Forecasts are right: Rates will rise

Aside from poking at mass hysteria, OECD predictions offer little in the way of something new when it comes to mortgage rate predictions

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(Getty Images/Juan Monino)

(Getty Images/Juan Monino)

Quick Chicken Little, the sky is falling!

That’s my synopsis of the latest Organization for Economic Co-Operation and Development forecast regarding when mortgage rates will begin to climb in Canada.

Much like the fable, the OECD keeps pointing to signs of how Canada’s housing market is in for steep correction, or even a collapse. Much like the fable, the OECD is beginning to sound like an anxious chicken whipping up fears to cause mass hysteria.

I don’t think there’s an economist out there that wouldn’t agree with the assertion that mortgage rates are going to rise next year in Canada. Economists I’ve spoken to (including David Madani at Capital Economics and Robert Hogue of RBC Bank) predict a small increase by mid-year with an overall increase of just over 1% by year-end (2015).

Now, I may be naïve, but I don’t really think there will be much difference in the market if residential mortgage rates rise in May versus June. It’s certainly not a “sky is falling!” situation.

What I do know—and learned people have confirmed this—is that residential mortgage rates will rise before the Bank of Canada (BoC) will raise it’s rates. This is because the banks borrow money from the BoC in order to lend you the money for your mortgage—and banks are pretty concerned about borrowing at higher rates then they are lending at. Since the BoC is predicted to raise rates towards the Fall of 2015, it makes sense that buyers will see an increase in the posted and discounted residential mortgage rates in late spring or mid-summer.

Of course, the OECD predictions are predicated on the idea that the BoC will have to increase it’s overnight and fixed income rates sooner because there’s already inflationary pressure in the economy. But as Mr. Hogue pointed out during our interview, “the Bank of Canada will not push the panic button easily.” Just a few months ago, the BoC had to contend with higher than expected core inflation. Rather then react and adjust monetary policy, the BoC examined the causes. Dropping oil rates and a strengthening U.S. economy were the primary reasons and, despite inflation of 2.4% (the target is 2%), they opted to monitor the situation.

“The Bank proceeds cautiously,” explains Hogue, “and they are mindful of U.S. monetary policy.”

And this is important, says Madani. At some point, the Bank’s long-term rates will go up and this has more to do with an improving U.S. economy and the U.S. Federal Reserves move to increase U.S. Treasure note rates, explains Madani,  then with the Bank’s desire to curb inflation. Even the OECD nods to this important correlation between Bank of Canada yield rates and U.S. Treasury rates. Their report predicts Canada’s economy will grow by 2.6% in 2015 and 2.4% in 2016, “largely driven by export demand from the U.S. economy.”

But just ask a U.S. policymaker and they’ll tell you that one quartile’s uptick in the economy doesn’t make a strong economy, or prompt persistent inflation. We have to string a couple of strong economic quartiles before we know that their is sustained growth. That’s what the BoC is doing. Rather than react to fluctuating inflationary pressures, they’re looking at the overall domestic and global economy and making common sense decisions.

Now, if that means a yield increase in September—prompting rising mortgage rates in May—I don’t think this will cause the sky to fall on our nation’s housing market.

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4 comments on “Forecasts are right: Rates will rise

  1. Just a side note, it is U.S. Treasury notes not U.S. Treasure notes. Regarding interest rates, there was a decent rise on fixed bond yields until December-2013 last year with 5, 10 and 30 year rates all about 75 to 100 basis points or 0.75% to 1.00% higher with the highest rates for U.S. 30 year and Canada 30 year yields at 3.92% and 3.26% at that time.

    Compare to today’s, November-25-2014 U.S and Canada 30 year bond yields at 2.96% and 2.49%, both U.S. and Canada year yields 5, 10 years are 1.57%, 1.49%, 2.26%, 1.96%. They are pretty low so a rise in rates next year in 2015 is not really a surprise if or when it happens.

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  2. I remember last year, December-5, 2013, I bought some 18 to 21 year provincial bonds with yields at 4.17% to 4.244%. Today, November-25, 2014, the same provincial strip bond yields are anywhere from 3.57% to 3.64%.

    Just to give an idea of the impact after about 1 year later, the total less compound interest paid at maturity is 27.4985%, 4.224% versus 3.64%. For example, a $50,000 RRSP investment would be worth $13,749.25 at maturity.

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  3. A Correction to my last post, the $13,749.25 is less interest paid at maturity on a $50,000 RRSP investment or any $50,000 investment for November-25-2014 versus December-5-2014. Sorry for any misunderstanding I may have caused.

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  4. Rate increase…really? The world, other than the U.S., is currently in a deflationary environment. I don’t see how the U.S. alone can continue to hum along. I would bet no interest rate rises in 2015.

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