The world of mortgage rates is a complex dance, and it's time to take a closer look at the moves being made. In this article, we'll explore the potential narrowing of the window for cheap mortgage money and the factors that could impact it.
The Rate Game
CIBC Capital Markets has made a bold prediction: the Bank of Canada's policy rate may change direction in 2027. Avery Shenfeld, their chief economist, believes that while the economy still needs a boost from low-interest rates, the housing market and population growth will eventually recover, leading to a climb in Canada's key rate.
But here's the catch: as the Bank of Canada faces pressure to tighten its policy, variable and short-term mortgage holders could face a reduced potential payoff for the same risk.
Neutral Rate Drift
CIBC also predicts that Canada's neutral rate, the theoretical policy setting that maintains economic balance, will drift higher. This is due to an expected rebound in capital spending, including housing.
What's more, Canada's improving non-U.S. exports, potential new trade deals, and increased domestic AI investment could further support mortgage rates.
Market vs. Economists
Markets are pricing in a 25-basis-point hike by January, while economists like Shenfeld forecast a more conservative 50-basis-point increase by mid-next year. So, why the discrepancy? Shenfeld attributes it to a 'monkey see, monkey do' approach, with markets following the U.S. lead.
America's Influence
America's debt and its impact on our mortgage rates is a significant factor. CIBC identifies government deficits as a direct driver of the neutral rate, and with U.S. deficits at around six percent of GDP compared to Canada's one percent, the difference is notable.
JPMorgan projects U.S. debt could reach 120 percent of GDP over the next decade, which could push global public debt beyond the current $100 trillion mark, with significant interest costs.
The Impact of U.S. Rates
Historically, Canadian and U.S. five-year bond yields have moved in tandem, with a strong correlation. So, if U.S. rates surge, Canadian mortgage holders should be prepared, even if domestic factors don't seem to warrant hikes.
JPMorgan's long-run forecast suggests U.S. rates could add over 80 basis points if inflation remains stable. Additionally, the de-globalization trend and increased capital demand due to reshoring manufacturing could further impact rates.
Tech Borrowing
Tech companies' massive borrowing could also keep global rates elevated, with potential spillover effects on Canadian bonds. This is particularly relevant as tech firms' appetite for debt could impact the mortgage-critical five-year bond yield.
Inflation vs. Risk Premiums
Interestingly, inflation breakevens are relatively tame, suggesting that the recent surge in longer-term bond yields isn't solely due to inflation fears. Instead, investors are demanding higher risk premiums, especially given America's fiscal outlook.
The Doom Loop
The C.D. Howe Institute warns of a potential 'doom loop' scenario, where rising government borrowing costs lead to swelling federal deficits, further increasing rates in a self-perpetuating cycle. This is a real concern, especially with ever-increasing U.S. debt.
The Impact on Canadian Mortgages
While Shenfeld doesn't believe a U.S. default is likely, he acknowledges that increased debt issuance could push rates up, impacting Canadian mortgage rates. If these theories hold, the window for cheap mortgage money may indeed be narrowing.
Cyclical Nature of Rates
It's important to remember that rates are cyclical, and while they may rise, they will eventually fall. The Bank of Canada's inflation target ensures this. However, the duration of the hike cycle is uncertain.
The Future of Mortgage Rates
CIBC predicts that the U.S. neutral rate could drift down as the AI investment boom slows and the cost-cutting benefits of AI are realized. By then, North American growth may stumble, particularly if Washington curbs its spending.
The key question is whether investors will start punishing American fiscal habits. If so, fixed mortgage rates could remain elevated for an extended period.
Final Thoughts
While the potential for rate hikes is a concern, Shenfeld suggests that large, imminent mortgage rate spikes are unlikely. Bond markets may assume a direct correlation between U.S. and Canadian rates, but our inflation rate is better contained.
If you're carrying a mortgage for years, it's wise to model different rate paths and consider variable, fixed, and five-year fixed options. The fixed rate may win out if market expectations are met, but it's always good to test different scenarios.
