Canada’s Overnight Rate Doesn’t Tell a Full Story

bank-of-canada-effective-overnight-rate The Bank of Canada’s overnight target rate is the headline interest rate in Canada.  It sets the trend in a host of other key rates like mortgages, car loans, and commercial loans.

Currently, the overnight target stands at 1.00%—the lowest in history.  According to TD, however, it’s a misleading barometer.  A recent report from the bank suggests the effective overnight rate is closer to 2.48%.

According to TD, enormously wide credit spreads and other factors are actually making it “feel like the overnight rate is higher than it is.”  Put another way, TD says “higher levels of (lending) risk” have “pushed out spreads to levels much higher than ever previously witnessed. This has reduced the efficacy of Bank of Canada interest rate movements.”

As a result, the Bank of Canada has had to over-cut rates to compensate.

In the mortgage world spreads have improved but they’re still fat.  For example, TD says short-term borrowing spreads are averaging about 0.44% above normal.  This impacts all kinds of instruments, including bankers’ acceptances—which help set the prices of variable-rate mortgages.

For long-term borrowing, spreads are even wider.  Using TD’s metrics, 5-year fixed mortgage premiums, for example, are still 1.42% higher than they should be.

Canada’s unusual spreads, among other things, have forced the bank of Canada to cut rates more than normal to inject adrenaline into our flailing economy.

Signs now point to further cuts on March 3:

  • TD chief economics and rates strategist, Eric Lascelles, predicts the BoC will drop the overnight rate by yet another 1/2%.  (Bloomberg)
  • “The deteriorating conditions in the labour market are
    consistent with the Bank of Canada’s outlook and should
    not change its decision to cut another 50 basis points in
    March.” (CIBC)
  • “We’re sticking to our call that they cut 50 basis points (1/2%) and leave their rate on hold for a long time.” (Scotia Capital economist, Derek Holt)
  • Fixed income traders “are pricing in a 100% chance of a 1/4% cut and a 30% chance of a 1/2% cut by March 3, 2009.” (CEP)

After March 3 it’s anyone’s guess where rates will go next. However, if the BoC does cut again, most analysts seem to think prime rate may drop and then stay put for a while.

It remains to be seen whether the bond market (and fixed mortgage rates) will do the same.

  1. It’s not true that nobody saw it coming. Lots of people saw it coming but those same people didn’t want to believe all the money they were making off of it was bad.

  2. George Soros, Jim Rogers, Robert Prechter, Andrew Lahde, James Kunstler, John Rubino, Peter Schiff, Jim Puplava, Eric Sprott, William Bonner, Nouriel Roubini, Marc Faber, Nassim Taleb, John Embry, Dave Chapman, Bob Hoye, James Dines, Jim Willie, Doug Casey, Adam Hamilton, Vince Cable, Gillian Tett, David Branchflower, George Armoyan…

  3. This is just a list from names that I quickly thought of
    Dom, I guess you’re talking about the hedge fund guy.
    Ryan : I read his blog.
    Remember that Greenspan was sayiing how safe the system was because derivatives made the system more liquid…
    I forgot Jim Sinclair.

  4. But you just have to love a guy that started from nothing : “Rogers, whose full name is James Beeland Rogers, Jr. was born in Wetumpka, Alabama. Rogers grew up in Demopolis, getting started in business at the age of five, picking up bottles at baseball games. He got his first job on Wall Street, at Dominick & Dominick, after graduating with a bachelor’s degree from Yale University in 1964. Rogers then acquired a second BA degree from Balliol College, Oxford University in 1966. After Oxford, Rogers returned to the U.S. and enlisted in the army for a few years.
    In 1970, Rogers joined Arnhold & S. Bleichroeder, where he met George Soros. That same year, Rogers and Soros founded the Quantum Fund. During the following 10 years the portfolio gained 4200% while the S&P advanced about 47%”

  5. Okay. I guess then the advice should be: “Everyone’s circumstances are different — talk to John”.
    Right, John?
    Or do none of the people you listed qualify as “professionals”?

  6. “Are those the same professionals that didn’t see this crisis coming?”
    I’m reading this thread and it’s pretty funny. All you monday morning quarterbacks who think these pundits are futuretellers are delusional.
    The point was that “Mortgage Novice” should speak to a broker or banker to determine which mortgage term best suits their needs.
    Not one of the pundits listed here are mortgage advisors.
    Moreover, not one predicted anything remotely akin to the global credit catastrophe we’ve witnessed. Back up this list of meaningless names with actual predictions they made in 2005 or prior……..not that it’s even relevant to Mortgage Novice’s question in the first place.

  7. John (I) : I’m just having fun here. I know what your point was. But the exercise of predicting the direction of rates has everything to do with the future of the credit crisis.
    I just find it funny when “professionals” make investment calculations based on 7-8% return per year until 2020. I can’t see how that’s possible. Even 4% seems like a scretch.
    Asians hold our mortgages, they will decide which way rates will go.

  8. Exactly, I was wondering about the first question posed, which was essentially, where are rates headed? Based on the numbers cited in the post, do fixed rates have room to move down in the next 6 to 12 months?

  9. Remember though, that fixed rates will climb before prime does. So if you wait till prime starts to move up again, you will have already missed the boat. And as an added complication, it is possible that the spread could change without prime moving anywhere. This is all well and good, but the reality is that fixed rates are VERY low at the moment, could they go down another 25-50BPS? maybe, but it doesn’t mean that today’s rates are not a good deal. Last bit of advice is the if your financing plans depend on the rates moving 25-50BPS, than you need some new plans… :-)

  10. I wish you “Johns” would distinguish yourselves (or, if it is the same John, distinguish your two personalities), because it is awfully difficult to follow

  11. The one that makes sense is not me. ;)
    One day this multi decade bull market in the bond market will reverse and then Blair’s advise will be the best one. Today’s fixed rates will be looking like major bargains.

  12. My problem, if you can call it that, is I have a variable mortgage at prime minus .5. I’m paying 2.5% at present which is looking like it will fall to 2 or 2.25%. I am still looking to lock in for a 3yr or 5yr term but am reluctant to sacrifice the principal that I am currently paying down. Any comments on if/how people see the fixed rate spread on bond yields moving? As noted it seems to be at record highs.
    Cheers,

  13. Vance and Grigore
    Keep in mind that variable rates would have to go up well above the current fixed rates in order for you to benefit from the switch to a fixed rate mortgage. Unless your mortgage is up for renewal shortly, I imagine that riding out this variable rate will be your best bet. Reason being that you are paying less interest on a higher amount so the savings on this larger mortgage amount will offset the extra cost of higher interest payments once the variable rate passes the current fixed rate offerings.
    I don’t have an Excel spreadsheet to run the numbers but I imagine that roughly for every year you spend at 1% below fixed rates, you then would need to ­be at > 1.1% above the current fixed rate for the same number of years on the remainder of your mortgage before it would have been beneficial to use a fixed rate mortgage in the first place.

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