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Last week’s reports included a lot of new information that is relevant to Canadian mortgage rates. We received the U.S. and Canadian employment data for August and the Bank of Canada (BoC) met and offered its latest economic and interest-rate commentary. We’ll cover all of these developments in today’s post.
The Latest U.S Employment Data (for August)
The U.S. economy added 169,000 new jobs last month, fewer than the 180,000 new jobs the consensus was expecting. There were also revisions to the June and July employment data which reduced the number of new jobs created in those months by 74,000. While there is always volatility in the monthly employment data, there is no denying that momentum for U.S. job creation continues to slow - the most recent three-month average of 148,000 new jobs per month is much lower than the previous three month average of 172,000 new jobs each month.
U.S. employment trends would be closely watched by investors in any economic environment but they take on even more significance today because the US. Federal Reserve has tied the winding down of its quantitative easing (QE) programs to the health of the U.S. labour market. In that context, and on an overall basis, it seems the latest data should make the Fed less inclined to reduce the magnitude, if not the timing, of its initial QE taper.
Here are some other highlights from the latest report (SPOILER ALERT: It wasn’t all bad):
- The overall U.S. unemployment rate fell from 7.4% to 7.3% - but that’s because even more people gave up looking for work.
- To that end, the participation rate, which measures the proportion of Americans who are either employed or actively looking for work, fell to 63.2%, marking its lowest level in thirty-five years.
- Meanwhile, in a somewhat strange twist, the situation for those Americans who were gainfully employed actually got better. Average hours worked increase from 34.4 to 34.5 and while that might seem like a small change, David Rosenberg estimated that this increase in employment output is actually equivalent to the U.S. economy creating 400,000 new jobs for the month.
- Average earnings grew by 2.2%, which is the best increase in two years. If incomes are rising faster than the rate of inflation, that means that U.S. consumers have more purchasing power (and they account for about 70% of overall U.S. economic activity).
Thus, while the latest U.S. employment data show that the number of unemployed workers is rising, working Americans on average were actually better off by the time August was over. The key question everyone is asking now is: What does the Fed think about these new data?
The Fed has warned that it will taper its QE programs if U.S. economic momentum continues to strengthen and it has long said that it will use the health of the U.S. labour market as its single most important gauge. But how will the Fed square the fact that there are a record number of disaffected working-age Americans with the fact that those Americans who are actually working are putting in longer hours and are now seeing their incomes rise at a healthy pace? Which matters more?
My guess is that at this point, the massive overhang of unemployed working-age Americans, which is a long-term problem, matters more to the Fed than the healthy rise in average incomes, which so far has been much more of a short-term trend. Nonetheless, I still think that the Fed will taper because QE3 really hasn’t had much positive impact on the U.S. economy and because it has heightened credit-bubble and overall economic destabilization fears. But I think the initial taper will be of a token size, maybe even just enough to keep the percentage of overall U.S. treasuries bought by the U.S. Fed in line with recent trends. (As a reminder, the U.S. treasury will issue less debt for the remainder of 2013 because the U.S. federal deficit has shrunk. This means that the Fed can reduce, or taper, the amount of treasuries it buys while still maintaining the proportion of treasuries it buys relative to other investors.)
Given the still vulnerable state of the U.S. economy and the potential for an outsized market reaction when the Fed officially starts to taper, it’s hard to imagine that it will do anything more than what it feels it must to preserve any semblance of future credibility.
The Latest Canadian Employment Data (for August)
The Canadian headline employment number was much better, but here again, volatility is the watchword. Overall Canadian employment grew by 59,000 new jobs, which was well above what the consensus was expecting. That headline, however, like so many others, must be weighed in a broader context.
In July, overall employment declined by 40,000 jobs, meaning that we have averaged 10,000 new jobs over the last two months. Compare that to an average of 12,000 new jobs over the last six months (from February to August, 2013), and to an average of 29,000 new jobs in the six months prior to that (from August, 2012 to January, 2013), and a more accurate picture of a sharp slowdown in employment begins to emerge.
While the headline seemed to fuel a run up in bond yields last Friday, there was little follow through in the details. For example, most of the new jobs were either part-time or in the “self-employment” category, which is often associated with a weakening job market (because there is no measure of how many of those people are voluntarily self-employed).
It was encouraging that the Canadian employment data showed the kind of bounce back from the prior month that we hoped for after last month’s big drop, but longer-term trends indicate that it was nothing to get too excited about.
The Latest Bank of Canada Commentary
The BoC met last Wednesday and there was a collective yawn when it announced, to the surprise of no one, that it would leave its overnight rate unchanged. It has now been three years since the BoC last moved its overnight rate - the rate on which variable-mortgage rates are priced.
Here are the highlights from the BoC’s accompanying commentary with my comments in italics (apologies in advance for my irreverence):
- The BoC said that overall global economic momentum has “moderated”. Doesn’t that word sound so much more palatable than “slowed”?
- Recent U.S. economic data “point to slightly less momentum overall than anticipated”. We’re not in Kansas yet, Toto.
- The Bank believes that there are “early signs of recovery in Europe”. Still not sure if those are signs of economic rebirth or the final throes of a slowly dying and fundamentally flawed model. Time will tell.
- “Japan’s situation remains promising”. If “promising” means that Japan’s economic car is gaining speed, then yes, I suppose that is promising. Of course, the brick wall that Japan’s economic car is speeding towards (a.k.a. the increased carrying cost of Japan’s staggering public debt) is another matter altogether.
- “Uncertain global economic conditions appear to be delaying the anticipated rotation of demand in Canada towards exports and investment.” Are we surprised?
- “Household credit growth has continued to slow and mortgage interest rates are higher, pointing to a continued constructive evolution of household imbalances.” The bond market appears to be doing what Mr. Flaherty could not, try as he might.
- Inflation in Canada remains subdued. “Subdued” sounds less definitive than “virtually non-existent.”
- “A gradual normalization of policy interest rates can also be expected, consistent with achieving the 2 per cent inflation target”. We would like this sentence to instil confidence in businesses that rates will stay low long enough for them to invest in growth. At the same time we hope that our phrasing puts just enough doubt in consumers’ minds to keep them from increasing their borrowing levels any further. Please don’t ask us where businesses should expect their growth to come from if we want consumers to spend less at the same time as our export demand is declining.
Five-year Government of Canada (GoC) bond yields surged 18 basis points higher last week, closing at 2.13% on Friday. Lenders continue to increase their five-year fixed rates in response and market rates are now offered in the 3.59% to 3.79% range. As always though, borrowers who know where to look can do better.
Five-year variable-rate discounts are available in the prime minus 0.50% range (which works out to 2.50% using today’s prime rate). The recent spike in fixed rates is testing the courage of variable-rate borrowers who are watching the cost of their parachute (otherwise known as their fixed conversion rate) rise precipitously. For what it’s worth, I think that the factors leading fixed rates higher will take a long time to cause substantially higher variable rates and I am not advising my clients to lock in at this time.
In recent discussions I have offered the following take on the factors that have fuelled the recent run up in fixed rates: There is speculation that the U.S. will soon begin to significantly slow its QE programs (I think that tapering will be largely symbolic at the outset); we have seen a reduction in the fear premium that GoC bonds have enjoyed because of their “safe haven” status (which geopolitical risks in Syria and the next Greek bailout should have something to say about, to highlight just two examples of many); there is growing confidence in the U.S. economic recovery (which is still an open question with 90 million adult-aged Americans out of work and a looming debt-ceiling fight in Congress soon to play out); and some people are getting excited about the Canadian employment picture (which any credible look at longer-term trends should quickly quell).
My conversations with clients include more detailed examples, but this post provides some idea of why I continue to think variable rates are a compelling option, even at a time when the road ahead is somewhat less certain in the face of rising fixed rates.
The Bottom Line: The latest U.S. employment data indicate that the U.S. job market still needs a lot more time to heal. If the voting members of the U.S. Federal Reserve continue to believe that ultra-loose monetary policy is still necessary to help along this healing, then I expect both U.S. and Canadian short term interest rates (the ones our variable mortgage rates are based on), to stay at today’s ultra-low levels for the foreseeable future.
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