Fixed Rates are Likely to Move Higher

The increase in Australia’s key lending rate has led investors to believe that Canada will have to increase rates sooner rather than later. This expectation was priced into the Canadian Bond Market on Thursday and Friday of last week. The increase should translate into higher fixed mortgage rates before the end of the week.

Please do not be alarmed. This is a natural reaction to Australia’s move, the stronger than expected employment numbers from Canada and our robust housing market. Although these economic indicators would lead us to believe that the Bank of Canada must increase rates we must keep in mind that the Canadian Dollar will have a say in all of this. With a dollar that is almost at par, our Central Bank understands the ramifications of increasing interest rates too quickly, and the Governor of the Bank of Canada has made mention of this in the past week.

Bond rates jump up and down when the market interprets economic information from Canada and around the globe. In this instance the market expects the strong economic numbers from Canada and the Australian Central Banks move to all but guarantee an increase in our Overnight Rate on or before June of 2010.

This expectation leads to an increase in our Bond yields as the market expects rates to increase. As Bond yields increase mortgage lenders must increase their mortgage rates to sell mortgages at competitive yields.

Here are some factors that we believe should bring the fixed rates back down in the short term.

1. Australia may have increased their key lending rate but their largest trading partner is not the United States of America, but rather China. China has fared much better in the past 18 months than the U.S.A and is roaring out of this recession with a huge appetite for trade. Canada’s trade growth is heavily reliant on the U.S. Consumer; Americans are not only spending less money but will be unlikely to by Canadian when our dollar is at par and our goods and services become far more expensive.

2. Our Employment numbers may have looked great when they were released last week but it is important to look at the report more closely to identify some trends that might not inspire great confidence. Primarily, the report identifies that many of the jobs were created in the Government Sector. Secondly that an unusually abysmal summer Student job market this summer should have impacted the seasonal adjustment usually placed on the employment number less than it actually did (each year Statistics Canada adjusts the October employment numbers to adjust for the number of students that are leaving the job market, since fewer students actually had jobs this adjustment lead to an increase in the actual employment rate). Finally, in a bad economy people stop looking for work and are therefore taken off of the list of unemployed, thereby reducing the unemployment rate.

3. Our housing boom. Although prices are increasing it is because of affordability and not because of a roaring Canadian economy. The rush of people now buying are simply those who put everything on hold while the world was collapsing. This pent up demand will soon move through the system and bring our housing market to a more normal level.

In short we feel that a variable rate is still a great place to be, but if you are concerned about no being able to lock into a super low 5 year fixed rate it may be time to give us a call and discuss a fixed rate strategy.

Marcus Tzaferis

Take the Savings of the Variable Rate Over the Security of a Fixed Rate

The Bank of Canada has all but guaranteed to increase interest rates in 9 months and Canadians are flocking to the security of fixed rate mortgages. At the same time we are seeing variable rate mortgages become more competitively priced.

As the premium priced into variable rate mortgages begins to fall away at a greater pace, one must begin to look more closely at the fixed rate vs. variable rate argument. The purpose of this newsletter will be to investigate the factors affecting these two popular mortgage options in more detail in order to make a decision as to whether to go fixed or variable.

Fixed Rates:
How much longer can rates stay this low? The Canadian Bond market, which is a very clear indicator for mortgage rates, has showed little movement as of late but should begin to move once an increase in the Bank of Canada’s overnight rate is priced into the market. With the expectation that bond yields will begin to increase the current fixed rate mortgage options are beginning to look very appetizing. On offer, some of our mortgage lenders today, are 5 year fixed rates as low as 3.74% and this is about as cheap as we have seen mortgage rates in the last 10 years. With 5 year fixed rates so low many people are asking themselves whether it is indeed time to lock into a fixed rate mortgage and prepare for the upcoming tidal wave of inflation that will drown us in higher interest rates.

Variable Rates:
In February of 2009 we prepared an article advising our clients that the extra fat on the variable rate mortgage pricing would soon fall away and make the product far more attractive. After the almost 1% weight loss program these variable rate mortgages endured, it is a very good time to start looking at them again.

Canadian Mortgage Lenders have made some very generous returns on our mortgages over the last year, citing increased risk and increased borrowing costs. With de-thawed credit markets and red hot stimulus from the Canadian Government, the risk premium has melted away and going forward variable rate mortgages will be priced below prime.
To make an informed mortgage decision, consumers must begin to weigh the immediate savings of a variable rate mortgage against the long term security of having a low fixed rate.

We believe that although the Bank of Canada will increase rates as promised on June 4th of 2010 there will not be enough economic growth to warrant further dramatic increases in rate. On June 4th Variable Rate Mortgage holders will see their mortgage rates rise by the exact amount of the Bank of Canada Rate hike (probably between 0.5% to 0.75%). After that rate hike the medium term health of the Canadian economy will not be strong enough to warrant further interest rate movement for some time.
At the time of writing this newsletter, I caution you that my opinions are not widely held. Fears of inflation from the flurry of economic stimulus, not too mention a rebounding North American economy evidenced by soaring equities are leading many economists to believe that interest rates will be increased rapidly by the Bank of Canada.

To this my rebuttal is that a weak US consumer and a strong Canadian Dollar will hold back economic growth and mute the inflationary pressure that so many are calling for. In short, interest rates will not be moving anywhere to quickly.

The Governor of our Central Bank appears to be a no nonsense, shoot from the hip kind of guy. In the event that he decides to begin to scale back our monetary stimulus he will no doubt give us fair warning and provide us with a plan as to how our economy will return to a more sustainable long term growth model without excessive monetary stimulus.

Although we suggest a variable rate mortgage, we advise you to discuss your mortgage options with us before you make your final decision. Keep in mind that not all variable rate mortgages are created equal. Ensure that your variable rate mortgage allows you to lock into a fixed rate at any point over the term of your loan, and be sure that the fixed rate that you will be taking is a discounted fixed rate. All too often do we see Canadian Banks attempting to switch their existing variable rate mortgage clients to higher than market fixed rates.

As always, if you have any questions please do not hesitate to contact us.

Thanks,

Marcus Tzaferis