both the U.S. and Canada pushed them higher on Friday.
When the BoC met last week, it kept its overnight rate unchanged at 1.00% as
expected. In its accompanying commentary the Bank softened its interest-rate
guidance once again, saying that “the considerable monetary stimulus currently
in place will likely remain appropriate for some period of time, after which
some modest withdrawal will likely be required”.
Here are my key takeaways from the Bank’s latest statement:
- The BoC offered a more optimistic view of global economic growth, thanks
largely to improving conditions in China, and it attributed the fourth-quarter
slowdown in our domestic economic momentum to a decline in inventories. This is
noteworthy because a slowdown that is caused by a reduction in inventories can
be transitory if businesses subsequently increase their production and replenish
their stockpiles quickly.
- The BoC statement referred to “a more constructive evolution of imbalances
in the housing sector”. This means that the Bank is now less concerned about the
risk of housing and credit bubbles. That is significant because BoC Governor
Mark Carney has repeatedly referred to rising household debt levels as the
greatest threat to our domestic economy.
- The BoC said that “inflation has been somewhat more subdued than projected
in the January MPR”, acknowledging that it once again overestimated our rate of
inflation in its forecasts. The most recent Consumer Price Index (CPI) for
January showed year-over-year inflation of a mere 0.5% and this is well below
the “medium-term inflation rate of 2%” that the BoC believes it must achieve to
maintain price stability. Some bond-market investors have been betting that our
economy’s current disinflationary trend will force the BoC’s hand, requiring it
to lower rather than raise its overnight rate in response. This belief was
bolstered by the Bank’s reference to “material excess capacity in the
Bond-market investors reacted to the BoC’s latest statement by pushing bond
yields lower, believing that the Bank was projecting a more subdued growth and
inflation outlook. But then the latest Canadian and U.S. employment reports were
released on Friday and optimism quickly returned.
The headline Canadian and U.S. employment numbers were impressive.
Canada added 50,700 new jobs in February, with average hours worked
increasing and average incomes rising faster than our rate of inflation. Most of
the newly created jobs were for full-time private-sector employment and many of
them were of the higher-paying service-sector variety.
The main concern associated with this strong employment report is that it
doesn’t jibe with any of our other macro-economic data, which indicate that our
economy has hit a soft patch and is dangerously close to stall speed. As a
result, the experts I read think that this short-term disconnect cannot continue
and they expect our employment numbers to soften in the coming months.
Conversely, the strong U.S. employment data are more consistent with other
U.S. macro-economic data, which indicates that the U.S. economy is gaining
momentum. For that reason I think it was the U.S. employment data, more than our
latest domestic report, which pushed Canadian bond yields higher on Friday.
The U.S. economy gained 236,000 new jobs in February, exceeding consensus
expectations of 165,000 new jobs for the month. The gains were spread across the
private market in both the manufacturing and service sectors. Average hours
worked and average incomes both rose, and the U6 unemployment rate, which is
considered a broader and more accurate measure of U.S. unemployment, fell to
14.3% which is the lowest it has been since last summer.
While the latest U.S. employment report certainly offered some much-needed
encouragement for our exporters, I don’t think the rally it triggered in our
bond market last week will be sustained. That’s because this enthusiasm was in
large part caused by the numbers exceeding the now ultra-low expectations bar
for U.S. employment. Consider the following:
- The U.S. economy has lost approximately nine million jobs since the start of
the Great Recession and despite record amounts of federal government stimulus
for the last five years and counting, current U.S. employment has not recovered
to anywhere close to its pre-recession levels.
- There have been 5.8 million fewer Americans working full time and 2.8
million more Americans working part time since the start of the Great Recession.
This is consistent with a worrying long-term trend: higher-paying jobs being
replaced by lower-paying jobs.
- The U.S. labour force participation rate, which measures the percentage of
the total eligible work force that is currently employed, now stands at 63.5%.
This is the lowest the participation rate has been in thirty years.
- Of the total U.S. unemployed, 40% have now been out of work for more than
one year and chronically unemployed people are much harder to re-integrate into
the work force.
- The U.S. economy will have to average the 236,000 new jobs we saw in the
February employment report for the next year and a half in order to reach the
U.S. Federal Reserve’s target of 6.5% unemployment by 2015 (and that assumes
that the historically low participation rate remains largely unchanged). In
other words, the U.S. economy still has a huge amount of labour capacity to
absorb before its labour costs will be putting any significant upward pressure
Bluntly put, I’m all for a little enthusiasm, but let’s temper it with a bit
of the salt provided above.
Five-year Government of Canada (GoC) bond yields finished eight basis points
higher for the week, closing at 1.38% on Friday. Spring market mortgage-rate
competition between lenders was unaffected by last week’s bond yield volatility
and five-year fixed rates are still widely available at rates below 3.00%.
(Apologies to Federal Finance Minister Flaherty who is trying to convince
lenders that five-year fixed-mortgage rates should stay above 3.00%, market
forces and bond yields be damned.)
Variable-rate mortgage discounts were unchanged for the week and can still be
found in the prime minus 0.40% to prime minus 0.45% range.
The Bottom Line: I think the latest round of investor optimism that
was triggered by Friday’s Canadian and U.S. employment reports will be short
lived. In the end, I believe that last week’s more cautious interest-rate
commentary from the BoC will prove, in the fullness of time, to have provided us
with a more telling indication of where mortgage rates are headed for the
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