Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
The bad dream that is COVID-19 has muddied the mortgage rate outlook again.
As Omicron threatens Canada’s recovery, many with variable-rate mortgages now expect – and hope – the Bank of Canada will keep rates lower for longer. Expectations in the bond market, however, suggest the variable-rate party won’t be extended for long.
Investors now expect the first Bank of Canada rate hike by April, consistent with major economists’ expectations and the BoC’s own guidance. Last week, market pricing suggested a hike in March – these implied rate forecasts change like the wind.
Regardless, the market clearly doesn’t think Omicron will defer rate hikes as much as Delta. Nor did it keep the U.S. Federal Reserve from projecting two more hikes in 2022 (three total) in its rate announcement on Wednesday. And with the prices soaring on housing, food, clothing and just about everything else you need, can demands for wage gains be far behind?
Once the central bank is convinced that rising wages are fuelling significantly higher price levels, it’ll have little choice but to hike rates in order to keep inflation expectations anchored near 2 per cent. The questions will then shift to the pace and extent of rate hikes.
Falling neutral
The most interesting question is not when rates will go up, but by how much. And the answer may have changed this week.
Visions of a never-ending pandemic and fears of inflation dramatically outpacing incomes have driven U.S. consumer confidence to a near-decade low, according to the University of Michigan’s consumer sentiment for the U.S. And in case you’re wondering, American sentiment does impact Canadian rates.
Add the fact that so many people are saddled with debt these days and it’s harder for a recovery to stay airborne once rates start rising.
That’s why it wasn’t surprising this week to hear the Bank of Canada say neutral interest rates “are lower than in the past and will likely remain low in the future.” The neutral rate is “the interest rate at which monetary policy neither stimulates nor holds back economic activity,” it said.
After its new inflation mandate this week, the bank reiterated that it may need to hold interest rates low for longer. It followed that up Wednesday by noting it’s “likely to lower its policy rate to the effective lower bound (0.25 per cent) more often in response to [economic] shocks.”
Decoding it all
RBC Dominion Securities wrote this week that the bank’s new framework implies “a terminal rate no higher than the 1.75 per cent reached in the 2017-18 hiking cycle.”
Leading up to a rate-hike cycle in 2022, that’s about as variable-rate friendly an outlook as you’re going to get.
Indeed, variable is where risk-tolerant, financially secure borrowers want to be – long-term. That’s particularly true after the prime rate has already risen between 75 and 175 basis points, which, history suggests, is when the odds overwhelmingly favour variable. (There are 100 basis points in a percentage point.)
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In 2022 and 2023, however, it’s possible that inflation won’t be as short-lived as the Bank of Canada thinks. We have to remember that the bank isn’t clairvoyant. It has continually underestimated Canada’s inflation problem.
The risk is that rates shoot above the bank’s estimated neutral rate and punish variable-rate borrowers. This is partly why fixed mortgage rates are still relevant to so many.
To sum up Omicron’s effect, it’s likely going to be more fleeting than inflation. If price levels don’t cool significantly by spring 2022, the central bank may be forced to repeatedly tighten monetary policy more than expected, despite Omicron putting the brakes on near-term growth.
Quiet week on the rate front
Despite a big dip in bond yields – which typically lead fixed rates – the lowest nationally available five-year fixed rates held steady. Rates tend to be sticky during the holidays. It’s possible we see a few lenders and brokers trim fixed rates before New Year’s, but I wouldn’t expect much improvement in the lowest rates.
Variable pricing is going nowhere fast until the new year. Floating rates are still roughly 130 bps cheaper than five-year fixed rates. That upfront rate advantage continues to lure in borrowers, especially with Omicron dimming the economic outlook.
Mortgage brokers and credit unions offer some of the lowest insured and uninsured rates on a provincial basis. Google “best five-year fixed rates,” for example, and you’ll find the cheapest five-year deals.
Rates in the table are as of Dec. 15, from providers that lend in at least nine provinces and advertise rates on their websites. Use these rates as a guide for the most that an average creditworthy borrower should pay. Insured rates apply to those buying with a down payment of less than 20 per cent, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases of more than $1-million and may include applicable lender rate premiums.
This & That
· On Friday, Canada’s banking regulator is set to announce the minimum interest rate that borrowers must prove they can afford to get a federally regulated mortgage. It now stands at 5.25 per cent. With the Bank of Canada hinting at lower rates for longer and fears of a housing bubble, the question is how much Office of the Superintendent of Financial Institutions will hike the minimum qualifying rate to protect the banking system from housing overvaluation. My guess is a rise of 15 to 45 basis points.
· The latest data from Canada Mortgage and Housing Corp. show 53 per cent of 2021 homebuyers were first-time buyers. Most first-time buyers tend to be much more sensitive to rate hikes than repeat buyers.
On its own, the government’s proposed 1 per cent “Underutilized Housing Tax” will do little to slow home prices. But the tax, which targets foreign buyers, may combine with higher rates and more federal mortgage tightening (if it happens, as I expect) to dampen homebuyer sentiment in 2022. Of course, rates aside, the two biggest home price drivers remain record-low housing inventories and a household formation that leads the G7. A tax that would only apply to a very small percentage of homebuyers is almost meaningless at addressing the supply shortage.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.
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