Dave Larock in Interest Rate Update, Mortgages and Finances
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The U.S. Federal Reserve has sounded increasingly hawkish of late, with its members repeatedly raising the prospect of a rate hike in either September or December of this year. Tough talk from the Fed is nothing new, but there may be some new thinking behind it now (more on that in a minute).
The Fed’s rate-increase rhetoric has been primarily attributed to improvements in the U.S. employment data, so all eyes were on the latest U.S. non-farm payroll report last week as investors tried to gauge how the U.S. labour market’s current momentum might affect the Fed’s tightening timetable.
The latest data proved disappointing. The headline number came in well below consensus expectations and the details showed that momentum in the most cyclically sensitive parts of the U.S. labour market has continued to slow.
Here are the key details from the latest U.S. non-farm payroll report:
- The U.S. economy generated an estimated 151,000 new jobs in August, well short of the 180,000 jobs that the consensus had been expecting. In addition, the initial June and July headline estimates were revised down by another 1,000 jobs.
- Average hours worked declined from 34.4 to 34.3, and average wages rose by 0.1% for the month. Nothing to get too excited about there.
- Goods-producing employment fell by 24,000 jobs, marking the sixth decline over the past seven months for the sectors of the U.S. economy that make and build things. (These sectors have lost a total of 102,000 jobs over that period.) These are the jobs that drive growth in other parts of the labour market and they are also quite cyclically sensitive, so this continued decline in goods-producing employment is bad news for the overall health of the labour market and correlates with slowing overall economic momentum.
- Both the unemployment rate (4.9%) and the participation rate (62.8%) were unchanged for the month. (As a reminder, the participation rate measures the percentage of working-age Americans who are either employed or who are actively looking for work.) The participation rate still hovers well below its long-term average, and since there are a larger-than-normal number of disenfranchised workers who have given up looking for work (and are therefore not officially counted as unemployed), today’s official U.S. unemployment rate isn’t as encouraging as it might look at first glance.
Bluntly put, if you’re an investor using the latest U.S. employment data as a gauge for when the Fed will next raise its policy rate, the August data should have you moving out your rate-hike timetable. But what if the Fed has finally come to the conclusion that monetary policy can’t influence the labour market as much as it had hoped? And what if the Fed’s members are finally becoming more worried about the negative side effects of its ultra-loose monetary policy?
Any rational policy maker has to acknowledge that there is a significant and growing cost to keeping rates so close to 0%. Here are some of the key factors that support this view:
- Ultra-low interest rates have forced financial institutions to take on more risk as lending spreads have fallen. Over time, credit quality has deteriorated and the risk of credit bubbles forming in areas like student loans and sub-prime auto lending has increased. To wit, there is now a record $1.3 trillion in U.S. student debt outstanding, and sub-prime auto lending now constitutes about 30% of the $1 trillion U.S. auto-loans market. The delinquency rates for both have been steadily rising.
- Ultra-low rates have also put insurance companies and pension funds in dire straits because they can’t earn the returns they need to cover their long-term liabilities. And because regulations tightly restrict the types of investments that these companies and funds can make, they are forced to buy AAA-rated debt at whatever price is offered, even in cases where yields are negative. How exactly does an insurance company make that work?
- Ultra-low rates also force individual investors to take on more risk (and in many cases, undue levels of risk) in an effort to replace their lost yield. This vulnerable segment of the population increases over time, making the overall U.S. financial system less stable and creating ripe conditions for the next crisis (for example, when equity markets correct and retired pensioners have no way to recover their losses).
- The Fed believed that ultra-low interest rates would stimulate consumer demand, but that hasn’t happened. Instead, savers and pensioners who rely on interest income have had to cut back on their spending, and U.S. consumers who entered the Great Recession with high debt levels and low credit scores haven’t been able to refinance their debts to take advantage of lower borrowing rates.
- The Fed’s aggressive monetary-policy interventions since 2008 have used up most of its dry powder, leaving it with a diminished capacity to provide meaningful stimulus when the next recession hits (despite its protestations to the contrary). Meanwhile, like a drug addict who needs increasingly larger doses to produce the same effects, financial markets have now become accustomed to radical unconventional policy measures like quantitative easing, negative interest rates, outright asset buying and the like.
The Fed continues to say that its path will be “data dependent” and focused on its dual mandate of preserving price stability and promoting employment growth. But if it raises its policy rate in 2016, it is unlikely that it will do so because the employment data confirmed that it was time. Instead, the Fed may finally be reconciled to the fact that it has kept policy too loose for too long, and that the costs of not raising its policy rate outweigh any incremental benefits.
As for the risks of raising rates in a low-growth, low-inflation environment with an economy in the midst of a still fragile labour-market recovery, we might well be learning more about that scenario sooner than we think.
Five-year Government of Canada bond yields fell four basis points last week, closing at 0.69% on Friday. Five-year fixed-rate mortgages are available in the 2.29% to 2.39% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at about 2.49%.
Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: The latest U.S. non-farm payroll report came in weaker than expected and, if the Fed is still focussing on the health of the labour market, it should be less likely to raise rates in 2016. But if the Fed now believes that it has kept rates too low for too long, we may see a U.S. rate rise in 2016 after all. While I am not betting on that outcome at this time, it could happen. That would lead to a short-term spike in our bond yields, and by association, our fixed mortgage rates. Stay tuned.
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
September 6, 2016
Mortgage |