How Long Will This Rate Bottom Last?

Donald Trump has “blown up” the bond market. That’s CNBC’s depiction after the president-elect’s victory wiped out $1+ trillion of its value in the last week.

Trumponomics, Trumpflation, the Trump Thump, Trumpulus, or whatever you want to call it, has incited fear in bondland. Traders envision 4%+ GDP growth, inflation, massive deficits, a potential U.S. credit rating downgrade and unravelling of the greatest bond bull market of all time.

All of this is conspiring to reshape investors’ mindsets…radically. It’s raising the implied odds that 2016’s bottom in rates won’t be broken for several quarters, at a minimum.

And if the bond market is somehow mispricing Canada’s economic prospects—and yields do fall 55+ bps to new lows—imagine what hideous fate that would portend for Canada. It’s a fate that, given a soon-to-be-robust U.S. economy (the destination for 73% of our exports), now seems less probable.

But make no mistake, we’re staring at much uncertainty through 2018, not the least of which is:

  • How much will a resurgent U.S. economy boost Canadian exports?
  • What kind of trade deal do we get post-NAFTA 1.0?
  • Where does oil go next?
  • How much does a cheaper loonie absorb any trade shock?
  • Will Ottawa keep Canada’s business environment (tax regime) competitive with the U.S.?

These questions and others will have econo-gurus debating interest rate direction for months. Our clients will see their headlines and ask the perennial question: “Should I lock in?” And the answer will be as clear as ever: There is no clear answer.

But here’s something we can tell clients with confidence. The rate paradigm as we knew it on November 7th was transformed on November 8th. In 2017, the economy that we sell three-quarters of our goods and services to will be firing on two more cylinders, and net net, that could help Canadian business, boost Canadian inflation and be rate bullish.

And if we’re wrong, borrowers will have far bigger problems to contemplate than not picking the bottom in interest rates.

  1. It’s actually pretty hard to judge the impact of the Bond markets just now because there are 2 other material factors:

    1. The ‘usual’ November increase that most of the big banks go through – before pulling things down again in Spring.
    2. The new mortgage rules

    I would also say that taking the investor attitude and locking in – in the face of uncertainty – is probably also wise for mortgage consumers.

  2. Exports account for 30% of Canadian GDP, half of which are commodities which are tied more to global growth than specifically the US (not to mention are more capital intensive businesses than labor). Of the remaining 15% of non-commodity exports from our GDP, an uptick in US activity should have a positive effect although may be somewhat offset by anti-trade policies under the new administration.

    The problem that will likely arise is that the real estate industry in Canada is now much higher than non-commodity exports as a percentage of GDP (ie real estate is more than 15% of our economy) and it is incredibly sensitive to interest rate changes (property prices have risen significantly higher than rents have risen in the most recent housing run-up, which indicates most price growth is coming from a lower cost of carry versus a higher rental returns).

    An increase in interest/financing rates on the back of strong US growth should be seen as a net negative for Canada according to the size of the real estate sector within our economy versus the export sector. Exports are being used to spin this as a positive as they were when rates dropped and our dollar fell but in reality the benefit to Canada from low rates has been much more important in the real estate sector, a benefit that will reverse itself with higher rates.

    A debate over fixed versus variable doesn’t seem like the right conversation to be having if you in fact believe rates will continue to rise.

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