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Many argue against variable-rate mortgages given that rates “can’t drop much more.” But while it’s true that rates are near the bottom, there’s still a question of “where’s the bottom?”

The Bank of Canada’s floor for the overnight rate—the rate that drives prime rate—was previously established at 0.25%. It sat at that all-time low from April 2009 to June 2010.

At the time, Governor Mark Carney said:

“…We thought long and hard about where the effective lower bound was in Canada. Our judgment was—and it’s been validated, I think—that we could bring rates down to 25 basis points…and that markets would continue to function well.”

“Because there are transaction costs associated with operating [shorter-term money] markets…if the net yield is close enough to zero, then those markets will cease to function.”

In its April 2009 Monetary Policy Report the Bank added:

“In principle, the Bank could lower the policy rate to zero. However, that would eliminate the incentive for lenders and borrowers to transact in markets, especially in the repo market. Therefore, to preserve the effective functioning of markets in a low interest rate environment, the Bank is setting an effective lower bound (ELB) of 25 basis points for the overnight rate…”

Much has transpired since then, however. Louise Egan, a spokesperson for the Bank of Canada, says that since 2009 “we’ve seen in some other countries that it’s possible for nominal interest rates to be negative due to the costs of holding currency, and so the thinking has advanced among central banks on the subject.”

In today’s world, if inflation risked falling below the Bank of Canada’s 1-3% target range, a 0% overnight rate wouldn’t be off the table completely, just unlikely. In fact, even negative rates are possible, as we’ve seen in many other countries. But according to Desjardins, “outside of an unlikely scenario where the Fed adopted such type of policy, there is little chance that the BoC would go this far.” Moreover, the Bank would likely use other monetary policy levers before it took extreme measures like cutting the overnight rate to zero or below.

“You know, for us, forward guidance is usually the next sort of place [we’d consider]…,” said Governor Stephen Poloz last month. “…What you’re doing in forward guidance is…you’re trying to influence not today’s interest rate, but how interest rates are perceived through the yield curve, so that you’re affecting the profile of expectations for interest rates…That leads to…more financial stimulus than you otherwise would have with a normally shaped yield curve.”

“The Bank, of course, did use some forward guidance in the past,” Poloz added. “We said that when we would normally use it would be in unusual times or at the zero lower bound…”

That is consistent with its prior usage, notes Bank of America rate strategist Ruslan Bikbov. “We saw back in 2009…the next step after the quarter-of-a-basispoint (overnight rate) was forward guidance,” he says. “They haven’t actually discussed the possibility of negative rates, or even zero.”

The Bank of Canada, as noted in this paper, can “reduce long-term interest rates by issuing forward guidance…” Doing so “lowers market expectations of the future path of the policy rate.” In turn, the 5-year government yield would likely drop, as would longer-term fixed mortgage rates.

If forward guidance doesn’t work, the BoC could try its hand at quantitative easing (QE). That’s where the Bank buys government securities in order to keep prices up and rates down. The fear, however, is that QE could remove bonds from trading, negatively impacting liquidity in Canada’s small-ish government bond market.

If QE did come to pass, it could potentially mark the long-term bottom in rates. That’s partly because its stimulative effect would likely result in higher inflation expectations, alleviating the need to ease policy further.

Given the BoC’s comfort with a 25-bps key lending rate, the 1 in 4 mortgagors with variable rates may see prime rate drop no more than another 10-25 basis points from here, depending on banks’ generosity following another 25-bps BoC reduction. And another cut is still very much on the table with Canada heading towards a “low-magnitude recession,” and with overnight index swap traders betting on a rate cut by January.

The wildcard is the Federal Reserve. It could hike rates later this year—some speculate as early as September. Of course, Canada’s rate market could always keep diverging from the U.S., but given the long-term correlation of U.S. and Canadian rates, a Fed hike could easily keep Canadian rates level, if not boost them somewhat.

“If the Fed moves in September, you will probably see higher rates in Canada, including five-year bonds,” said Bikbov. “By December, we may see another cut from the Bank of Canada and potentially another hike from the Fed. I think the net-net effect will probably be a five-year rate (in Canada) that’s a little bit lower.”

At the very least, we have lots more rate volatility and uncertainty to look forward to. So if you’re a mortgagor watching all of this, hold on for the ride. Rates in the second half of 2015 could be one surprise after another.

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Our recent story on changeovers in the benchmark 5-year bond sparked some good questions about how and when the benchmark changes. As noted in that previous story, when the market rolls over to a new benchmark bond, it can play havoc with bond yield charts (which many mortgage pros watch for clues on rate direction).

Here are some related FAQs on bond issuances and benchmarks:

Question: How often does the Bank of Canada (BoC) auction off new 5-year government bonds?
Answer: The Bank of Canada currently auctions two new 5-year bonds per year. Thereafter, each of those bonds is re-opened (re-auctioned) two to four more times. More info

Question: Does the benchmark change because the Bank of Canada designates a new benchmark? Or does the market decide on the official benchmark?
Answer: The market decides. “Benchmark bonds are not determined by the Bank of Canada,” says the BoC. “Benchmark bonds are market convention.”

Question: When does the benchmark change for the 5-year bond?
Answer: “The benchmark bond usually changes after the last re-opening of the new bond,” says the Bank of Canada. At that point, the new bond takes over as benchmark and becomes the bond that you see quoted by the media, displayed in charts and so on. The old bond sticks around, but it becomes less and less traded as time goes on.

It’s sometimes hard to know when the benchmark will change because “the number of re-openings is not pre-announced,” says the BoC. “The decision on the number of re-opening depends on multiple factors, like borrowing need, benchmark target size and market condition.”

If you’re interested, here’s a list of the benchmark bonds and the dates they came into being: http://www.bankofcanada.ca/stats/assets/pdf/bench_CDN.pdf. You can use this link to confirm whenever Canada has switched to a new benchmark. Our thanks to the Bank of Canada for this information.

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No rate cut surprises to report today.stephen-poloz

Canada’s key lending rate “remains appropriate,” said the Bank of Canada this morning. That’ll keep prime rate at 2.85% for now.

The BoC’s economic commentary today was both grim and hopeful. The economy “stalled” in the first quarter, it admitted—thanks in part to the “oil-price shock.”

Looking further down the road, however, we got more of the same brand of optimism we’ve come to expect from the Bank—i.e., that the economy will get back to “full capacity” in a few years or less. In the meantime, the Bank says our cheapened loonie and widening output gap will “offset each other,” keeping inflation near 2% on a “sustained basis.”

What does sustained mean, you ask?

Well, barring some out-of-left-field inflation catalyst, the Bank’s assessment portends little probability of rate hikes in 2015. And financial markets agree. OIS traders are pricing in a 44% chance of a rate cut by year-end, according to Bloomberg.

As a result, “interest rate relief” will continue to provide a “cash flow…buffer” for indebted consumers, said Governor Stephen Poloz in today’s press conference. That is particularly true for variable-rate mortgagors.

“On the surface, lower interest rates would be expected to promote more borrowing, which would increase this vulnerability,” Poloz noted in his prepared remarks. “However, in the near term, lower borrowing rates will actually mitigate this risk, by reducing payments for mortgage holders and giving us more economic growth and employment gains. “

That’s all good, but with Toronto/Vancouver home prices on a Saturn V rocket trajectory, mortgage policy-makers have to be wondering if and when they should apply the housing brakes.

Average-home-price

CAAMP CEO Jim Murphy believes Ottawa better not jump the gun just yet. “Canada is now two housing markets. One, Vancouver and Toronto, and two, the rest of the country,” says Murphy. “In recent visits to Ottawa and in discussions with government officials, CAAMP has highlighted the [existence of these] two housing markets…Any further changes would impact markets that are not seeing house price appreciation or, in some cases, actual price declines.”

OK, but what about two sets of mortgage rules—one for richly valued markets and one for weaker markets?

“It’s a very interesting question,” says Murphy. “The same issue has been raised with the Bank of Canada about regional interest rates—higher in a region with a strong economy and lower elsewhere. I’m not sure that is possible.”

“For mortgage rules, it may be possible, but it’s still difficult. For, example, do mortgage rules apply to the City of Toronto or to the GTA?”

For now, it looks like the status quo may prevail. “The federal government continually monitors the housing market and consults with stakeholders like CAAMP to gauge opinions on the market. Our sense is that changes are not imminent and are unlikely before the October federal election.”

Barring significant mortgage rule tightening, it may take an economic downturn or improbably large rate hikes to derail single-family price momentum (national numbers are being skewed predominately by single-family home sales in Toronto/Vancouver). And neither seem imminent.

That said, the “data never go in a straight line,” Poloz remarked earlier, and we have no way of knowing what’s around the corner. Will the U.S. Federal Reserve finally jack up rates and pressure the BoC to follow? Will oil prices rebound or fall to new lows? Will a U.S. recovery and hobbled loonie boost demand for Canadian exports? Will EU stimulus work, or backfire? Is another financial crisis waiting in the wings? Fill in your own ‘what if’ here _____________. Any of these possibilities could play on rates in the year to come.

Meanwhile, we’re just a stone’s throw from a new record low for Canadian bond yields. Our most important fixed mortgage rate driver, the 5-year bond yield, rose 3 basis points on today’s news. But if we break below 0.55% and hold there, look out. Five-year mortgages near 1.99% could rocket Toronto/Vancouver prices from the stratosphere to the exosphere.

5yr Bond Yield

Sidebar: Here’s the full text of today’s BoC’s statement: Link. The next Bank of Canada interest rate pow wow is May 27, 2015.

 

The BoC Sits Tight…Again

Prime rate has been entrenched at 3% for four years now, the longest stretch of flat rates since the 1950s. And the BoC gave no hint of change at today’s rate meeting.

Here’s the gist of its statement from this morning:

  • The BoC attributed the recent inflation upturn to “temporary” factors
  • “…The housing market has been stronger than anticipated,” it says (no doubt mortgage policy-makers are watching home prices like hawks)
  • The bank believes our economy could run below capacity for “the next two years”

But it’s usually the last paragraph that matters most in BoC statements, and the key line from that paragraph was:

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BoC Update: Rates Stay Level

Macro of a yellow spirit level on whiteLike most of its last 29 rate announcements, today’s Bank of Canada rate statement was a snoozer. But for those with debt, dull is good. It keeps a lid on variable-rate borrowing costs.

For most, the only meaningful line in the BoC’s statement was:

With inflation expected to be well below target for some time, the downside risks to inflation remain important.

In other words, there’s no danger of variable rate hikes for as far as the eye can see. So, if you’re like most financially secure borrowers in a discounted adjustable-rate mortgage, there remains little reason to lock in.


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BoC Decision: Pleasantville for Variable Mortgagors

Pleasantville-in-the-rate-market

Today’s Bank of Canada (BoC) interest rate decision was reassuring for variable-rate borrowers.

  • The Bank announced that Canada’s key lending rate will remain just 75 basis points above its all-time low.
  • The Bank suggested its next move is just as likely to be a rate cut as a rate hike.
  • It said the risk of falling inflation “has grown in importance” and that inflation won’t rise back to its target for “about two years” (suggesting even less chance of a prime rate increase through 2015).

Even if inflation does return to its 2% target, that alone isn’t enough reason for the Bank to raise rates.

So essentially, it’s Pleasantville right now for variable-rate borrowers, with no hikes in sight.


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BoC Rate Guidance: Use with Care

Bank-of-Canada-Benchmark-RateThe Bank of Canada exudes credibility. It’s an internationally respected central bank, it operates with minimal political interference and it has contained inflation for 22 years.

So when a Bank Governor gets surprisingly hawkish, we immediately see headlines like “Interest rates expected to increase.” Thousands of mortgagors key off those headlines and scramble to lock in fixed rates.

That very thing started happening in April 2012. But, as this Yahoo! Finance story points out, Canadians paid a price if they heeded Mark Carney’s 2012 warnings and locked in.


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Bank of Canada Rate Biases

Road to Higher Interest Rates - Words on StreetWhen the Bank of Canada talks rates, analysts hang off of every word. They pay special attention to biases in the Bank’s wording (i.e., which way the Bank is leaning on interest rates).

The media loves to pump commentators for predictions on whether the BoC will keep its rate “bias,” not keep its bias, do something unexpected with its rate bias, and on and on. It’s quite the drama over what is usually a 1-3 sentence statement in a BoC press release.

On Wednesday, the Bank of Canada left Canada’s key rate alone. It also chose to leave its 13-month-long rate hike bias intact, saying:

“…the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required.”

The question some may be wondering is, should this sort of statement mean anything to the average mortgage consumer?


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