US Fed Cuts Rates by 0.50%—What It Means for Canadian Mortgages
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The US Federal Reserve (US Fed) has officially lowered its federal funds rate (FFR) by 0.50%, marking the first cut since March 2020. This decision, aimed at stabilizing the US economy in the face of slowing growth and cooling inflation, is expected to have significant consequences for global financial markets, including Canada. While the immediate impact is felt in the US, Canadians—especially those with mortgages—should pay close attention to how this development could influence their borrowing costs.
The Federal Reserve’s interest rate decision was the subject of much speculation in the financial world. The big question was whether they would cut rates by 0.25% or 50%. The bond futures market suggested a 63 / 37 probability for a 50 bps cut yesterday as uncertainty stemmed from mixed signals in the US economy. While the Consumer Price Index (CPI) showed a welcome decline to 2.5% in August, core CPI increased slightly more than anticipated. GDP growth was strong in Q2, but much was driven by government spending and decreased savings rates – two unsustainable factors in the long run.
The US employment situation also painted a complex picture. Job growth had recently undershot forecasts, and prior estimates were revised downwards. However, average wage growth remained strong, and the unemployment rate decreased. There were indications of slowing hiring, although layoffs had not yet increased. If the economic deceleration persists, layoffs could be the next phase.
This potential for increased unemployment likely weighed heavily on the Fed’s decision. Unlike the Bank of Canada (BoC), whose mandate is solely on price stability, the Fed has a dual mandate of maintaining price stability and promoting maximum employment. This dual mandate could have made the Fed more inclined to respond swiftly to any signs of slowing employment growth. Historically, this dual mandate explains why the Fed has often favoured larger initial rate cuts compared to the BoC.
The growing concern was that the Fed might have kept interest rates too high for too long, given the increasing downside risks to the US economy. Recent economic data could have strengthened this argument, further contributing to the debate surrounding the size of the then-upcoming rate cut.
Key Takeaways
- The Fed’s 0.50% rate cut will likely lower Canadian mortgage rates.
- The extent of the impact will depend on the BoC’s response and ongoing economic factors.
- Canadians should closely monitor the Fed’s comments, ongoing actions, and how the BoC might react on October 23rd
How US Fed Rate Cuts Impact Canada
Influence on Bond Yields
US bond yields tend to drop when the Fed cuts rates, which often has a ripple effect on Canadian bond yields. Since bond yields influence fixed mortgage rates, Canadian homeowners and homebuyers could see lower fixed rates on new mortgages due to US rate cuts.
Currency Impact
A Fed rate cut typically weakens the US dollar, strengthening the Canadian dollar’s buying power. A shift that would ease pressure on the BoC to keep rates high to support the loonie, potentially leading to lower Canadian borrowing costs. Typically, the loonie can withstand between 75 to 100 bps differential between the US and Canada policy rates, currently 75 bps apart.
Variable vs. Fixed Mortgage Rates
Variable and adjustable mortgages could become more attractive if the BoC follows the Fed’s lead and cuts interest rates in response. While fixed-rate mortgage holders may not see an immediate change, future cuts could drive those rates down on new mortgages.
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How the Bank of Canada Might Respond to the Fed’s Rate Cut
Pressure to Follow Suit
The BoC may feel pressure to lower rates following the Fed’s move. If the US economy slows down due to reduced rates, Canada—heavily dependent on US trade—might face economic headwinds. To avoid widening the rate differential, which could weaken the Canadian dollar and drive up import costs, the BoC might consider cutting rates to keep the two economies aligned.
The Fed’s decision to trim the world’s largest economy’s policy rate signals that the US economy is slowing down. As its largest trading partner, Canada will feel these ripple effects strongly. When the US economy weakens, Canadian exports can decline, affecting the nation’s GDP and potentially influencing the BoC to follow suit with its rate cuts to sustain growth.
Economic Considerations
Despite the US rate cut, the BoC could hold off on cutting its rates if inflation remains a concern in Canada. Governor Tiff Macklem has clarified that the BoC’s main priority is keeping inflation within its target range, so any cuts will depend on whether inflationary pressures ease, as the Consumer Price Index (CPI) in August returned to 2%.
Impact on Canadian Mortgages
If the BoC follows suit with its rate cuts, Canadians with variable mortgages could benefit from lower interest-carrying costs on their payments. In contrast, those holding adjustable mortgages would see their mortgage payments reduce. Financing conditions would improve for those looking to renew or refinance. However, if the BoC maintains its current rates while the Fed cuts, Canadian mortgage rates could remain high, creating challenges for mortgage holders and prospective homebuyers.
What Homeowners Should Consider
Canadians should begin evaluating their mortgage options in light of this rate cut. Those with adjustable-rate mortgages (ARM) and variable-rate mortgages (VRM) may see immediate benefits, while fixed-rate mortgage holders should monitor future rate movements. Canadians holding HELOCs would also have an immediate reprieve as monthly interest costs would lower.
Today’s US Fed’s decision clarified the direction of economic policy, and Canadians should watch closely for the BoC’s response over the coming months. The outcomes of both central banks’ policies and comments will shape the future of mortgage rates in Canada.
CIBC’s Unique Forecast and Canadian Outlook
CIBC’s recent forecast sheds light on a significant shift in monetary policy expectations for Canada. They anticipate a 2.25% floor for the overnight rate at the lower end of the BoC’s updated neutral rate. These cuts are expected due to a “weakening labour market,” mortgage renewals over the next two years, and growing household debt burdens.
If this prediction holds, variable and adjustable mortgages may outperform fixed-rate options in Canada. CIBC’s forecast suggests that although Canada’s overnight rate remains restrictive, it will likely drop in response to broader economic pressures, creating opportunities for homeowners and buyers seeking more favourable borrowing conditions.
Managing Mortgage Risks
Given the economic uncertainty, Canadians may want to consider hybrid mortgage solutions. These options allow borrowers to hedge risks by splitting their mortgages into fixed and variable components, benefiting from rate decreases while minimizing exposure to potential rate hikes. This strategy helps well-qualified borrowers adopt a more flexible mortgage strategy, particularly when rate fluctuations are increasingly likely.
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Frequently Asked Questions (FAQs)
How does a US Fed rate cut impact Canadian mortgage rates?
A US Fed rate cut often leads to lower US bond yields, influencing Canadian bond yields. Since fixed mortgage rates in Canada are tied to bond yields, this will directly impact Canadian fixed mortgage rates. However, the overall impact on variable and adjustable rates will depend on how the BoC responds to the Fed’s decision and future monetary policy announcements.
Will the BoC lower rates following the US Fed’s cut?
The BoC operates independently of the US Fed but often considers global economic trends when setting policy. If the Canadian economy shows signs of a slowdown or if the US dollar weakens significantly, the BoC may choose to cut rates to align with the Fed’s actions. However, the BoC will prioritize inflation control and may hold off if inflationary pressures in Canada resurge.
What does the Fed’s rate cut mean for Canadians with variable-rate mortgages?
If the BoC follows the Fed’s lead and cuts rates, Canadians with variable and adjustable mortgages could see lower interest on their monthly payments. Floating mortgages are directly tied to the BoC’s overnight rate so any reduction would offer immediate payment relief to adjustable mortgage holders. In contrast, variable mortgage holders will see more of their principal being paid down.
How will the US Fed rate cut affect fixed mortgage rates in Canada?
Fixed-rate mortgages in Canada are more closely tied to bond yields, so the immediate impact of the Fed’s cut may be limited. However, new fixed mortgage holders will benefit from lower rates if Canadian bond yields continue to fall due to the US rate cut.
Should Canadian homeowners consider refinancing after the Fed’s rate cut?
If mortgage rates decline following the Fed’s rate cut, it could be a good time for Canadian homeowners to explore refinancing options. Lower interest rates could reduce monthly payments or shorten mortgage terms, potentially offering long-term savings.
Final Thoughts
The US Fed’s 0.50% rate cut marks a significant shift in economic policy to stabilize the US economy. While the direct impact is on US markets, Canadian mortgage holders and prospective buyers should stay alert to how this move could influence mortgage rates in Canada. The coming months will be crucial in determining the direction of Canadian borrowing costs and overall economic stability.
Mortgage holders and borrowers shopping for their best mortgage rate should check nesto’s mortgage rates forecast and speak with a mortgage expert about the Prime Time mortgage offer. Prime Time offers continual savings with a lower mortgage payment, adjusting with each rate cut, allowing flexibility to convert your mortgage to a fixed rate at any time without penalty.
Canada’s mortgage market is dynamic, and professional guidance can be invaluable in choosing your mortgage strategy. Reach out to nesto mortgage experts and lock in your best mortgage rate.
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