Chad Moore Calgary Mortgage Broker

The Bank of Canada has outlined a rate hike plan, with three phases:

1. Asset purchase tapering.
2. Reinvestment purchasing.
3. Monetary tightening.

What phase of Monetary tightening are we in now?

The Bank of Canada has officially tapered their bond (asset) purchase program, as part of the pandemic economic stimulus, from $5B/week to $0. The BoC is now purchasing bonds at their maturity, ceasing the growth of their balance sheet (ownership of Government debts). Purchasing bonds at their maturity is still a form of economic stimulus, albeit much less.

Monetary tightening (rate hikes) timeline?

The timeline for interest rate hike(s) is bumped up to mid 2022.

Tiff Macklem, Governor of the Bank of Canada, looked Canadians in the eye, in the depths of the pandemic, and said rates will be low for a “long time”. He basically begged Canadians to go and borrow money. And they did.

Tiff has also been quite vocal about inflation being transitory. Oops. Now the narrative is “inflation is transitory, but not short lived”. Here is a clip to a CTV video interview with Tiff Macklem (link).

Inflation is proving to be more persistent than many policy makers thought (hoped?). It turns out, shutting the global economy down, restarting everything and drastically increasing the money supply does lead to inflation.

The October 2021 Monetary Policy Report (MPR, link) shows inflation continuing to rise for the remainder of this year, then gradually (conveniently?) falling back to the 2% inflation target mid 2022.

So, for right now, the rate hike forward guidance is mid 2022. Will rate hikes actually curb inflationary pressure though …?

Monetary Policy Tools Deemed Impotent?

A traditional monetary policy response to Consumer Price Index (CPI) inflation numbers above the 2% target, is raising interest rates. This is what’s causing some concern of variable rate Mortgage holders, or prospective variable rate Mortgage borrowers – the threat of rising rates.

The monetary policy response to the pandemic, and recovery from the pandemic, is anything but traditional. Much of today’s inflationary pressure is a result of several over simplified factors:

1. Base effects. Year over year comparison of inflation numbers are skewed in drastically different economic environments in a short period of time (pandemic lock downs v. opening economy).
   
2. Pent up demand. Pend up or delayed consumer spending is being unleashed in the economy.
   
3. Restricted supply. Supply of goods, for many many reasons, are restricted.

Monetary policy tools are better designed to battle inflation due to demand forces. Tightening monetary policy makes debt more expensive which incentivizes Canadians to pay down debt, reducing discretionary spending. Both results inherently cool inflationary pressure.

Monetary policy response (raising rates), due to supply side economics, is likely not how Central banks want to battle inflationary pressure. This is where the Bank of Canada is desperately trying to control the narrative of inflation (“transitory but not short lived“). Hiking rates too soon and too steeply is not solving current supply restraint inflationary pressures.

Here is a link to a detailed article outlining Canada’s current inflationary situation I find readable and helpful (link).

I honestly think the need for emergency low central interest rates is behind us which means several rate hikes are justifiable.

Interest rate exposure.

Who remembers the ’80’s? Well, amongst other memories from the 80’s, interest rates peaked at 21%. WOW! I’ve heard from some folks they’re worried about rates spiking out of control. I do not think that is wrong to worry about. But I don’t think rates will spike all that high though.

I think in the next 18 months rates climb by 0.75%. I’m making a call (calling myself out)! Those in variable rates, or thinking about entering a variable rate, will have exposure to the up-side of rate hikes. This can be a bit stressful for many people. I’ve fielded enough calls and emails from my clients considering locking in or worried about further rate hikes. This is a part of the roller coaster when being in a variable rate Mortgage. You know what though? Variable rate clients will also have exposure to the down side of rate decreases too! We are all reminded, interest rates cycle up and down.

Rate Hikes And Canadian Housing.

Movements in Real Estate values, and the overall economy, typically follow the expansion or contraction of the short term credit cycle. When lending policies ease, Mortgage qualifying loosens, interest rates drop, and credit markets are flush with cash – this leads to economic expansion.

When monetary policy tightens, this is a contraction of credit, and synonymous with a dampening of the housing market. Canada’s economy is entering a monetary tightening phase (removal of stimulus essentially) so housing should cool, right?

Wrong.

This time is different (classic thought). Yes, this interest rate hike cycle can be different, specifically for Calgary’s housing market. I’m not necessarily worried about my clients being able to weather a rate hike cycle. I think the major worry is the entire financial system becoming insolvent as a result of higher borrowing costs.

I think this rate hike cycle might be different for Calgary’s housing market for a couple reasons:

1. Mortgage stress test. Version one of the stress test started in September 2016 and was applied to insured Mortgage borrowers (less than 20% down payment). Version two of the stress test, the current version, took effect January 2018 and is applied to all Mortgage borrowers in Canada. The stress test qualifies borrowers at a higher rate, typically around 2% above, current market interest rates. This helps insulate borrowers from the effects of higher rates.
   
2. Oil & Gas economy. Calgary’s economy is closely coupled to the health of the oil and gas sector. Oil and gas seems to be out of a down cycle that dogged our local economy from 2015-2019 (remember?). The effects of this down turn are still in play, particularly with office vacancy downtown. The local economic spin off of oil and gas in Calgary, and Alberta, seeps into all parts of our economy. Oil and gas seems to be cycling up, and hopefully cycles strongly for the next 10 years!
   
3. Timing of renewals. Fixed rate Mortgage holders renewing into today’s interest rate market, or renewing this coming Spring, are actually renewing at about the same rates as they currently have. If these same Mortgage holders renewing into a variable rate Mortgage, they would be discounting their Mortgage rate.

The above reasons of why rate hikes might not have a negative effect on Calgaryians who own Real Estate. How might higher rates effect new home buyers though? Will a Bank of Canada rate hike cycle, and higher fixed Mortgage rates, dampen home buying demand?

Generally, the answer is yes. Higher rates mean higher debt service costs, which require higher wages to service the debt. This might encourage buyers to lower their purchase price search to accommodate their budget. This seems like a rational explanation of how a Real Estate market might function. I’m reminded today’s Real Estate market is anything but rational. I default to you – if borrowing costs rise, would that change the price level of home you shop for?

The $65,000 dollar question.

Should I go fixed or variable. I’ve written about this before (link). Read that post for a more in-depth answer. What would I do? I’d first look at the difference between fixed and variable rates. If the difference is more than 0.75% I’m taking a very close look at variable rates. Today, I’d go variable. I’d then set my payment higher to accelerate my Mortgage pay down. If/when variable rates increase, my payment would not change. The amount I pay to principal vs interest would change. To be clear, I am still helping my clients fund fixed rate Mortgages. There is no right or wrong answer to the age old question “fixed v variable”. The truth is what works best for YOU!

Conclusion.

If the Bank of Canada ends up spiking interest rates on Canadian over the next 12 month – I’m going to hit the streets in protest (kidding)! Canadian’s were basically begged to go out and borrow money, while being promised rates will remain “low for a long time”. Here we are.

That said, the “need” for emergency low rates seems to be subsiding. And I think slowly raising rates is a positive. These rate hikes should indicate a growing and healthy economy. Waiting too long to raise rates, then spiking them quickly, might turn into a bad situation quickly.

I think Calgary’s housing market is well positioned to handle any rate hike policy because our oil and gas sector seems to be on strong footing at the moment. The last Bank of Canada rate hike cycle we saw (2015-2019), was when our oil and gas sector was on our knees. That was an ugly time for many.

If you’re choosing a Mortgage product, please consider the overall strategy and plan versus focusing on interest rate. Here’s why …

I am switching many of my clients Mortgages right now for HUGE savings. HUGE! They have the options and flexibility to do so because they have a full service Mortgage. Many Mortgages, with discounted interest rates, are frozen. Those clients cannot move to save money. They’re locked in. Stuck. But at the time, they saved the equivalent to a cup of coffee per month by going after the “lowest rate”. Now, having the flexibility and options to make a Mortgage change saves THOUSANDS! Keep this in mind when deciding who you’re working with, and what Mortgage you are choosing. I do not think interest rate is everything.

Give me a call if you are planning to purchase, sell or make any Mortgage change. 403-809-5447.

Talk soon,

Chad Moore