How Recent GDP Data Could Impact Mortgage Rates
We've just received the latest GDP data for both Canada and the United States, and in this blog post, we'll dive into how these figures might affect mortgage rates in the near term. Additionally, we'll explore the challenges posed by the mortgage stress test in Canada and the pressing issues facing Canadian mortgage borrowers.
Canadian GDP Sees Sluggish Performance
Last week, Statistics Canada confirmed that our Gross Domestic Product (GDP) displayed no growth in July, following a 0.2% decline in June. Moreover, the estimate for August indicated a meager 0.1% expansion in our economy. These statistics prompted adjustments in the bond futures market, leading to reduced expectations of another interest rate hike by the Bank of Canada (BoC) this year. This trend aligns with the market's sensitivity to economic data releases.
The sluggish momentum in our GDP growth underscores the impact of the BoC's previous interest rate hikes, which are now becoming discernible. It also suggests that the savings buffers created during the pandemic, enabling consumers to manage higher costs while maintaining spending, are gradually depleting.
However, it's essential to note that sluggish economic growth alone won't suffice to bring inflation back in line with the BoC's 2% target. The overarching theme is that we have a considerable distance to cover before reaching that objective.
Strong and Steady US GDP Growth
In stark contrast, recent data reveals that the United States achieved a year-over-year GDP growth rate of 2.1% in the second quarter. The US economy is currently operating at a significantly more robust pace compared to Canada, driven by two key factors:
1. Productivity Surge: Productivity in the United States has shown remarkable improvement since the pandemic began, whereas Canadian productivity has steadily declined during the same period. The significance of this measure, particularly over the long term, cannot be overstated.
2. Household Debt Discrepancy: During the 2008 Great Recession, US households substantially reduced their debt levels, while Canadian households continued to accumulate debt, as indicated in the chart. This divergence in household debt-to-GDP ratios suggests that the US consumer may be less sensitive to interest rate hikes, potentially causing the US Federal Reserve to maintain higher policy rates for a more extended period than the BoC. This scenario could have repercussions on Canadian fixed-mortgage rates.
Fixed vs. Variable Mortgage Rates
Fixed mortgage rates in Canada are heavily influenced by Government of Canada (GoC) bond yields, often moving in tandem with their US counterparts. This synchronization may keep Canadian fixed mortgage rates elevated, even amid a weakening domestic economy.
Conversely, variable mortgage rates in Canada are not subject to the same constraints. They adjust in line with the BoC's policy rate, providing a more accurate reflection of domestic economic conditions.
Reevaluating the Mortgage Stress Test
As our economy decelerates and our housing markets cool down, it's time to reconsider some established practices. One such practice under scrutiny is the 2% inflation target. Some argue that this target is arbitrary and that a slightly higher target, around 3%, might be more suitable in the future.
The mortgage stress test is another policy tool under scrutiny given the evolving circumstances. While it made sense to qualify borrowers at rates close to long-term averages when mortgage rates were exceptionally low, the situation has changed. Mortgage rates have climbed above historical averages, and the BoC's policy rate remains in restrictive territory. The question arises: Is it still appropriate to qualify borrowers at rates 2% higher than their already elevated current levels?
While an immediate change to the stress-test rate isn't advocated, policymakers must navigate the housing market's momentum to combat inflation. There's also the issue of excess leverage in certain regional markets that heated up during the pandemic. However, the debate about reducing or altering the stress test will likely intensify, perhaps sooner than anticipated.
An Unjustifiable Policy: Renewal Borrowers' Dilemma
A notable flaw in our banking regulator's mortgage rules is the requirement for renewing borrowers switching to a different lender at renewal. They must be requalified at today's stress-tested rates, unlike borrowers who renew with their existing lender.
Initially designed to prevent excessive competition among lenders for highly leveraged borrowers, this policy inadvertently traps many borrowers with their existing lenders. This often forces them to renew at inflated rates. Despite criticism, the regulator has yet to address this anti-competitive policy and its impact on borrowing costs.
With today's stress-test rates exceeding 8%, more borrowers are unable to access competitive rates. This should increase pressure on our regulator to rectify this issue.
In Conclusion
While the five-year GoC bond yield showed minimal changes recently, a mid-week surge in bond yields led to further increases in fixed mortgage rates. Predicting when fixed rates will stabilize is challenging due to the strong upward momentum in bond yields. Therefore, those seeking a mortgage are advised to secure the best available rate today, as even a seemingly less favorable pre-approval rate could become highly competitive in the near future.
Variable-rate discounts have remained unchanged, and although the consensus suggests the BoC may have completed its rate hikes for 2023, uncertainty persists. The bond futures market's volatility, coupled with forthcoming employment reports from both the US and Canada, could trigger additional rate fluctuations.
