Dave Larock in Interest Rate Update, Mortgages and Finances
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Investors held their collective breath last Wednesday as they waited to learn whether the U.S. Federal Reserve would raise its short-term policy rate (called the “funds rate”) above 0% for the first time since December 2008.
The Fed funds rate is the single most important interest rate in the global economy. It is the Fed’s main monetary policy tool for controlling U.S. inflation and growth rates because it serves as the base rate on which all other U.S. interest rates are priced, either directly or indirectly.
Given that the Fed funds rate has a profound influence over the U.S. economy, which, along with China, has been the world’s main economic growth engine for decades, and given that bond yields in many other countries are significantly influenced by U.S. bond yields, any change in the Fed funds rate initiates a cascading impact that permeates throughout the global economy.
This impact is keenly felt in Canada, where our Government of Canada (GoC) bond yields have moved in lock step with their equivalent U.S. treasury yields since the start of the Great Recession. This is why anyone keeping an eye on Canadian fixed mortgage rates should keep a watchful eye on the Fed’s policy guidance.
The continued improvement in U.S. economic data has convinced many investors that the Fed will finally start raising its funds rate at some point in 2015 and the Fed has, at times, helped foster this view through its carefully worded ongoing commentary. But does the Fed really want to raise rates, or does it just want to plant enough concern in investor’s minds to dissuade them from making risky, speculative bets based on a lower-for-longer view that might ultimately threaten the stability of the U.S. financial system? After all, this isn’t the first time since 2008 that markets have expected the Fed to raise the funds rate, and each time, at the eleventh hour, the Fed has stayed its hand and instead, adjusted the targets it uses to determine when monetary policy tightening will be appropriate. (The Fed is not only in charge of the interest-rate ball … it also owns the goal posts.)
Again last week, the Fed left its funds rate unchanged, and when I read Fed Chair Yellen’s most recent post-meeting press conference commentary I continued to find plenty of hints that the Fed has no plans to raise its funds rate for as long as it can delay and still maintain its credibility.
Here are some examples of Fed Chair Yellen’s comments that lead me to that view (with my comments in italics):
In a sign of just how cautious (and nervous) the Fed will be even when it eventually does tighten monetary policy, Fed Chair Yellen added the following reassurances:
Now let’s put the Fed’s most recent commentary in a Canadian mortgage-rate context.
Bank of Canada (BoC) Governor Poloz has repeatedly said that the BoC expects to delay its first overnight rate increase until well after the Fed begins raising its funds rate. This means that the Fed’s first rate hike will act as a kind of distant-early-warning-system which should give our well informed variable-rate borrowers plenty of lead time to prepare for rate rises here at home.
Furthermore, if investors believe that the Fed will adopt a cautious approach when it does finally start to tighten monetary policy, this should help keep U.S and Canadian bond yields in check, and in so doing, prevent our fixed-mortgage rates from spiking as part of a market over-reaction.
In summary, the Fed’s cautious commentary should help maintain the status quo and allow the U.S. recovery to continue on its current trajectory. Over the past seven years of this recovery, we have seen the Fed warn markets that interest rates will not stay at ultra-low levels forever when it perceived that investors were becoming complacent about rate risk, and conversely, to emphasize that it will take an exceedingly cautious approach to policy tightening when markets signal a belief that U.S. rate rises are imminent. Thus, the Fed is using its guidance to balance investor sentiment like a see-saw, making adjustments each time its delicate status-quo balance tilts either direction. With expectations of the Fed’s first rate hike now pushed farther off into the future, that balance appears to have once again been restored.
Five-year GoC bond yields fell by ten basis points last week, closing at 0.92% on Friday. Five-year fixed-rate mortgages are offered in the 2.49% to 2.59% range, and five-year fixed-rate pre-approvals are available at rates as low as 2.69%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range depending on the terms and conditions that are important to you.
The Bottom Line: The Fed used its latest market commentary to counteract the belief that it will begin tightening monetary policy in the very near future. Instead, it emphasized that it will use caution when timing its first rate increase and also when determining the extent and duration of its overall tightening cycle. This approach implies that both our fixed and variable mortgage rates should remain at or near their current levels for some time to come.
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: integratedmortgageplanners.com/blog Email Dave