March 1, 2021 | Feelings

“I was wondering,” writes Tom, “who sets mortgage rates?

“I have heard people say ‘the PMO / Bank of Canada / Big 5 Banks will stop interest rates hikes.’ Others say that these three have no influence at all.  So who or what actually dictates mortgage rates in Canada?”

Smart question. Fuzzy answer.

First, short-term rates (called variable because they, ah, vary) are heavily influenced by the bank prime rate, which is in turned usually dictated by the Bank of Canada benchmark rate. But not always. Banks can diddle with the cost of a VRM for marketing reasons, too (as TD & Scotia did last Friday).

Second, long-term fixed rates (unchanged during the term of a mortgage, most popularly five years) are determined by the cost of borrowing, which is a bond market thing. That’s why some banks upped their rates over the weekend, in response to last week’s big move up in the yields on five-year Government of Canada bonds. So selected mortgages got more costly (and others will follow) even though the central bank rate didn’t move a single basis point (which is one one-hundredth of a percentage point).

Third, all of this is subject to the lender’s feelings. A bank or CU can drop (or hike) rates whenever it wants – like during the spring housing silly season – to drum up more business. Lately HSBC, for example, has been ruthless in chopping its loan costs in order to build its home loan book. And there are mortgage lenders around who actually dole out money they borrowed from other lenders, so rates can vary depending on the margin they design.

As for the PMO (where Mr. Socks lives), zilch. Politicians can huff and puff all they want about the housing market, interest rates, oil prices, stock market valuations, bond yields or the weather, but they have no direct impact. Yes, they can change CMHC rules – like minimum down payments or mortgage insurance rates – as well as rules around using RRSPs as deposits or a homebuyer program, but they can’t touch the cost of money.

So, see? It took only 300 words to answer. Plus that response is only partial, since rates/bond yields are determined by the economy, inflation expectations, central bank bond-buying plus what’s going on with stocks, vaccines and (of curse) the virus. For example, lots of money can flow into bonds when yields rise to the point where investors earn a return equaling the dividends stocks pay, but with less risk. Like now, it seems…

Does this suggest equity market volatility if we’re on the path to lots of inflation as the economy reopens and the vax (especially the J&J brew) flows?

Absolutely. It’s inevitable. We’ve seen that lately. Markets toppled from all-time highs as bond yields advanced. Seasoned investors will probably see this as a buying opp, since we’re clearly on the road to big GDP gains in Q3 and 2022. As the virus fades and things reopen, higher corporate profits will drop P/E ratios, making stocks look way less expensive. (P/E represents the price of a share relative to the money that company earns. From a recent high of about 31 on the US market, it’s expected to drop down to 19, thanks to vaccines.)

Back to mortgages. Whither from here?

Yields on five-year Canadas dipped a bit after last week’s pop, but anything is possible now. The big lenders have been upping fixed-term rates and lowering VRMs, trying to keep loan volumes plumped that way. The Bank of Canada probably won’t start hiking its benchmark for a year and loan costs are still low enough to create buyer frenzy between now and the summer (when herd immunity becomes a factor and WFH starts to crumble and people shop for pants).

Best bet in a post-Covid world is still this: lock ‘er up.

Meanwhile, did you see the latest mortgage numbers? Staggering. In 2020 we had double-digit unemployment, massive government bailouts, a pandemic, recession and negative inflation rate and guess what Canadians did? Yup. We borrowed more money than in any year in a decade, increasing mortgage debt by almost 8% – the fastest pace in ten years – to $1.7 trillion. That’s $14,000 for every household in Canada that owns real estate (8.54 million). But only 551,392 houses changed hands in the nation last year. Do the math.

So, Tom, the main question is this: do you think the conditions that created the lowest mortgage rates ever in the midst of an historic economic and once-a-century public health emergency will continue, or change?

Answer that right, and you know what’s coming.

Garth Turner March 1st, 2021

Posted In: The Greater Fool

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