Dave Larock in Interest Rate Update, Mortgages and Finances
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The U.S. economy added 138,000 new jobs in May, well below the consensus forecast of 184,000. More importantly, the May headline number came in well under the average of 160,0000 new jobs that were created over the prior six months.
This result bolsters the view that the U.S. labour market is losing momentum and much of the detailed data further support that assessment. Despite this, the U.S. Federal Reserve continues to prepare financial markets for another policy-rate increase in June, and the futures market is currently assigning a 94% probability that this will occur.
At first glance, this timing seems counter-intuitive for a Fed that has until now focused its monetary-policy muscle on helping to improve the health of the U.S. labour market. But I think the Fed’s upcoming decision will mark a change in approach and in today’s post, I explain why.
Let’s start by taking a quick look at the key details in the most recent U.S. non-farm payroll report (for May):
Today’s tepid U.S. employment backdrop coincides with U.S. GDP growth rates of about 2%, and inflation hovering at around the same level. By any historical measure, this hardly seems like a time for the Fed to be tightening monetary policy. That is, unless it is willing to accept that its extended period of ultra-loose monetary policy has not fuelled a healthy labour-market recovery as was hoped.
While it’s true that the unemployment rate has now fallen to historically low levels, that is, in part, a function of a suppressed U.S. participation rate, and although new jobs are being created, they have tended to be the lower paying variety. Consider that in 2009, average U.S. wages were rising at the same annualized pace (2.5%) as today, even though the U.S. unemployment rate was more than double where it is now. That means that more jobs haven’t translated into more income growth for the average American worker over the past eight years.
While the Fed’s ultra-loose monetary policy has had only a minimal positive impact on the health of the U.S. labour market (and even that is debatable), the negative side effects of this policy have been easier to see and, more importantly, are no longer possible to ignore.
Here is a summary of the rising risks that I believe have caused the Fed to shift its focus from trying to stimulate employment growth to trying to preserve overall economic stability:
Ironically, the Fed’s decision to continue raising its policy rate in the face of relatively weak economic growth may hasten the arrival of the very recession that it worries it is so ill-equipped to fight. And the more the Fed tightens, the greater these odds become.
It will be interesting to see how the Canadian bond market reacts to the Fed’s next policy-rate increase. Our bond yields have been tightly correlated with their U.S. counterparts since the start of the Great Recession, but the Bank of Canada (BoC) has made it clear that it will lag the Fed’s tightening timetable and that it still thinks the Loonie’s value is too high relative to other non-U.S. currencies. Perhaps the Fed’s decision to continue tightening will also serve to weaken the correlation between GoC bond yields and U.S. treasury yields. For my money, it certainly should.
Five-year Government of Canada bond yields fell two basis points this week, closing at 0.93% on Friday. Five-year fixed-rate mortgages are available at rates as low as 2.19% for high-ratio buyers, and at rates as low as 2.24% for low-ratio buyers, depending on the size of their down payment and the purchase price of the property. Meanwhile, borrowers who are looking to refinance should be able to find five-year fixed rates in the 2.59% to 2.69% range.
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 0.70% (2.00% today) for low-ratio buyers, again depending on the size of their down payment and the purchase price of the property. Borrowers who are looking to refinance should be able to find five-year variable rates around the prime minus 0.40% to 0.45% range, which works out to between 2.20% and 2.25% using today’s prime rate of 2.70%.
The Bottom Line: The Fed is all but certain to increase its policy rate when it meets next week. While that would normally lead to higher fixed rates for Canadians, the correlation between Canadian and U.S. bond yields should weaken now that the Fed and the BoC are proceeding on such divergent paths. Time will tell.
David Larock is an independent mortgage broker 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