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July 4, 2017 | So Much For That

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

 

Back in December, when we all lived in innocence, a Nanos poll found 40% of Canadians thought they’d circle the drain if interest rates were to rise. But, fortunately, eighty per cent (in another survey) said this would never happen. Even the economists were benign. No hike in 2017, they predicted, bravely.

Well, so much for that.

Rates start to increase for the first time in seven years at 11:15 am Ottawa time next Wednesday.

That’s when Bank of Canada boss Stephen Poloz will release the latest ‘Monetary Report’ and make the big announcement to a press theatre full of reporters. The betting is for a quarter point jump this time. Could be more, but 50 basis points would be like a direct Kim Jung Un missile hit on downtown Vancouver. So, nah, unlikely.

 

But next Wednesday is the beginning, not the end. The current expectation – to be confirmed with the next labour stats on Friday – is the cost of money will rise again before the end of the year, most likely on October 25th (another Wednesday). So, at a minimum, the central bank rate will double in the next five months.

The reasons why are already old. The economy’s growing okay, the oil shock is behind us, companies are hiring again, inflation’s creeping higher and US rates are on the march. If Poloz fails to move, our currency will suffer. Worse, the moisters will continue snorfling and Hoovering up debt at an alarming rate and housing will eventually blow up, instead of merely deflating like an unwanted BF.

Many will argue that central bankers screwed up royally by allowing ‘emergency rates’ to stay in place for the past nine years. The direct correlation between the cost of money and the cost of a house, for example, is irrefutable. Did you catch the latest ‘affordability’ report of the Royal Bank? When owning a house with a 25% down payments takes 72% (Toronto) or 79% (Vancouver) of pre-tax income, things will not end well. Families owe more money than the entire economy generates (over $2 trillion), another direct result of a central bank rate of 0.5%.

So this is the end of it. And the adjustment will not be painless.

The bank prime will surely rise by the full amount of the Bank of Canada increase (even though last time it did not fall by the same). So the prime goes to 2.95%. Secured lines of credit (HELOCs) travel from the 3.2% range to 3.5%. Fixed-rate mortgages are also expected to increase, since the yield on the five-year Government of Canada bond they’re related to has surged from 0.9% to about 1.44%. Business loans, credit card rates and variable-rate mortgages will also be more expensive.

Soon an end will come for the few 2.5% five-year mortgages left, and even for HSBC’s predatory 2.3% fixed-rate offering. Some people believe homebuyers with pre-approved cheapo mortgages will be goaded into making offers even in a declining market, and that could certainly be the case. But, overall, rising money costs are real estate poison. Three or four increases from now (that puts us about next April) the landscape will look far different.

Well, Kyle from Calgary just wandered in with a question.

“Hey Garth, long time reader and proud dog owner (yes, this is the obligatory suck up in order to increase my odds of you answering my question).” Good cowboy, Kyle. Proceed.

“I signed a variable mortgage 2.5 years ago for Prime -0.85 which currently put me at 1.85% (free money). For BOTH of the most recent BoC’s rate cuts of 0.25 my lender only cut my rate by 0.15.  Firstly, this should be illegal however I’m sure somewhere in my fine print it states they can do that.  Secondly, with the BoC about to increase rates what are the chances they are only going to increase my rate by 0.15? Seriously, how is this not illegal?  I signed up to take on interest rate risk, along with the associated interest rate rewards but am not seeing them.  What happened to consumer rights?  Good thing I own bank ETF’s so I catch a piece of their profits on the other side.”

Yes, check the contract. Your VRM rate is tied to the prime, and banks can make the prime rate whatever they wish. In 2015 when the central bank unexpectedly slashed its rate in half the chartered banks were reluctant to follow, since their net interest margins were being squeezed mercilessly. So they didn’t. Otherwise savers would have ended up getting zero or less on their deposits as the bank gave people like you free money.

Now that we’re going in the other direction, bankers are hot to hike the difference between what they shell out on savings and collect on loans. So after next Wednesday nobody with a TFSA savings account (what a tragedy) should expect to see the return rise by a quarter point. But Kyle’s home loan certainly will.

One solution: buy the preferred shares of the big banks, or any ETF chock full of rate-reset prefs. As interest rates slither higher, so will the capital values of these assets – which meanwhile cough out a steady dividend of more than 4%, plus deliver a dividend tax credit to boot. The last genius to suggest this was our weekend blogger, but I could tell from comments posted here that many people misunderstand preferreds. They like Trump, too.

We may be on to something.

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July 4th, 2017

Posted In: The Greater Fool

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