Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News
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Cyprus is a tiny country that accounts for only 0.2% of the euro zone’s economic
output and its finances are broken beyond repair.
Given its small size, the temptation to use Cyprus to set a tough new
precedent for future euro-zone bailout proposals is understandable. This is
especially true for German Chancellor Angela Merkel, who will stand for
re-election in September and who needs to re-establish her austerity-at-all-cost
credentials with German voters after repeatedly compromising on bailout
deadlines for the euro zone’s larger countries.
From that perspective, last weekend’s bailout proposal was just what the
Chancellor Merkel’s political strategists ordered. It came with the toughest
bailout provisions yet, including an unprecedented requirement that Cypriot
deposit accounts with balances of less than 100,000 euros be charged a one-off
tax of 6.50%.
This proverbial pound of flesh was supposed to reassure German voters that no
one in the euro zone’s profligate peripheral countries would be immune from
consequences of over-indebtedness. But the same principal that was designed to
sell well on the German campaign trail also threatens to undermine all of the
euro-zone leader’s confidence-restoring efforts since the financial crisis
began. Ironically, the decision to introduce the threat that small-scale bank
depositors could lose part of their savings in future euro-zone bailouts has
almost certainly raised the cost of future bailouts for the same German voters
that this policy was intended to appease.
The euro-zone crisis essentially comes down to a lack of investor confidence
in the ability of several countries to honour their financial obligations.
Mounting debt and deficits have combined with slowing economic growth to erode
investor confidence, and it has taken huge balance-sheet commitments by the
European Central Bank (ECB) to restore some measure of calm to euro-zone bond
markets. (Since Germany is by far the strongest backer of ECB debt, the ECB’s
commitments are largely German commitments.) Massive ECB programs like the
Long-term Refinancing Operation (LTRO) brought the euro-zone crisis back from
the brink and bought time for the euro zone’s notoriously slow-moving leaders.
But in the interim, little real progress has been made and the euro-zone crisis
has remained one shock away from being pushed right back to its breaking
Enter last weekend’s Cypriot bailout proposal, which may ultimately prove to
be the proverbial grain of sand that triggers the next euro-zone banking crisis
in much the same way that the assassination of little-known Archduke Franz
Ferdinand in June of 1914 set off a string of events that led to World War I. If
small scale depositors in Spain, Italy, Portugal and Ireland now worry that
their savings accounts are in danger, as they should, we could see line ups at
their banks that will resemble the gas-station line ups in the U.S. at the
height of its 1973 oil crisis.
It may not happen right away but when Spain finally asks for its bailout,
which I believe it inevitably will, I expect those bank lines to start forming.
If they do, the ECB will have no choice but to bolster government and bank
balance sheets at a cost that will make the seventeen-odd billion euros that it
will take to save Cyprus from collapse look like a mere rounding error.
In the end, the Cypriot parliament voted to reject the euro zone’s proposal
last week and yesterday a new proposal that didn’t include a haircut for small
scale bank depositors was agreed to. But end-user confidence in the euro-zone
banking system has been irrevocably undermined.
Five-year Government of Canada (GoC) bond yields were five basis points lower
for the week, closing at 1.32% on Friday. Five-year fixed-rate mortgages are
widely available at well below 3.00% rates and ten-year fixed rates remain well
Five-year variable-rate mortgages are still offered in the prime minus 0.40%
range and as more and more lenders drop their rates to compete for these
borrowers, additional rate discounting may follow.
The Bottom Line: We may well see a short-term rise in GoC bond yields
as the immediate threat of a Cypriot default abates and as investors sell off
some of their safe-haven debt in response. Even so, this short-term change in
bond-yield momentum should not lead to a rise in our fixed-mortgage rates. That
isn’t likely to happen until investor greed outweighs investor fear and that day
still seems a long way off.
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