One truth in economics is that mortgage rates typically follow inflation expectations, at least over time.
That eventually poses a problem for borrowers, particularly after consumer prices take flight, like they have this year. U.S. core inflation, for example, recently jumped the most in four decades, 0.9% on a monthly basis.
That “was well above what I and outside forecasters expected,” remarked Federal Reserve Vice Chair Richard Clarida. (Our country usually takes its rate cues from the U.S., so when the Fed talks, Canadian markets listen.)
But the bond market, which is normally hyper-sensitive to rising inflation, did something unexpected this week. It shrugged off the inflation concerns.
Instead of pushing rates up, investors drove them to their lowest level in three months. The Bank of Canada said this week that inflation will ease up by year end, and markets believe it.
This all begs one key question, however. Are rising consumer prices just temporary or will record stimulus, supply shocks, opportunistic firms, rising wages, de-globalization, commodity price increases, spending record savings, and other trends keep prices elevated?
Clearly most of these inflationary trends will peter out eventually, but no one can say that all such inflation pressures are short-term. Some are clearly less temporary, and that should prove apparent when the economy fully re-opens.
If inflation remains above target for 6+ months, this would only reaffirm that rate normalization is Canada’s destiny.
“The speed of this economic recovery is like no other,” said TD Economics this week. In years gone by, economic forecasts like those we’re seeing from the Bank of Canada “would already have caused the Bank to start tightening policy,” Capital Economics said in a report.
So, the market believes it’s just a matter of time before bond yields resume their ascent. Knowing that, lenders may pass along a smidge of their funding cost savings (savings precipitated by falling yields). But we anticipate that few, if any, major fixed-rate cuts are on the near-term horizon.