Dave Larock in Interest Rate Update, Mortgages and Finances
Editor's Note: The Interest Rate Update appears weekly on this blog - check back every Mon for analysis that is always ahead of the pack.
Financial markets held their collective breath last Thursday as they waited to hear whether the U.S. Federal Reserve would raise its policy rate for the first time in more than nine years.
The Fed stayed its hand, as the market, but not most mainstream economists, had predicted. In its accompanying statement, the Fed cited global instability and a lack of inflationary pressures as its main justifications for continued monetary-policy caution.
Before we break down the Fed’s latest commentary, let’s recap why the Fed’s policy-rate changes matter to Canadian mortgage borrowers.
Had the Fed raised its policy rate, the U.S. dollar would most probably have surged higher, thereby lowering the cost to Americans of the exports we sell into U.S. markets while increasing the cost of the imports that we buy from our southern trading partners. The U.S. and Canadian economies are tightly linked, and Canadian provinces trade more with their neighbouring U.S. states than they do with their provincial counterparts. As such, changes in the U.S./Canadian exchange rate send ripples throughout our economy, creating winners and losers as the relative value of our currencies fluctuates.
In addition, while the Bank of Canada (BoC) has said that it will lag the Fed when it begins to tighten monetary policy, the BoC cannot decouple its monetary policy from Fed policy completely or indefinitely. Fed rate increases will hasten the arrival of the day when our own policy rate will rise, as distant as that prospect may still seem.
So it was with great interest (pun intended) that Canadians watched, and more importantly, listened to the Fed’s decision to hold rates steady based on its current assessment of the state of the U.S. and global economies. Here are my five key takeaways from the Fed’s latest commentary and analysis:
The Fed has now set a very high bar for its first policy rate rise, and while its decision gives the market a short-term reprieve, it also heightens the fear that the Fed will wait too long before beginning to raise its policy rate, and then will have to raise more sharply than it would like in order to keep inflation under control. For example, Fed Chair Yellen cites the lack of wage inflation as part of her justification for maintaining ultra-loose monetary policy but she knows full well that labour costs are a lagging indicator. Many believe that the Fed will overshoot on its timing if it relies on rising labour costs as a key signal. It also doesn’t help that the Fed has a well-established track record of having kept rates too low for too long in the past.
So rates didn’t rise, but investor uncertainty did.
Five-year Government of Canada bond yields rose by one basis point last week, closing at 0.76% 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 2.64%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.75% range, depending on the size of your mortgage and the terms and conditions that are important to you.
The Bottom Line: The Fed’s decision to leave its policy rate unchanged and to adopt a more dovish policy stance may ultimately prove to be a cautionary be-careful-what-you-wish-for tale. The Fed’s inaction should keep both our fixed and variable-rate mortgages at or near today’s level for the foreseeable future. But it’s the more distant future that neither we nor the Fed can yet see that is making everyone just a little bit more nervous after last Thursday.
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