What a difference a month makes.
In late May, the Bank of Canada (BoC) announced a scheduled rate decision and barely an eyebrow was raised among traders and economists alike. At the time, there appeared to be no urgency to move rates (either way), and most observers expected any prime rate increases would come well into 2018, if at all. Our own take largely reflected this, and we even went so far as to say "...there may be some downward pressure on fixed rates over the next few weeks, especially for the 5 year term". Well, frankly, that prediction is looking very wrong.
Over the last couple of weeks, and particularly the last several days, there has been commentary from various Bank of Canada officials that imminent rate hikes are firmly on the table. As central bankers from around the world met in Sintra, Portugal this week, a common theme that emerged was "markets should prepare for higher rates" (aside: if you've never been to Sintra, do go - it's beautiful). This talk has significantly increased speculation that the Bank of Canada could raise their overnight rate as soon as their next scheduled meeting, on July 12th. Any hike would of course affect prime rate and consequently variable mortgage rates. Factoring in this new reality, Canadian bond yields have been going up as well. Shorter term yields have especially been sensitive, as evidenced by this 2-year yield chart produced by esteemed Bloomberg journalist Luke Kawa:
Chart courtesy of Luke Kawa Follow @LJKawa
The 2-year yield is now right back to where it was before the BoC surprised everyone with two rate drops in early 2015 (at the time, the goal was to counter the economic effects of the oil price shock). Since changes in bond yields rates generally precede changes in fixed mortgage terms, there is now increasing expectation that banks/lenders will need to hike fixed mortgage rates to maintain profitability. Indeed, we've already had some lenders give us notification that they will be raising fixed rates in the coming days.
This all begs the question: if you're a mortgage holder (or about to become one), is there cause for concern? We believe the short answer is likely "no". So far, despite building yield pressure over the last year, fixed rate increases have remained largely subdued - competitive forces within the mortgage industry are keeping rates low and many non-bank lenders, already experiencing a slowdown in their business due to CMHC's rule changes, will be unlikely to lead a charge higher. At the same time, the BoC is likely to take a very measured approach to raising rates - clearly this Canadian borrowing cycle is well into/past its peak, and over-tightening today could have some nasty consequences if the real estate winds in Toronto/Vancouver start blowing the other way concurrently.
Still, and as always, we encourage borrowers to:
- Budget for modestly higher rates (1%-1.5%) and continue to reap the reward when they don't fully materialize.
- Expect that any rates increases may not be permanent - rate movements are never in a straight line and the emotions that come with trying to act on financial headlines can be stress-inducing. As long as you're comfortable with your payments, know that you'll never time the market perfectly.
- Pay attention to the CAD/USD exchange rate. The more the Canadian dollar displays volatility, the more likely the BoC will be forced to consider the repercussions that come with it.
- Speak to our team when in doubt - We're happy to give you advice on where rates might be going, and why.
Finally, before locking a variable rate into a fixed, it's important to remember that for all of the marketing around fixed rates being the "safe" choice, they actually come with their own risks: fixed rates can carry unexpected penalties if you eventually need to break your mortgage early (in order to refinance, move, or make changes to title). Most variable rates have penalties capped at 3-month's worth of interest; given the choice between penalty certainty and potentially larger IRD penalties, we prefer the devil we know.