Five U.S. Observations and What They Mean for the Canadian Economy and Our Mortgage Rates

Dave Larock in Interest Rate UpdateMortgages and Finances

Editor's Note: The Interest Rate Update appears weekly on this blog - check back every Monday morning for analysis that is always ahead of the pack.

Mortgage Update Pic

The Canadian economy has shown encouraging signs of improvement of late and market watchers are now predicting that our fourth quarter GDP will come in higher than expected.

While that would further reduce the odds of a Bank of Canada (BoC) rate cut in the near future, which I’m not betting on anyway, neither is it likely to cause the Bank to consider hiking its policy rate. Our economy still has a significant amount of excess capacity, so while an uptick in growth would be encouraging, we will need to see several more quarters of above-trend growth before the current gap between actual output and our maximum potential output closes (and that is around the time that the BoC would be expected to start raising its policy rate).

In the meantime, there is still plenty of action south of the 49th parallel. To that end, here are five recent observations about U.S. events that are unfolding that will weave their way into our economy’s interest-rate narrative over time:

  1. Want to know the real reason President Trump isn’t going to upset the U.S./Canada trade relationship? It isn’t because Prime Minister Trudeau charmed him at their first meeting or because he has any type of soft spot for Canada. It’s electoral math. President Trump was elected in large part because he won electoral votes in three states that normally vote Democratic: Michigan, Wisconsin and Pennsylvania. The economies in all three states rely heavily on cross-border trade with Canada and any disruptions that are tied to the Canada/U.S. trade relationship would risk undermining President Trump’s base of political support in the rust belt. (David Frum made this observation in a recent interview with Steve Paikin on TVO.) This reality should reassure anyone who is worried about a deterioration in the U.S./Canada trade relationship.
  2. The S&P 500 index has surged higher since President Trump was elected, partly on the bet that he will stimulate the U.S. economy with a broad range of new infrastructure-spending measures. I think that time will show this to have been a bad bet to make, regardless of the outcome. On the one hand, there is plenty of doubt about whether President Trump will be able to follow through on his plans because the Tea Party wing of the Republican party is expected to reject any new initiatives that require an increase in the federal budget deficit, and because the scale of spending cuts required to avoid increasing the deficit would be politically unsalable. On the other hand, the U.S. Federal Reserve has made it clear that it plans to accelerate its policy-rate hike timetable if the federal government launches new, large-scale infrastructure-spending initiatives. The Fed wants to ensure that it stays in front of future inflationary pressures, and rate hikes are bad for stock valuations. One way or the other, the run up in stock values that is tied to an expected rise in federal infrastructure spending will prove ill-founded.
  3. We have seen a divergence between the U.S. economic data and the U.S. sentiment readings that gauge the current mood of market participants. While the hard U.S. data have been mixed of late, U.S. sentiment readings have shown improvements in the outlook for consumers, investors, and for both large and small businesses. The optimists believe that these upticks in sentiment are an early sign that the U.S. economy is set to improve, while the pessimists believe that the hard data are the real proof of what the future economic pudding will look like. Over time, the sentiment readings and the economic data will converge and then we’ll know which group had it right. My money is on what the hard data are telling us at this point.
  4. The minutes from the Fed’s latest meeting were released last week, and they showed an increase in rate-hike rhetoric. In spite of that, bond-market investors still aren’t betting on materially higher rates. While the Fed is now speculating about rate hikes as early as March, with as many as three or four hikes expected in 2017, the bond-futures market is (barely) betting on the next hike happening in May/June, and is only calling for two hikes in 2017. More tellingly, ten-year U.S. bond yields continue to trade at the lower end of their recent trading range, so if materially higher rates are on the horizon, the bond market isn’t pricing it in yet (and that’s in spite of the fact that the rate of U.S. inflation has risen of late).
  5. Of course, the traditional metrics that are used to determine whether the Fed will raise rates and how quickly it will do so may not even matter at this point. As I wrote last year, the Fed may be ready to acknowledge that ultra-low policy rates have hurt the S. economy more than they have helped. For example, this extended period of ultra-low rates has led to the mispricing pf risk assets as investors chase yield, fuelled asset bubbles and imperilled insurance companies and pension funds because they can’t earn the yields they need to cover their long-term liabilities. Ultra-low rates have also reduced the incomes and spending power of pensioners and savers, and diminished the Fed’s capacity to provide meaningful stimulus to the U.S. economy through additional rate cuts when the next downturn hits. If the Fed thinks that it has already kept rates too low for too long, the traditional data that it uses to determine the correct policy-rate path will be inconsequential.

Five-year Government of Canada bond yields fell seven basis points last week, closing at 1.09% on Friday. Five-year fixed-rate mortgages are available at rates as low as 2.44% for high-ratio buyers, and at rates as low as 2.49% for low-ratio buyers. Borrowers who are looking to refinance should be able to find five-year fixed rates in the 2.69% to 2.84% range, depending on the terms and conditions that are important to them.

Five-year variable-rate mortgages are available at rates as low as prime minus 0.80% (1.90% today) for high-ratio buyers, and at rates as low as prime minus 0.60% (2.10% today) for low-ratio buyers. Borrowers who are looking to refinance should be able to find five-year variable rates in the prime minus 0.45% range (2.25% today), depending on the terms and conditions that are important to them.

The Bottom Line: The U.S. electoral college math that won President Trump the White House should provide reassurance to Canadians that U.S./Canada trade relationships will remain strong. In the interim, while the recent U.S. economic data remain mixed, the Fed may decide to raise its policy rate anyway if it is finally willing to acknowledge that the current extended period of ultra-low policy rates is exacerbating systemic risks. If the Fed isn’t going to use traditional metrics to determine the correct policy path, that will make it increasingly difficult to forecast the direction of both U.S. and Canada rates in future. Nevertheless, we will continue to try, so 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: Email Dave   

Mortgage     |    

Toronto’s most authoritative real estate insights, delivered right to your inbox.