Is a Short-Term Spike in Fixed-Mortgage Rates Coming? Monday Morning Interest Rate Update (September 15, 2014)

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

Editor's Note: Monday Morning Interest Rate Update appears weekly on this blog - check back every Mon for analysis that is always ahead of the pack. 

Mortgage Update Pic

When the U.S. Federal Reserve meets this week, it is expected to adopt a more hawkish interest-rate stance in response to improving U.S. economic data. If that happens, U.S. bond yields will continue their recent rise and, given that Canadian bond yields have moved in lock step with their U.S. counterparts for some time now, an increase in our five-year fixed mortgage rates may follow.

The U.S. Fed finds itself in an increasingly difficult position. On the one hand, the Fed continues to tie its ultra-loose monetary policies to the strength of the U.S. labour market recovery, and the U.S. employment data still leave much to be desired. On the other hand, jobs data usually act as lagging indicators during recoveries, and other U.S. economic indicators seem to indicate that the U.S. recovery is now on a more solid footing. There is growing concern that the Fed will end up behind the curve if it waits much longer to start raising short-term interest rates. This could stoke inflation and ultimately force the Fed to raise rates sharply to catch up, dealing a harsh blow to U.S. economic momentum in the process.

The Fed also has an ongoing credibility issue to worry about. It has moved the goal posts it uses to estimate the timing of its next policy-rate increase several times already, and the longer the Fed waits, especially in the face of improving U.S. economic data, the more investors come to expect low rates to continue indefinitely.

To counteract this, over the past several years, every time U.S. investors become increasingly complacent about the threat of higher rates the Fed has issued some sort of warning to act as a check on group-think bubble psychology. This has triggered a short-term spike in bond yields that has been accompanied by tremors in the equity markets, followed by a ‘clarification’ from the Fed that then backtracks on its more hawkish language. If past is prologue, we should expect the same pattern to unfold this time.

I say this in part because I don’t think the Fed believes that the U.S. economy is ready for materially higher borrowing rates. While it’s true that the Fed has almost completely unwound its quantitative easing (QE) programs, the main objective of the third round of QE was to artificially suppress longer-term U.S. interest rates. That is still happening in spite of the Fed’s QE drawdown. David Rosenberg recently reported that the U.S. Fed, the Bank of Japan and the Bank of China have purchased more than 80% of all the new U.S. Treasury issues thus far in 2014, which means that these central banks are taking up the slack in demand for U.S government debt that QE3 would have otherwise left behind. Thus, the U.S. bond market is as hopped up on stimulus as ever, just with a slightly more opaque version.

So if you’re in the Fed’s war room at the moment your objective is to come up with language that puts a scare in the low-rates-for-longer crowd while hedging just enough to keep U.S. bond yields from surging higher. Talk about balancing on a knife edge!

If U.S bond yields spike over the short term, we should expect to see our fixed mortgage rates rise. But Bank of Canada (BoC) Governor Poloz has repeatedly said that the BoC will not raise its overnight rate as soon as the U.S. Fed increases its comparable policy rate, and I think he will remind markets of this in an effort to counteract any sustained upward pressure on our bond yields.

While it’s true that Canadian monetary policy cannot operate completely independently of U.S. monetary policy over the long term because our economies are so interlinked, today our overnight rate is 1% higher than the equivalent U.S. policy rate so we do have room to manoeuvre at the moment. In fact, BoC Governor Poloz will probably be happy to hear the U.S. Fed talk about raising its policy rate more quickly than previously expected. As the gap between the expected timing of increases in Canadian and U.S. short-term rates widens, the Loonie should weaken against the Greenback, and in so doing, make our exports more competitive in the process.

Five-year Government of Canada (GoC) bond yields rose twelve basis points last week, closing at 1.71% on Friday. Five-year fixed-rate mortgages are available in the 2.79% to 2.89% range, and five-year fixed-rate pre-approvals are offered at rates as low as 2.99%. Borrowers who are actively looking to purchase or refinance over the short term are well advised to lock in a pre-approval as soon as possible to mitigate the risk of short-term fixed rate increases.

Five-year variable-rate mortgages are available in the prime minus 0.75% to prime minus 0.60% range, depending on the terms and conditions that are important to you.

The Bottom Line: Expect to see GoC bond yields rise if the U.S. Fed adopts a more hawkish tone at its meeting this week as expected. This could well push our five-year fixed mortgage rates higher over the short term, but I think BoC Governor Poloz will be quick to remind markets that Canadian short-term rate increases are still a long way off, and that his words should help moderate any sustained upward yield and rate pressure. Stay tuned.       

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, Move Smartly, and on his own blog: Email Dave

Buying     |     Mortgage     |     Market     |    

Toronto’s most authoritative real estate insights, delivered right to your inbox.