The Bank of Canada stuck to its long-standing script today, reiterating that:
You’ve heard it all before.
Implied future rates have dropped in the bond market since peaking on March 22. Traders are now implying that 5-year bond/mortgage rates in 2024 will be about 0.35 percentage points lower than expected just five months ago.
That reflects nothing other than our bumpy recovery, one that’s been dogged by the most infectious wave of COVID yet.
Eventually herd immunity will bring us near business as usual, but the bond market is growing weary of predicting when that will be. With ¼ of eligible Canadians and young people still unvaccinated, it won’t be this year.
On that latter note, inflation expectations remain worrisomely high. That's led the BoC to temper its prediction that inflation is temporary. If the BoC is wrong on that prediction, it's the biggest risk that floating-rate mortgagors face.
The Bank’s statement today had optimistic notes, as it should. The storm clouds of COVID will pass, and Canada’s economy will recover, justifying higher mortgage rates.
At this stage, however, it’s clear that the start/stop nature of Canada’s recovery has done further lasting economic damage. Last week's horrendous GDP report was evidence of that. In turn, the Bank of Canada's “terminal rate” (peak rate) at the end of the recovery could end up lower than expected. That theoretically improves one’s chances in a variable rate, albeit slightly.
From a term selection standpoint, fixed and variable rates are in a horse race with no clear winner. A well-qualified borrower who values rate certainty can’t go wrong in a 5-year fixed near/below 2%—assuming you don’t plan to break the mortgage early or you choose a “fair penalty” lender. Insured mortgagors are still locking in below 1.59%—incredibly cheap money for a five-year term.
Conversely, the risk-takers among us (those with financial security) shouldn’t reject floating rates simply because they fear extreme hikes in the future. If the BoC is right about inflation being transitory—and it’s staking its reputation on it—then the significant upfront savings in a variable could offset your losses when rates start climbing. But that remains a gamble.
As we’ve noted before, term selection based heavily on future rate forecasts is a fruitless task. That’s why today’s 1.74% hybrid mortgages (half 5-year fixed and half variable) remain so appealing. They’re a sensible diversified approach to term selection where you’re guaranteed to win on at least half your bet, and not lose much on the other half.
Chart source: Bloomberg