Abnormally low inflation is keeping Stephen Poloz awake at night. The Bank of Canada (BoC) admitted as much on Wednesday.
Analysts took the BoC’s headline comment (“downside risks to inflation appear to be greater”) as a sign that rate hikes will be a 2015 story.
But, for now, there is one key indicator that trumps Canadian CPI inflation, and this is it:
What you’re looking at is a chart of the U.S. benchmark bond yield. In early 2014 it will likely influence Canadian fixed mortgage rates more than any other factor (as it often does).
Economically speaking, we’re in bed with our neighbours below. Their recovery is our recovery. Despite temporary divergences, U.S. and Canadian bond yields should remain tightly correlated. (This is relevant because bond yields lead fixed mortgage rates.)
For that reason, we must keep at least one eyeball on U.S. rates, despite the fact that Canadian inflation is below target.
If U.S. yields continue uptrending, so should Canadian fixed mortgage rates. That could hold true even if the Bank of Canada kept short-term Canadian rates as-is for the time being.
Speaking of short-term rates, financial markets have been pricing in greater odds of a rate cut than a rate hike through mid-2014. While no one truly expects a cut, this probability is nonetheless positive for existing variable-rate mortgagors.
And new variable-borrowers could be happier yet. That’s because lower short-term funding costs may very well improve variable-rate discounts. The improvement would be slight, but noticeable. Just this week we saw the first prime – 0.70% rate since 2011. (It was from an online mortgage broker in B.C. and is not market-representative…yet).
So how do new borrowers plan around all of this? One sensible option for many is the 50/50 hybrid mortgage. Some call it the mortgage for people who can’t make up their mind. But it’s actually a mortgage for people wise enough not to pretend they’re smarter than the market.
A 50/50 hybrid (half-variable/half fixed) can now be found for 2.95% or less. For that price, you’ll enjoy:
- 50% less rate hike exposure (versus a variable rate)
- A chance to benefit if deflation threats or unemployment keeps the BoC sidelined past 2014 (Bay Street consensus is for the first hike in mid-2015).
The next BoC rate meeting is slated for January 22. That day will be must-watch TV because, by then, we will have:
- Two more inflation reports under our belt
- Two more employment reports
- Knowledge of whether national housing prices make another record high (housing imbalance is the second thing keeping BoC chief Poloz up at night)
- Clarity on the risk of another U.S. government shutdown (current U.S. government funding expires January 15)
- More hints on whether incoming Fed chair Yellen will trim rate-friendly quantitative easing.
That last point could chart the course of bond yields more than anything else.
Rob McLister, CMT
I don’t think interest rates and by extension mortgage rates are going anywhere soon with inflation so low.
Inflation was also 0.7% in May and fixed rates shot straight up 0.75 percent.
One thing that Rob is trying to make clear is:
1. Prime rate (and by extension anyone in a variable) is affected by Macro decisions by the BoC. So inflation, growth, currency, etc. This is not likely to move short term.
2. Fixed rates (4+ yr terms generally) are determined mainly by bond yields (about 98% correlated). US 10yr rates are way up which may be a sign that between this, a possible decrease in quantitative easing and a stronger recovery than expected may cause fixed rates in Canada to increase as bonds rise.
thanx for the clarification rob…for those of us on a variable and wondering about locking in to a fixed before they rise sharply its good to know — but not really that surprising — how closely we are tied in with the u.s. of a…
“deflation threat”, thanks for the laugh. Because the thought of more affordable prices keeps me awake at night, too. I’ll say it again, Brokers shouldn’t try to be economists.
That 50/50 hybrid mortgage mentioned above is interesting. Do many lenders offer this product for investment properties?
There are a small number of lenders who offer rental hybrids at very competitive rates, including some banks and a few credit unions. You might want to chat with a broker and some of the big non-broker lenders (e.g. RBC).
The Bank of Canada sets the inflation target at 2.0%, not 0% or less. That’s intentional.
The threat is not more affordable prices, which are typically beneficial if:
a) due to positive factors like productivity gains or technological advances, and
b) the overall level of prices continues to grow in a safe range.
The threat this story refers to is the risk of economic destruction that coincides with sustained widespread price drops. Deflation can maim corporate profits, trigger mass layoffs, push down incomes, raise people’s real debt burden, discourage spending, kill asset prices, and create harmful wealth effects.
The BoC will err on the side of lower rates if it senses a greater risk of deflation. Whether you hear this from a broker or an economist, the facts stand on their own.
We’ve established from your comment that you’re not “concerned” with being rude. Nor do you seem “concerned” with economic theory.
I like affordable prices too but I also like having a job.
Maybe you could explain what your idea of “more affordable prices” has to do with deflation and monetary policy. Something tells me we’d all get a hearty laugh out of that.
Inflation today is not relevant. It is projected inflation in 2015 that Poloz cares about.