Canadian Fixed Mortgage Rates Highjacked By US CPI Inflation

Canadian Fixed Mortgage Rates Highjacked By US CPI Inflation

The Bureau of Labor Statistics reported that the US experienced higher-than-expected inflation in March 2024, reaching 3.5%, exceeding predictions and rising 0.3% from the previous month. The news was disappointing, as the market and consumers were hoping for lower rates on both sides of the border. While rates remain elevated, borrower confidence wanes, and spending on everyday and big-ticket household items declines, slowing business investment.

The recent surge in US yields had a ripple effect on the Government of Canada’s 5-year yields, resulting in a 14-basis-point (0.14%) increase. This surge, the most significant jump since October, reminds us that Canada’s mortgage rates are subject to external influences beyond its control. The close relationship between our countries’ bond markets means that fluctuations in the US market can directly impact Canada’s financial stability. This recent increase highlights the need for Canada to carefully navigate and adapt to changes in the U.S. bond market to safeguard the Canadian economy, mortgage rates, and the dollar’s buying power.

Consumer Resilience Keeps Inflation Unpredictable in the US

The recent release of the US Consumer Price Index (CPI) report has taken the spotlight away from the Bank of Canada’s April 10th decision to maintain interest rates. While we know that inflation is unpredictable, the US economy’s resilience has sparked curiosity among policymakers and economists, who are now questioning whether the US inflation data is merely a temporary blip on the road to overcoming the surge in inflation or a foreboding sign of long-term sticky inflation. 

The Federal Reserve (Fed) and the Bank of Canada (BoC) anticipated that reaching their 2% inflation target would be challenging. However, bumps in the road typically involve both ups and downs. In this case, the US has yet to reach the peak of this particular bump. While inflation is hard to predict, US inflation has increased for months, with the last easing in January. At the same time, Statistics Canada reported that the core inflation measures here came in lower for March and have been moving in the opposite direction from the US.  

In the past, inflation typically never increased or decreased in a straight line. It often takes unexpected turns, lasting anywhere from months to years. This is why central banks advised governments and the public against making hasty decisions based on short-term negative information. This time, the US consumer is showing remarkable resilience. The current situation is unique because consumers are displaying a strong ability to bounce back from challenges. The exceptionalism in the US market is standing out compared to previous times.

Rate Relief Timeline Shifts

Although both central banks have confirmed that rate relief is on the horizon, the timelines for the Bank of Canada’s lower policy rate and the Fed’s lower Federal Funds Rate keep shifting further down the line. US bond auctions have not been as successful of late, and when bonds don’t sell as well as expected, their yields rise to make them more enticing, which drives up costs for related securities that use them, such as fixed mortgages.

Interest rates are crucial in determining the perceived risk associated with investments. Following this week’s federal government budget announcements, the risk factor for real estate investments in Canada has increased. This means that investors may now view real estate investments as riskier due to the impact of this fiscal budget on interest rates. 

The bond market has already factored in many anticipated rate cuts that have been postponed, making the gap between fixed and floating rates quite large. This leaves investors to adjust their expectations this week in light of the delay in rate cuts. The difference between fixed and variable rates remains significant, with more than 100 basis points (equal to a whole percentage point) at almost any lender when considering comparable fixed and variable mortgage rates. 

Shrinking Discounts on Canadian Fixed Mortgage Rates

The BoC will likely cut rates before the Fed, which means increased pressure on the loonie to retain its buying power as we purchase goods priced in US dollars, which continue to surge relative to a basket of foreign currencies. Fixed and variable rates in Canada can differ significantly, so even if there is a rate cut in June or July, fixed rates might continue to rise. This difference is critical to understand because it can affect the cost of borrowing. The lowest 5-year fixed rate for insured mortgages for home buyers with less than a 20% down payment is currently approximately 4.84%. If this rate rises another 30 basis points (bps), it could reach 5.14% within the next two months. However, if the rate cut expected in June is delayed, this rate could go even higher.

While variable rates are subject to change based on market conditions, fixed rates remain the same throughout the mortgage term. If there is a rate cut, it may not affect fixed mortgage rates in Canada, and borrowers with fixed-rate mortgages may not benefit. Conversely, opting for a fixed rate at this time allows borrowers to have a firm grip on the expenses associated with their monthly payments and other debt payments. This is particularly beneficial for those substantial mortgage payments that consume a significant portion of many Canadian households’ monthly income. Securing a fixed rate ensures that these payments remain consistent and predictable, giving you greater control over your financial situation.

Inflation Heading in the Right Direction

Canada’s inflation rate was also affected by various factors, just as the forces disrupted the US CPI’s decline. These factors included monetary policy, commodity prices, geopolitical conflicts, wage growth, and supply-side challenges. These forces significantly impacted the overall inflation rate in Canada, causing fluctuations and changes in the prices of goods and services.

The Bank of Canada is confident that inflation will continue to decline slowly, even as the economy improves. They now believe inflation at the end of the year will be only 2.2%, lower than their previous forecast. If this prediction holds true, mortgage rates will go down. According to current patterns, the BoC and the Fed are expected to raise interest rates only if there is a notable rise in inflation in Canada or the US.

Advice for Mortgage Holders and Prospective Homebuyers

Currently, bond markets indicate more than a 75% probability of a rate reduction at the upcoming June 5th Bank of Canada meeting and the likelihood of a rate increase for July’s announcement. While these odds are favourable, they are subject to change due to other challenges, such as disruptions to oil supply stemming from the expansion of the conflict in the Middle East.

Borrowers seeking the best mortgage rate should remain optimistic that lower inflation in Canada could lead to lower mortgage rates later in the year. However, if you have a mortgage set to close or a pending maturity coming up for renewal within the next 120 or 150 days, it would be advisable to contact your mortgage broker or nesto mortgage expert and secure a rate lock today. 

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