Prime Rate at 7.20%: Changing course?

Welcome to the 3rd edition of our Mortgage Newsletter for the year! As spring breathes new life into the world around us, we're thrilled to share the latest updates and insights with you. With the promise of longer days and warmer weather ahead, let's embrace this season of renewal and growth together.

To kick things off, let's dive into this morning's announcement from the Bank of Canada regarding its policy rate. The verdict? A HOLD! The Overnight Rate remains steady at a multi-decade high of 5.00%, but there's hope for a shift in June 2024. Today's decision means the Bank/Lender Prime Rate stays unchanged at 7.20%.

You can access the complete press release by the Bank of Canada [here].

Since my last update on March 6th, 2024, we've observed some notable developments in the economic landscape in Canada. February 2024 brought a lower-than-expected inflation reading, coupled with an uptick in unemployment figures to 6.1% just last week. Despite these challenges, the rate of wage growth continues to outpace inflation, offering a glimmer of resilience. Moreover, January 2024's GDP figures revealed a growth rate of 0.6% from December 2023, injecting a sense of optimism into the economic outlook. As a result, the previously anticipated rate cuts in 2024 are now expected to aggregate to a more modest 0.75%.

To contrast, US March CPI, released this morning, came in higher than anticipated at 3.8% and that has reduced the expected rate cuts to just 2 or 0.50% in 2024.  Markets are now ruling out a June rate-cut by US Federal Reserve.  Key question is.. Will we see a divergence in the rate path between Canada and USA?

These developments carry significant implications for individuals navigating mortgage decisions, prompting a thorough review of my conclusions at the bottom of this email. However, before delving into those insights, let's first examine some key market updates.

Mortgage Interest Rates

Let's explore the current landscape of Fixed Rate mortgages. As you're aware, these rates closely track the trajectory of bond yields, making movements in bond yields a crucial factor. Presently, the 5-year bond yield stands at 3.726%, 10 bps higher than the closing yesterday (3.625%) given the higher-than-expected March CPI reported in USA.  It’s about 15 bps higher than 3.56% reported in our last communication on March 6th, 2024. Yields have stayed in a narrow range of about 35 bps between 3.378% and 3.73% during this period and it is rather uncharacteristic given bouts of dramatic fluctuations since January of 2021. While Fixed rates have generally trended downward during this period, it wouldn't be unexpected to see some slight adjustments upward, especially considering the significant gap compared to Variable rate options and the tempered expectations of rate cuts.

To offer you a visual insight into evolving trends, we've included charts below. These charts illuminate the trends of various aspects associated with mortgages with a 5-year term, be it Fixed or Variable.

Note: The rates indicated below are the most commonly available rates for Prime borrowers. Many Qualified borrowers secure a lower interest rate than depicted below due to superior credentials. Interest rates with B-lenders and Private mortgages are at a premium to these levels.

The charts above shows the trend in interest rate for the major types of mortgage products (Fixed and Variable) for the last 30 months or so.  For the shorter term (1-3 year) Fixed rate mortgages, the rates continue to be at a premium to corresponding 5-year rates. 

Generally, Fixed rate mortgage rates are higher than their corresponding Variable Rate mortgages at the time of securing one but currently we are in a phase where the relationship is inverse.  This typically happens when the interest rate trend is under reversal.  There is no guideline as to how long such an inverse relationship can persist but in "normal" times this period is limited to couple of months at best.  This inversion has persisted for about 17 months now and the chart might be implying that we have seen the trough.

Above chart shows the spread between the 5-year Canada Bond yield and 5-year Mortgage (Fixed rate).  This spread has been larger than usual for the 24 months or so but we seem headed back to the average. 

A higher discount on the chart generally signifies a heightened demand for Variable Rate mortgages. It reflects the dynamic interplay between borrower preferences and the response of lenders to this demand. Conversely, a lower discount may indicate a market shift towards Fixed Rate products.

Below are the key conclusions I can draw from these charts:

1. The spread between Bond Yields and Fixed Rates remains higher than usual, indicating that lenders still have room to lower rates even if bond yields do not decrease.

2. The significant disparity between Fixed and Variable rates is solely attributable to the policy decisions of the Bank of Canada. This results in a substantially higher cost (higher by 1.30% or more) for those opting to remain with Variable Rates.

3. Variable Rate mortgages are currently being offered at a “Discount” to Prime Rate, which is ‘lower’ than the long-term average. This suggests that they are not priced efficiently.

4. Borrowers considering a “New” Variable Rate mortgage are ‘assuming’ that the Bank of Canada’s Policy Rate (and consequently Prime Rate) will decrease by at least 1.75% to 2.25% within next 12 months to justify doing so. Likelihood appears to be reducing every month.

5. Borrowers with an “Existing” Variable Rate mortgages are ‘assuming’ that the Bank of Canada’s Policy Rate (and consequently Prime Rate) will decrease by at least 1.00% to 1.50% or more within next 12 months to avoid overpaying. Likelihood appears to be reducing every month.

6. Opting for 3-year Fixed Rate mortgage appears to be a better bet than choosing a Variable Rate mortgage given the uncertain outlook for rate cuts and significant spread.
   

For more insights, I would encourage you to read my recent blogs “Time sensitive: Should you Stick with a Variable Rate or Switch to Fixed?” and “Navigating Your Mortgage Renewal: Best Practices for Homeowners”

Note: If you need help with your financing options, are interested in working with me or want to learn more about my services, please don't hesitate to get in touch. I'd be happy to chat!