Bond yields fall on global banking instability
Your Mortgage Memo news for the week of March 17, 2023
Memo 1: Bank defaults mean bond yields – and fixed mortgage rates – are dropping
There’s nothing like a black swan market event to turn the tables on rate expectations.
New instabilities in the global financial system were exposed this week, following the default of several regional banks in the US, and a considerable bail-out for European investing giant Credit Suisse. Markets have roiled in response; despite the respective American and EU financial systems’ abilities to absorb the fallout successfully, fears are rising that more banks will follow suit and kick off another global financial crisis.
Bond yields slid steeply on the news. In Canada, both the government five- and two-year yields have dropped by more than 50 basis points (mirroring the drop in US treasuries) which has in turn put downward pressure on fixed mortgage rates. And the market is indeed benefitting from new discounts this week, as some lenders have shaved up to 30 basis points off their five-year fixed rate offerings, with the lowest now at 4.69%.
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Current events have also shifted the narrative for central bank decision-making; while news of Silicon Valley Bank’s default initially had analysts calling for a full-on rate hold from the US Federal Reserve, that’s now abated to a 25-basis-point hike in its rate announcement on March 21 - 22.
A quarter-point increase will bring the Fed’s federal funds range to 4.75 - 5%, marking a total increase of 475 basis points since it kicked off its hiking cycle last spring. It is now expected the American central bank will need to increase by one more quarter point before hitting pause for the remainder of 2023, before recessionary factors pave the way for rate cuts next year.
It goes to show how quickly the rate environment can evolve – just one week ago, a jumbo half-point hike had seemed inevitable, following comments from Chair Jerome Powell that more aggressive monetary policy would be needed moving forward to tame inflation.
This chilled-out take for the Fed also eases pressure on the Bank of Canada, making it easier for our central bank to stick to its rate hold commitment, with the small possibility of a rate cut by December. That means those currently holding variable-rate mortgages will likely be spared any upward movement for the foreseeable future.
“Short of the downside US economic risks being realized and rippling quickly across the Canadian border, we don’t see the BoC cutting policy rates,” write BMO economists Jennifer Lee and Michael Gregory. “Besides, the combination of the pause and recent steep rally in bond yields could start pulling down mortgage rates as housing sales activity is already showing signs of stabilizing (would sales subsequently be reinvigorated?). As before, we continue to look for the BoC to stay in pause mode for the remainder of this year, before commencing rate cuts early next year.”
Memo 2: US CPI still holding too strong
While this week’s market events will lead the Fed to take a calmer approach to rate hikes, its hand is still being forced by an unavoidable fact: inflation remains stubbornly high.
The February reading for the US Consumer Price Index clocked in at 6% on an annual basis, down from January’s 6.4% print. While it’s encouraging that the year-over-year headline picture is trending downward (and is now considerably below the 9.1% peak recorded in June), it remains well above the Fed’s 2% inflation target.
The worse news is that the core inflation measure – which strips out food and energy prices – still rose on an annual basis, up 5.5%, and 0.5% from January, when it rose only 0.4%. The latter is notable, as the Fed pays close attention to this metric as a real-time reflection of how inflation is playing out.
Overall, the numbers reveal inflation continues to be resilient in the face of the Fed’s rate hikes, and that the central bank’s battle isn’t over yet.
Memo 3: RBC makes an official recession call
Speaking of those recession fears, one of Canada’s biggest banks has now made an official call that one is unavoidable, and will unfold throughout the economy in the second and third quarters of this year.
In a special report out this week, the bank said while economic growth has been resilient in the face of steep rate increases, and early data shows GDP may be creeping up after a flat Q4, the economy still has “substantial lags” – which “often end up having unintended consequences.”
“Recent turmoil in financial markets has cast doubt on whether the Fed will continue to raise interest rates. The Bank of Canada already moved to the sidelines announcing a pause in rate hikes in January. But higher interest rates will continue to cut into household purchasing power with a lag,” write the report’s co-authors. “Housing markets have continued to retrench, both in Canada and abroad. The global manufacturing outlook has softened, and easing supply chain disruptions and lower (albeit still-high) commodity prices are helping to slow inflation. Against that backdrop, the most likely scenario is still that the U.S. and Canadian economies will both enter mild recessions over the middle-quarters of 2023.”
The bottom line
If you’re a mortgage rate shopper, recent events could translate into lower-priced options in the coming weeks. It’s a great idea to work with a mortgage broker, who can keep abreast of the rapidly shifting landscape, along with the changes in the mortgage-rate pricing landscape.
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