Of all the things that could possibly move Canadian mortgage rates, a murderous dictator committed to nuclear brinkmanship was not on the radar.
But that’s the world we now live in, thanks to Vladimir Putin’s reckless warmongering and tragic invasion of Ukraine.
Russia now faces financial crisis and depression, which could lead Mr. Putin to lash out in ways we don’t want to imagine. And “if Putin concludes that he has no future, the risk is that he will decide that no one else should have a future either,” Montreal-based BCA Research wrote on Friday.
After the Russian President put his nuclear forces on high alert, BCA ballparked chances of a “civilization-ending global nuclear war” at 10 per cent in the next 12 months. Its surreal commentary would be hyperbolic if only we were dealing with a more stable adversary.
Whatever the true doomsday probability, the mere notion of nuclear weaponry being used in an escalation of the Russian war on Ukraine, and more broadly a recession that may result from soaring commodity-stoked inflation, has driven investors into the safe harbour of government bonds.
That bond buying crushed Canada’s five-year yield by more than 30 basis points in just days. By Tuesday evening, the yield had bounced back somewhat, trading at 1.61 per cent – down from a Feb. 16 high of 1.859 per cent. (There are 100 basis points in a percentage point.)
Normally, falling five-year yields pull down five-year fixed mortgage rates. But so far, this time is different.
On top of the potential for double-digit future inflation, the market must now weigh existential risk. These previously unthinkable scenarios have spawned two trends.
The first is a surge in risk premiums. That is, market fear and uncertainty are raising the cost of mortgage funding relative to risk-free government bonds. So despite bond yields dropping, banks have been hesitant to cut fixed mortgage rates, especially with competition already squeezing profit margins.
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Second, there’s a very real danger that central banks temporarily lose control of inflation. Textbooks say this risk should be met by aggressive short-term rate tightening. And if it is, variable mortgage rates will go along for the ride.
That’s why interest rates could pop quickly this year, with variable mortgage rates outpacing fixed rates.
What’s interesting is that the cycle is being accelerated. In any rate-hike cycle, we witness short-term rates – controlled directly by the Bank of Canada – go higher. As the cycle progresses, longer-term rates then drop as the market anticipates an economic slowdown resulting from such hikes. This time around, the divergence between long-term and short-term rates could happen quicker as the market prices in more near-term inflation danger, followed quickly by recession.
But arguably the biggest risk, existential threats aside, is that central banks hike rates too slowly.
In that scenario, inflation could top the most aggressive expectations, leading North Americans to lose confidence in monetary policy, panic buy ahead of further price increases and demand significant wage increases – further reinforcing the inflation spiral.
This may or may not be the most likely outcome, but it’s possible, which brings us to mortgage tactics.
Guessing is not a strategy
This is a tough time to be in the interest-rate prediction business. No one can foresee the twists in the road ahead.
But if you’re having to choose between a fixed and variable rate today, you can be reasonably confident of two things: surging variable rates and a subsequent recession.
Problem is, no one knows how long before surging rates give way to recession.
In the weeks to come, supply-shortage and commodity-fed inflation and the prospect of central banks losing their influence are bound to conjure up the memory of Paul Volcker.
Mr. Volcker was a Federal Reserve chair who had to use brute-force rate hikes to battle inflation expectations, driving North America into painful recessions in the early 1980s. Central banks should have learned a lesson from Mr. Volcker’s predecessors – that worrying too much about killing the economy short-term can lead to dire inflation that ravages the economy long-term.
The next 30 days of war could rewrite the inflation and growth narrative again. For all anyone knows, the probability of recession next year could skyrocket, with rates tumbling back down.
The most important takeaway is not the rate outlook, but the need to manage your interest cost exposure. Guessing that the Bank of Canada can counter global inflationary forces and keep rates from going “too high” is not a strategy.
We’re witnessing a cost-of-living spike that, based on historical frequency, you might only see once more in your lifetime. Inflation momentum like this doesn’t reverse quickly. For that reason, if the threat of lofty rates is too much for your finances or psychology to bear, locking in at least part of your mortgage is rational.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.
