Will Mortgage Rates Head Higher in 2015?

Dave Larock in Interest Rate UpdateMortgages and Finances

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The U.S. Federal Reserve issued its latest press statement last week and it didn’t leave me with the impression that it would raise its short-term policy rate in the near future, as some still expect it will.

The Fed’s timing matters to Canadian mortgage borrowers because the U.S. and Canadian economies are tightly linked, and as such, our monetary policies tend to move in the same direction over the long run, even though they can diverge for a period of time (as is expected to be the case if the Fed starts tightening any time soon).

Interestingly, while many economists think that the Fed will hike its policy rate as early as September, bond market investors are now pricing in only a 20% probability of that occurring.

One group has it wrong.

Here are five highlights from the Fed’s latest statement to help inform your opinion on who that might be, with my comments in italics:

  • “Economic activity has been expanding moderately in recent months”. It’s hard for me to imagine how signs of “moderate” growth in the midst of the slowest recovery since the Great Depression would inspire a shift to tighter monetary policy."

  • “Household spending has been moderate and the housing sector has shown additional improvement; however, business fixed investment and net exports stayed soft.” The cyclical parts of the economy are showing signs of improvement but that momentum won’t hold if businesses don’t invest in capacity expansion and productivity improvement, which they aren’t doing, even though they can almost borrow for free in the current market. Meanwhile, the spiking U.S. dollar has become a powerful headwind for U.S. exports, creating an impact that is akin to significant monetary policy tightening by the Fed. A rate hike would raise borrowing costs and give the Greenback more upward momentum, heaping still more suffering on U.S. exporters.
  • “On balance, a range of labor market indicators suggests that underutilization of labor resources has diminished since early this year”. This is encouraging, but it has also been a long time coming, and will the Fed risk choking off the economy’s hard-won employment momentum by tightening too soon? Especially when …
  • “Market-based measures of inflation compensation remain low; survey‑based measures of longer-term inflation expectations have remained stable.” The Fed’s most sacrosanct mandate is to maintain price stability, and if inflation stays benign this gives the Fed the leeway it needs to stay cautious. Which it pretty much telegraphed in its closing statement …  
  • “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” The Fed closed its latest statement leaving no doubt that it will err on the side of caution. I think that’s because it believes that it can more easily counteract the problem of too much inflation if it keeps rates too low for too long, as opposed to counteracting disinflationary momentum if it tightens too quickly instead.

I think the Fed’s latest statement makes it unlikely that there is a September rate hike in the cards. In fact, I think the triple whammy of the spiking U.S. dollar, plummeting oil prices and uninspiring growth rates in most of the world’s other major economies make it increasingly unlikely that the Fed will tighten at all in 2015. (And given that the Canadian economy is teetering on the brink of a recession, the odds of a rate hike north of the border are even more remote.)  

Haven’t we seen this before? Like last year, and the year before that, and … you get the idea.

If past is prologue … when the Fed issues its September statement it will shift to more hawkish language in an effort to plant a modicum of doubt in the minds of lower-for-longer speculators. Wash, rinse, repeat.  

Five-year Government of Canada bond yields were flat last week, holding firm at 0.77% when markets closed 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 size of your mortgage and the terms and conditions that are important to you.

The Bottom Line: The Bank of Canada (BoC) has said that it expects to lag the U.S. Fed’s monetary-policy tightening timetable, perhaps for some time. If that happens, the Fed’s first rate hike will act as a kind of distant-early-warning signal to Canadian mortgage borrowers that a BoC hike is somewhere on the horizon … but even that signal seems to be fading off into the distance once again. Given that, I continue to expect that both our fixed and variable rate mortgages will remain at or near 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, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave

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