Dave Larock in Interest Rate Update, Mortgages and Finances
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The U.S. Federal Reserve left its policy rate unchanged last week, as expected, but it surprised markets by removing two rate hikes from its Fed funds-rate forecast for 2016 and by adopting a much more dovish overall tone.
As a reminder, the Fed’s comments matter to anyone keeping an eye on Canadian mortgage rates because Government of Canada (GoC) bond yields have moved in virtual lock step with their U.S. equivalents since the start of the Great Recession in 2008. Our fixed-mortgage rates are based on GoC bond yields so the Fed’s comments and forecasts have direct impact on how much our fixed-rate borrowers pay for their loans. And given that the Bank of Canada (BoC) tends to move in the same direction as the Fed over time, the Fed’s longer-term rate forecasts and overall tone also act as a kind of distant-early-warning gauge for increases in the BoC’s overnight rate, which forms the basis for our variable mortgage rates.
Here are the highlights from the Fed’s latest statement (with my comments in italics):
1) U.S. job growth has been more about quantity than quality, and as such, cannot be counted as the “healthy” type, or
2) Average incomes are a lagging indicator and by the time they rise convincingly the Fed will have fallen too far behind the inflation curve and will have to raise rates more quickly than expected to catch up, or
3) Stagnant average incomes are the result of highly paid baby boomers leaving the workforce and being replaced by lower paid new entrants, a demographic shift that monetary policy can’t (and shouldn’t try) to counteract
1) Emerging-market instability risks caused by the surging U.S. dollar
2) The coming British referendum on exiting the European Union (EU)
3) Increasing odds that Italian banks will need bailouts on an unprecedented scale
4) At the same time, EU immigration policy disagreements making cooperation among member countries more difficult
5) Japan’s continued experimentation with unconventional monetary policy
6) The geopolitical impact of oil-price volatility
The Fed’s monetary policy decisions are also influenced by the actions of other central banks, and it must account for the direction of monetary policy in the world’s other large economies. To that end, the recent decisions by the Bank of Japan, the European Central Bank and the People’s Bank of China to adopt increasingly accommodative monetary policies would likely magnify the potential headwinds that would act against U.S. economic momentum if the Fed chose to tighten its monetary policy while everyone else is loosening theirs. Against that backdrop, even standing pat is its own form of tightening.
Five-year GoC bond yields fell by ten basis points last week, closing at 0.71% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.59% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at rates as low as 2.69%.
Five-year variable-rate mortgages are available in the prime minus 0.30% to prime minus 0.40% range, which translates into rates of 2.40% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: The Fed surprised markets last week by adopting a more cautious policy-rate stance despite some recent improvements in the U.S. economic data, most notably a falling unemployment rate that now sits at a drum-tight 4.9%.
The Fed’s more dovish stance implies that it will tighten its policy rate more gradually than had been expected, which should put downward pressure on bond yields. On the other hand, the Fed also appears more willing to tolerate rising inflationary pressures, which should put upward pressure on bond yields. For now those competing forces appear to be roughly offsetting, which means that our GoC bond yields, which trade in lock step with their U.S. equivalents, and our fixed mortgage rates on which they are priced, should remain stable for the near future. That said, those forces remain in precarious balance, so stay tuned. Meanwhile, if you’re a variable-rate borrower, the Fed’s statements should not trigger any near-term changes to your rate.
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