Borrowers trapped in ever-escalating variable rates got a small win on Wednesday when the Bank of Canada hiked 25 basis points less than expected. The bond market took this as a soon-to-happen pivot in central bank policy, signalling ”the beginning of the end” of interest rate hikes.
That, in turn, caused the fixed-mortgage funding costs of lenders to plummet. As this is being written, for example, four-year “swap rates” have plunged 54 basis points in six days. Four-year swaps are an interest rate derivative that roughly reflect a bank’s base cost of funding a five-year fixed mortgage. (There are 100 basis points, or bps, in a percentage point.)
Think about that for a minute. What changed so drastically in our economy from Tuesday to Wednesday? We got no new economic data in that time. The answer is, virtually nothing changed.
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Apparently, the market just wanted to hear the Bank of Canada say that smaller rate hikes are now required before it would believe that real inflation progress is imminent.
But that’s a lot of faith in an organization with a less-than-stellar forecasting record. At this point, this massive and rare collapse in Canadian bond rates may reflect more inflation hope (and short-covering in the bond market) than reality.
Should we assume rates have peaked?
Recession is almost a given. Many economists are therefore predicting a meaningful dip in inflation in 2023. But there’s no shortage of “what-ifs” to ponder.
What if, for example:
- An energy crisis drives oil, today’s No. 1 inflation driver, well above US$100 a barrel?
- Bank of Canada hikes don’t defuse inflation expectations fast enough because 53 per cent of Canadians don’t even know the bank has an inflation target, and most of the rest think the actual 2-per-cent target is almost 3 per cent?
- It takes more central bank rate hikes – than the 400 bps currently priced in by the bond market – to counter demand, wage inflation and the shock of prices soaring to near 40-year highs?
- Russia detonates a nuclear weapon or China attacks Taiwan, creating historic financial system disruptions, let alone more supply chain horrors?
Hopefully, none of this happens. But when these risks exist, and when central bankers have talked tough for months and boosted rates multiple times, and consumers still expect more than 5 per cent inflation in 2024, avoiding more inflation flare-ups should take precedence to avoiding recession.
And lastly, let’s not forget a crucial lesson from the 1970s. Recession and high inflation are not mutually exclusive. So there’s always that chance that the Bank of Canada’s demand destruction campaign may not be enough to get the Consumer Price Index to target by 2024.
How mortgagors should play it
Chances are, we’ll see fewer prices pressures and lower fixed rates in the first half of next year. But if you’re playing the probability game, you must also allow for the chance that rates stay elevated past 2023.
Most new mortgagors expect to renew at lower rates by 2024. That’s why lenders are seeing more people get short-term fixed rates today than they have in years.
But while one-year fixed rates may cost you less if market expectations pan out, a slightly longer term provide valuable protection. That protection could come in handy if the Bank of Canada’s failure to hike 75 bps on Wednesday blows up in its face.
Even a two-year fixed or three-year fixed provides more defence against the above “worst case” scenarios, while still allowing enough time for inflation to descend back to target.
And please – if you’re a qualified borrower hunting for short-term financing, keep shopping until you find a rate below 5 per cent, or as close to 5 per cent as possible. Nothing is more ludicrous than a prime borrower paying a half percentage point more for a name-brand mortgage.
The best short-term deals at the moment come from regional providers such as Community Savings in B.C., Rapport and Comtech Fire credit unions in Ontario, Assiniboine and Cambrian credit unions in Manitoba, and discount mortgage brokers.
Parting tip
In the event that recession drives fixed rates much lower in 2023, you’ll want to have refinance options. If you choose a fixed rate with a two-year term or longer, the best thing you can do in this regard is to get a mortgage from a fair-penalty lender. That means a lender that’s more likely to charge you a three-month interest penalty when rates drop 100 bps and you break your mortgage to refinance. (Hint: Big banks don’t make the cut.)
Rates in the accompanying table are as of Thursday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.