How Japan's New All-in Monetary Policy Will Affect Canadian Mortgage Rates (Monday Interest Rate Update)

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

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Since the start of the Great Recession, Government of Canada (GoC) bond yields
have been consistently pushed lower by wave after wave of troubling economic
news from beyond our borders.

GoC bonds are part of a shrinking pool of available safe-haven assets and as
economic fear and uncertainty have increased, so has the premium that
international bond-market investors are willing to pay for those assets. Since
our ever popular fixed-mortgage rates move in close relation to GoC bond yields,
this fear premium has created a significant interest-cost saving for the
majority of Canadian mortgage borrowers.Today,
Japan is most responsible for recent increases in investor uncertainty. The Bank
of Japan (BoJ) recently announced a new monetary stimulus package that would
make even U.S. Federal Reserve Chairman Ben Bernanke blush (the same man who
some have come to call Ben BernanQE). To put the latest announcement in
perspective, consider that the BoJ’s balance sheet expansion will be equivalent
to 30% of Japanese GDP over the next two years, as compared to the U.S. Fed’s expansion of 15% of U.S. GDP over the last five years. This is a
radical and unprecedented shift from what had previously been a conservative
central bank, and the impacts are already being felt around the globe.

The political pressure to do something of consequence in Japan was
understandable. Thirteen years of essentially 0% policy rates have done nothing
to reflate Japan’s low-growth economy and the BoJ has long been criticized for
not providing enough monetary policy stimulus along the way. Recently elected
Japanese Prime Minister Shinzo Abe was swept into office largely on a promise to
right that perceived wrong and he has not disappointed his supporters, quickly
appointing a new and compliant BoJ Governor, Haruhiko Kuroda, to do his bidding.
But while Prime Minister Abe has won short-term political approval, he will
ultimately be judged by the longer-term success or failure of his actions - and
the ultimate outcome of these actions is far from assured.

Interestingly, when BoJ Governor Kuroda announced the Bank’s most recent new
policy stimulus measures on April 4, Japan’s ten-year bond futures hit both a
twelve-month high and a twelve-month low on the same day. (I’m no stock picker
but GlaxoSmithKline, the maker of Tums, might just be in line for record sales
next quarter.)

The consensus is that the BoJ’s actions will produce two primary outcomes - a
depreciation in the Yen and an eventual rise in Japanese interest rates. Here
are the implications for Canadian mortgage borrowers if those developments come
to pass:

  • If Japan weakens its currency, other over-indebted countries which are just
    as desperate to increase their export sales will follow suit. The list varies
    from immediate neighbours like South Korea and China to countries as far away as
    Brazil and Switzerland (not to mention the U.S., which essentially got this
    whole beggar-thy-neighbour party started in the first place). The Bank of Canada
    (BoC) has stayed clear of this developing currency war and as such, barring a
    change in BoC policy, the Loonie can be expected to strengthen further as the
    global currency war plays out. This would make future BoC policy-rate increases
    less likely and would even open up the possibility of a BoC rate cut to
    counteract the Loonie’s continued strength.
  • If the BoJ achieves the 2% inflation rate that it has set as the target for
    its massive QE program, Japanese interest rates must eventually rise. Until now,
    90% of Japan’s government bonds have benn domestically held, primarily by aging
    members of the population. (These bond-market investors were previously content
    with 1% nominal interest rates because, in Japan’s deflationary environment,
    real return rates were still 2.5% to 3%). If Japanese inflation rises to 2%,
    those retirement-age investors would face heavy losses. This expectation has
    understandably triggered a massive sell-off in Japanese bonds and fueled a wave
    of new demand for safe-haven assets (like GoC bonds).

While there was an overwhelming political will in Japan to do something in
the face of their bleak economic prospects, Prime Minister Shinzo Abe should be
careful what he wishes for. After all, if your economy is heading towards a
brick wall, hitting the accelerator may produce a different result - but not
necessarily a better one.

Kyle Bass is considered by many to be the foremost Japanese investment expert
and he points out that if Japanese rates increase by only 2%, the interest cost
on Japan’s immense national debt will be equivalent to the Japanese government’s
entire tax revenue. As such, he believes that Japan’s new QE program has simply
accelerated its path towards eventual default. The BoJ can only counteract
market forces for so long – eventually those forces, and they alone, will
determine the true price of a Japanese bond.

Five-year GoC bond yields slid down another three basis points last week,
closing at 1.20% on Friday. These ultra-low GoC bond yields continue to
translate into rock-bottom fixed rates, with five-year fixed-rate mortgages
still widely offered at well below 3%. Will Federal Finance Minister Jim
Flaherty soon be calling international bond-market investors to chastise them
about their role in fostering sub-3% mortgage rates? I continue to think his
time would be better spent working on the much talked about new mortgage-penalty
disclosure rules that have been slow to materialize since first being promised
in the federal budget two years ago.

Five-year variable-rate mortgages are being offered in the prime minus .40%
to prime minus .45% range (which works out to 2.60% to 2.55% using today’s prime

The bottom line: Japan’s massive new quantitative easing program has
rattled bond-market investors to the point that it has even caused an increase
in demand for Italian and Spanish debt. (Further proof that risk is always
relative, I suppose.) It’s hard to believe that the euro-zone crisis is no
longer the foremost fear driving bond yields lower, but there you have it. I
guess Canadians will just have to live with these ultra-low mortgage rates for a
while longer.

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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