The Bank of Canada has issued its latest rate verdict. Here’s a breakdown of today’s announcement:
- Rate Decision: No change to the overnight rate
- Prime Rate: Also no change. Prime remains at 3.70%
- Market Rate Outlook: One more hike this year plus two more hikes next year. The market is not fully pricing in the next BoC rate increase until December.
- BoC’s Headline Quote: “Recent data reinforce…that higher interest rates will be warranted…We will continue to take a gradual approach, guided by incoming data…The Bank is also monitoring closely the course of NAFTA negotiations…and their impact on the inflation outlook…”
- BoC’s Full Statement: Click here
- Next Rate Meeting: October 24, 2018 (in 49 days)
The Spy’s Take: The BoC isn’t prone to gambling. That’s why no one expected it to hike rates today, amid Trump’s bold threat to Canadian jobs. Assuming Trump doesn’t rock Canada’s economy with auto tariffs, there should be enough clarity on trade to permit one more hike by year-end. Tariff risk aside, economic fundamentals unequivocally support more rate tightening. Today’s news does little to change the narrative on mortgage rates, as evidenced by 2-year yields barely budging after the announcement.
How to Play Today’s Rate Decision
The Bank made it clear, inflation is “higher than expected.” Be it temporary or not (no one can be sure), headline inflation is currently at the upper limit of the Bank of Canada’s tolerance: 3%.
Assuming the trade war doesn’t get ugly, above-forecast inflation remains a threat. That warrants more tightening by both the Bank of Canada and the Fed alike.
If Trump does make nice with Canada (remember, he “loves Canadians”…) and “allows” us to join NAFTA, economic growth—on both sides of the border—could feed off of Trump’s supersized U.S. fiscal stimulus package. The market thinks there’s a greater likelihood of that than the alternative.
This, in turn, raises a real possibility that growth and inflation could surprise central banks, causing rapid “catch-up” rate hikes. It can’t be understated: a central banker’s worst fear is being behind the curve on fighting inflation.
On the other side of the coin are the slew of looming geopolitical/geoeconomic threats. They could put an end to rate hikes in 2019, double-quick.
The world is not a stable place right now. Crises can come out of left field at virtually any time. And there are a lot of “left fields,” including: exclusion of Canada from NAFTA, economic contagion from Italy, Turkey, Venezuela, Argentina and/or military brinkmanship with Iran, North Korea or Syria.
Should any of these powder kegs blow, global sentiment could dive, investors could panic into risk-free assets and world growth could slow. Canada’s bond market would then see a surge of buying pressure. That could drive yields (and mortgage rates) back down in a matter of weeks.
The Bank of Canada is trying to see a picture through all this, but it’s getting a lot of static. On top of it all, Canadians are now more sensitive to higher rates than ever before. That means consumption is slowing faster with every 1/4% BoC rate increase. This somewhat limits the the odds of significant rate increases from this point forward.
Against such an unpredictable backdrop, your average investor would be wise to hedge their rate exposure. In the mortgage world, you can do that with a hybrid mortgage that’s part fixed and part variable.
Barring that, the risk tolerant and financially stable borrower can still afford to take some risk if they get a deep discounted rate. That means, a variable rate or one-year fixed rate near/under 2.70%. Two, three and four-year rates are still uneconomical at almost every lender (thanks partly to onerous default insurance policies by the federal government).
For those who suffer heartburn at the thought of 100+ bps of further rate hikes, or are worried about their ability to qualify with a new lender at renewal, the 5-fixed remains Canada’s best long-term rate value. But shop hard because “discounted” 5-year fixed rates vary by over 75 bps, and early breakage penalties (at some lenders) can make your eyes water.