How Canadian Mortgage Rates Are Impacted by Continued U.S. Fed Tapering – Monday Interest Rate Update (February 3, 2014)

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The U.S. Federal Reserve continued to taper its quantitative easing (QE) programs last week, announcing on Wednesday that it would reduce them from $75 billion/month to $65 billion/month.

This matters to Canadian mortgage borrowers for several reasons:

  • U.S. and Canadian monetary policies are tightly linked, making it highly unlikely that the Bank of Canada (BoC) will raise its overnight rate at least until the U.S. Fed hikes its equivalent Federal funds rate. Since the U.S. Fed has repeatedly said that it will not even consider raising the Fed funds rate until it has completely unwound its QE programs, the timing of this withdrawal acts as a kind of distant-early-warning system for Canadian variable-rate borrowers.

Reblogged from MoveSmartly.com | Dave Larock

  • The U.S. Fed taper is expected to strengthen the U.S. dollar and if the Loonie continues to depreciate against the Greenback, this will provide additional stimulus for our economy, particularly for our export-based manufacturers (which I wrote about last week).
  • The taper’s impact on our economy goes beyond monetary policy and exchange rates. For example, if QE is allowed to continue for too long it could fuel higher-than-expected U.S. inflation, which we would inevitably import over time. This would force the BoC to raise its overnight rate in response. Alternatively, if the withdrawal of QE pushes U.S. bond yields up, Government of Canada (GoC) bond yields, which move in lock step with their U.S. counterparts, would move higher and trigger a rise in our fixed-mortgage rates.

Here are the highlights from the Fed’s press release that included the most recent tapering announcement:

  • The Fed acknowledged the weak December U.S. employment data but expressed confidence in the broader U.S. labour market recovery, saying that “labor market indicators were mixed but on balance showed further improvement.” This implies that the Fed saw the most recent employment data as an anomaly that was impacted largely by seasonal factors, although a poor January jobs report could quickly alter that view.
  • The Fed made it clear that it will respond flexibly to changes in the U.S. economic outlook, saying that “asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.” That means that we should continue to expect bond-yield volatility as markets react to each new economic data release and try to interpret how it will affect the Fed’s QE tapering timetable.
  • “The Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.” Variable-rate borrowers take note: the Fed is reiterating that it will not raise its fed funds rate until well after QE has been completely unwound, and this bolsters my view that your rates shouldn’t be going up for some time yet.
  • “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.” In other words, Fed policy is still being guided by fears over deflation, which it mitigates with loose monetary policy, as opposed to concerns about higher inflation, which it mitigates with tighter monetary policy.
  • The Federal Open Market Committee (FOMC) vote to continue tapering was unanimous for the first time since June 2011. Some thought that had more to do with giving Federal Reserve Chairman Bernanke a proper send off at his last Fed meeting, as opposed to there being real convergence of FOMC committee member viewpoints. We should get a better idea of where the FOMC’s four newly minted voting stand at the next Fed meeting on March 18.

Now that the Fed has followed through with its second round of tapering, the consensus is that it will continue ratcheting down its QE programs until they are completely unwound by the end of this year. Here are a few reasons why I think that timetable is optimistic:

  • In a recent article, economist and market analyst Greg Weldon estimated that the U.S. treasury will have to issue $500 billion in new debt to cover the U.S. federal government’s budget deficit for this year, to say nothing of the nearly $3 trillion in maturing U.S. government debt that will have to be rolled over in 2014. Today, the Fed buys almost all of the newly issued U.S. treasury debt so when it withdraws (tapers) its support for U.S. bonds, who will become the marginal buyer of new U.S. debt at anything close to today’s low yields? If U.S. bond yields move higher, as I think they inevitably will if the Fed continues to withdraw its support, will the Fed hold firm or will it then choose to reassess “the efficacy and costs of such purchases”?

Forget house prices and debt, deflation is Canada’s new bogeyman

“After spending two years watching house prices and household debt measures, investors may spend 2014 focused on inflation reports when making bets on the Bank of Canada’s interest rate outlook.”

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Reblogged from Bloomberg News

The slow pace of consumer price inflation surprised policy makers in 2013, reviving rate-cut bets and prompting the central bank to abandon its bias to raise borrowing costs. Bank of Canada Governor Stephen Poloz said in an interview last month he can’t explain the weak inflation, which is now almost a percentage point below where the bank forecast it would be at the start of last year.

“A lot of people are starting to position for CPI releases,” Mazen Issa, senior macro strategist at Toronto-Dominion Bank’s TD Securities unit in Toronto, said in a telephone interview. “Inflation is going to be one of the major stories for Canada” this year.

Statistics Canada reported Dec. 20 that annual inflation in November was 0.9%, unexpectedly staying below the central bank’s 1% to 3% target band. The difference between Canadian and U.S. two-year yields narrowed by 4.22 basis points, the largest one-day reaction to Canadian CPI data since September 2011, when inflation was above the target band.

Inflation below 1% gives the Bank of Canada “plenty of reason to be dovish,” said Camilla Sutton, chief currency strategist at Bank of Nova Scotia in Toronto. The Dec. 20 report was “a disappointment because the market thought we would go back into to that 1 to 3%” target band.

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Inflation is almost non-existent, no matter what consumers think

“Inflation — like the data shows and the Bank of Canada keeps reminding us — is nowhere close to being a problem that would require jacking up interest rates. That’s not likely to happen for another year at the earliest — not until the Canadian economy is chugging steadily along and inflation is holding around the central bank’s ideal 2% target.”

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Reblogged from Financial Post, Gordon Isfeld

OTTAWA — We’ve seen a long string of mild monthly inflation reports from Statistics Canada for the past year or more, and the likelihood is there will be more of the same in 2014 and beyond.

Sure, food and gasoline costs can jump back and forth, and alcohol and tobacco prices are consistently near the top of the leader board. But the reality is that Canadian consumers shouldn’t have too much to complain about, inflation-wise, at the moment.

But still they do.

Perceptions can be skewed by big-ticket items, like houses and the appliances needed to fill them. A look at the cost of daily or weekly needs provides a different picture, one of mostly weak increases and equally narrow growth declines.

Inflation — like the data shows and the Bank of Canada keeps reminding us — is nowhere close to being a problem that would require jacking up interest rates. That’s not likely to happen for another year at the earliest — not until the Canadian economy is chugging steadily along and inflation is holding around the central bank’s ideal 2% target.

For now, the consumer price index is struggling to stay around the 1% mark.

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