Dave Larock in Interest Rate Update, Mortgages and Finances
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The U.S. Federal Reserve decided to hold its funds rate steady last week, but a key wording change served as a warning to markets that a rate rise may be imminent.
In its closing commentary, instead of continuing to use language consistent with a wait-and-see approach, the Fed was much more specific, indicating that it was now evaluating whether it will be appropriate to raise its policy rate “at its next meeting”.
This specific reference to the December meeting caused many analysts to speculate that the Fed was telegraphing a rate rise before the end of the year. That said, the U.S. futures market only increased the odds of a Fed rate rise in December from 35% to 50%, so it will take more positive economic data between now and then before a December rate rise becomes the market’s base-case scenario.
Those who read the Fed’s complete statement found plenty of language to support the view that its tightening timetable is not yet forgone conclusion. The statement went on to say that “this assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.” Even more specifically, the Fed said that it would need to see “further improvement in the labor market and [be] reasonably confident that inflation will move back to its 2 percent objective over the medium term.”
Here is my take on the current state of the key elements outlined in the paragraph above:
Canadian mortgage borrowers are well advised to keep an eye on the Fed because Canadian and U.S. bond yields have always been highly correlated, even more so over the past several years. If the Fed raises its policy rate and the Bank of Canada (BoC) stands pat, as is expected, this correlation will weaken, but Canadian monetary policy cannot entirely decouple from U.S. monetary policy for an extended period because our economies are so deeply integrated.
Financial markets understand the relationship between U.S. and Canadian bond yields well, so when the Fed does finally raises its policy rate, Government of Canada (GoC) bond yields are likely to be taken along for the ride, at least partially and initially. That means that our fixed mortgage rates, which are priced on GoC bond yields, are likely to rise in sympathy with U.S. rates. On the other hand, our variable mortgage rates, which are priced on the BoC’s overnight rate, can be expected to remain at their current ultra-low levels until well after the Fed’s first move, because the BoC has long said that it will lag the Fed’s initial tightening timetable.
Five-year GoC bond yields rose three basis points last week, closing at 0.88% on Friday. Five-year fixed-mortgage rates are available in the 2.49% to 2.59% range, and five-year pre-approval rates can be found at rates as low as 2.64%.
Five-year variable-rate mortgages are still being offered in the prime minus 0.65% to prime minus 0.75% range, but the most deeply discounted versions are now less widely available and may not be around for much longer.
The Bottom Line: The U.S. Fed has just indicated that it will be evaluating the incoming data to determine “whether it will be appropriate to raise the target range at its next meeting” and this overt timing reference has led to speculation that the Fed will raise its policy rate in December. While I think that is still far from a forgone conclusion, if I were in the market for a fixed-rate mortgage in the near future I wouldn’t want to be waiting for the release of the October and November U.S. employment reports without having a pre-approval firmly in hand. As always, forewarned is forearmed.
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