Dave Larock in Interest Rate Update, Mortgages and Finances
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Right now markets believe that there is about a 75% probability that the U.S. Federal Reserve will raise its policy rate at its December meeting. These odds spiked after the latest U.S. nonfarm payroll report showed that the U.S. economy created far more jobs in October than were expected (271,000 actual new jobs versus the consensus forecast of 190,000 new jobs). But the Fed has earned a reputation for doing the opposite of what markets expect over the past several years and the contrarian in me is reminded of Bob Farrell’s Rule #9 from his famous 10 rules of investing: “When all the experts and forecasts agree – something else is going to happen.”
While I won’t be surprised if the Fed does raise its policy rate in December, if only to provide symbolic reassurance to markets that the Fed thinks the U.S. economy no longer needs emergency-level interest rates, that action is still not a foregone conclusion. In her most recent comments, made last week, Fed Chair Yellen said: “While the Fed now expects that the economy will continue to grow at a pace that will continue to generate further improvement in the labor market, and to return inflation to our two percent target over the medium term, and if the incoming information supports that expectation, then our statement indicates that December would be a live possibility [for a rate rise] but importantly, we’ve made no decision about it.”
This begs a key question. If the Fed is going to continue to rely on “incoming information” between now and December before deciding if it will raise its policy rate at its next meeting, which incoming data to be released between now and then are most likely to cause the Fed to stay its hand?
At this point the Fed would likely cite falling U.S. inflation rates or a weakening employment picture (or both) as reasons for raising its policy rate for the first time in almost a decade, and I think they will get both between now and their December meeting.
Here are some examples of factors that could stop the Fed from tightening its monetary policy in December:
The Fed could use any or all of the examples listed above as reasons for not increasing its policy rate in December, but there are many more factors that could also come into play, such as a broad market sell off, rising global economic instability, geopolitical instability, plunging oil prices, bad economic data from China, and so on. The list is long and the interplay between of all of these variables means that we shouldn’t be counting on a Fed rate increase in December just yet.
What the Fed does still matters to Canadian mortgage borrowers because our economies are tightly linked. The Bank of Canada (BoC) has said that it will lag the Fed’s rate hike timetable, perhaps by a considerable margin, but if/when the Fed raises and the BoC stands pat, the Greenback will rise further against the Loonie. This will raise the cost of everything we import from the U.S. and lower the cost of what we export there, creating winners and losers in the process. Also, while it’s true that the BoC doesn’t have to move in the same direction as the Fed over the near term, Canadian monetary policy cannot decouple from U.S. monetary policy indefinitely, so the Fed’s shift towards a monetary-policy tightening stance serves as a distant-early-warning system for the BoC’s own tightening timetable (however far down the road that may still be).
Five-year Government of Canada bond yields fell eight basis points last week, closing at 0.95% on Friday. Five-year fixed-mortgage rates are available in 2.54% to 2.69% range and five-year pre-approval rates are offered at 2.74%.
Five-year variable-rates are available in in the prime minus 0.60% to prime minus 0.50% range, which translates into rates of 2.10% to 2.20% using today’s prime rate of 2.70%.
The Bottom Line: While markets are betting on a Fed policy-rate increase in December, I still think that is far from a foregone conclusion for the reasons outlined above. That said, even if the Fed does decide to raise next month, it is unlikely to do so without giving markets lots of reassurance that its monetary-policy tightening timetable will be much slower and more deliberate than in past cycles, and those soothing words should help minimize the potential impact on mortgage rates north of the 49th parallel.
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