by David Larock

Canadian mortgage rates continue to fall, and it now seems only a matter of time before they hit record lows, which I peg at about 2% for widely available five-year fixed-rate mortgages.

While the decline in mortgage rates has been hastened by the COVID crisis and the oil price crash, longer-term factors are also putting downward pressure on rates – and will continue to do so long after the current situation normalizes.

In today’s post, I’ll start by recapping how our policy makers’ actions have helped to reduce the crisis-related risk premiums that are still elevating lending spreads beyond their normal levels and inflating mortgage rates as a result. I’ll also highlight several longer-term factors that will combine to pull rates down for years to come. Then I’ll conclude by offering my take on how a declining rate outlook might guide borrowers who are looking for a new mortgage today or considering a refinance.

When COVID initially hit, yields on non-government debt surged higher as financial markets priced in crisis-related risk premiums. That pushed up mortgage rates, and then lenders raised more in a defensive move that bought them time to assess the volatile landscape.

Our policy makers responded quickly and aggressively in an effort to counteract the market’s initial reaction. For example:

• The Bank of Canada (BoC) slashed its policy rate from 1.75% to 0.25% and pledged to purchase massive amounts of federal, provincial and even corporate debt. Their main purpose was to provide liquidity, but the purchases also helped to put a lid on rates.
• The Canada Mortgage and Housing Corporation (CMHC) offered expanded access to various funding sources and pledged to purchase $150 billion worth of insured mortgages from lenders’ balance sheets (which works out to roughly 80% of the total amount outstanding).
• Our banking regulator, OSFI, reduced lenders’ capital requirements and allowed mortgages that were put into COVID-related payment-deferral programs to still be counted as performing loans.

Our policy makers pulled out all the stops, but their actions still haven’t completely counteracted the upward surge in bond yields and mortgage rates caused by those stubborn risk premiums.

Five-year fixed rates normally hover in a range of 1.25% to 1.50% above the five-year Government of Canada (GoC) bond yields they are priced on. The five-year GoC bond yield opened at 0.38% this morning, and that would typically translate into five-year fixed rates in the 1.63% to 1.88% range. But today’s five-year fixed rates are offered in the low 2% range. There is still a risk premium evident, but on the bright side, it is now smaller than it was at its peak when the crisis hit.

Five-year variable mortgage rates normally hover in a range of 1.25% to 1.50% over the BoC’s policy rate, which today stands at 0.25%. That should put variable rates in the 1.50% to 1.75% range, but today they are priced at or around 2%. We see evidence of a risk premium there as well, although it too is waning.

Our policy makers have now recently turned to jawboning, using their words and guidance to impact market psychology.

Last week new BoC Governor Tiff Macklem conceded that even the Bank’s best-case scenarios for our recovery are “pretty bad” and that “we’re in a deep hole and it’s going to be a long way out.”

U.S. Federal Reserve Chair Jerome Powell recently offered an even more memorable quote reflecting the same sentiment when he said: “We’re not thinking about raising rates – we’re not even thinking about thinking about raising rates.”

Most economists now expect that it may well be years before we see mortgage rates rise on either side of the Canada/U.S. border, but their forecasts focus on how long it will take for our economies to recover from the current crisis, a relatively short-term issue. We shouldn’t lose sight of long-term factors that will have longer-lasting impacts on the direction of Canadian mortgage rates.

These include:

• Technological advances – We are now in a period where technological innovation is dramatically reducing the cost of almost everything. Consider that today Amazon employs more robots than people. These innovations are turning industries on their heads, and the pace of change is accelerating, as is the downward pressure on prices. Lower prices mean less inflation, and less inflation means lower mortgage rates.
• Demographics – Like most of the developed world, our country’s average age is rising. Today, we have more seniors (aged 65+) than children, and the number of seniors is rising rapidly while the number of children is declining. Retirees spend less (which lowers overall demand) and they save more (which increases the availability of capital for lending). Lower demand and increased saving will exert downward pressure on mortgage rates for years to come.
• Debt ­– Debt is like an invasive garden weed that crowds out an economy’s access to the resources it needs for healthy growth. When those resources are choked off, both supply and demand are limited, and inflationary pressures are less likely to take hold. At the same time, high debt levels magnify the economic impact of rate increases, which means rates don’t have to rise by as much to slow growth and relieve inflationary pressures.

If you’re in the market for a mortgage today, here is my take on how the forecast above might guide your decision-making process:

• The risk premiums that pushed mortgage rates higher at the start of the current crisis are waning but are not yet gone.
• We don’t know when, or even if, those risk premiums will fully dissipate, but at some point they should. If that happens, and/or the long-term forces listed above continue to exert downward pressure on our mortgage rates as expected, they will likely reach record lows.
• If you need a mortgage soon, the key objective is to maintain flexibility so you can take advantage of lower rates if they continue to fall.
• The best ways to do that are either with a variable-rate mortgage, or with a fixed-rate mortgage that isn’t encumbered with exorbitant penalties.

Of those two options, both of which achieve the objective, I think variable-rate mortgages will prove to be the better choice for most borrowers for three reasons (which I wrote about in more detail here):

1. Today’s variable rates are lower than their fixed-rate equivalents and don’t appear likely to rise any time soon.
2. Variable rates come with a free option to convert to a fixed rate at any time. If fixed rates fall as expected, you may be able to convert down to a lower fixed rate.
3. The penalty to break most variable rates is only three months’ interest (whereas fixed-rate penalties are calculated using the greater of three months interest or the potentially expensive interest-rate differential penalty).

I will close this post by reminding readers that while I think it is now pretty much inevitable that record low mortgage rates are on the way, this is a forecast, not a guarantee.

As Yogi Berra once said, “It’s tough to make predictions, especially about the future.”

By: Myke Thomas

With evidence confidence in the real estate market is increasing, there are indications first-time home buyer intentions to buy have not wavered, says Phil Soper, president and CEO of Royal LePage.

“We saw intentions through the Environics study that Genworth did in February and May and we found intentions to buy are the same,” says Soper. “They’re asked if they intend to buy in three months, six months, 12 months and two years, and intentions, and didn’t slip from February to May. It’s interesting the intent of people to purchase with less than 20 percent down has risen materially, so my theory is just like 2009, there will be over-sized interest from the first-time home buyer group.”

First-time buyers are critical to the success of housing markets.

“When you come to the market as a first-time home buyer, you don’t have a home to sell, so you’re creating further imbalance in favour of sellers, so you’re propping up prices even more, so if we do have growth in the first-time homeowner sector, that will do even more to prop up prices,” says Soper. “Our expectation is that prices will soften during the foremost stay-at-home mandates that are still in place in Ontario and Quebec and as those are released all across the country, as they have been in Manitoba, Saskatchewan and Alberta. That balance we have between buyers and sellers will hold and the risk premium that buyers are demanding during the lockdown time will start to dissipate.

“Our outlook for the year is that prices will end up essentially flat or up one percent, nationally. We see about three percent softness in Calgary and about the same in Edmonton. We see prices rising a little bit in Vancouver and Toronto.”

Source

By: Ephraim Vecina

The Bank of Canada’s next interest rate decision and economic outlook in mid-July will largely depend on consumer activity and fiscal movements in the next few weeks, according to Toni Gravelle, the central bank’s deputy governor.

Cautiousness is warranted amid the risks and uncertainties arrayed against the Canadian financial system, Gravelle said.

“A lot will depend on whether we as a country are successful in managing the risk of possible future waves of COVID-19, and the pace at which containment measures are lifted,” Gravelle said. “This applies to the global economy as well as Canada’s.”

In the meantime, the bank will focus on maintaining as much stability as possible, considering that the domestic economy saw a 2.1% decline during the first quarter, with a possible 10%-20% drop on the horizon.

Late last month, the BoC’s former governor, Stephen Poloz, said that the institution will continue its program of purchasing Canada Mortgage Bonds, up to $500 million per week.

“This is to support the healthy functioning of an important market for mortgage lending to Canadians,” Poloz said. “Together, all these facilities should improve liquidity and funding conditions for lenders, which will help businesses and households access the credit they need. It will also help Canadians benefit more from our monetary stimulus during the recovery period.”

Source

by Ephraim Vecina

Despite multiple headwinds and the continuous ravages of COVID-19, Canadian market activity and purchasing power will be able to recover quickly after the outbreak eases, according to outgoing Bank of Canada Governor Stephen Poloz.

“We have to be able to manage the risks around those things, so I’m not going to dismiss [the worst scenarios],” Poloz told BNN Bloomberg. “But, me personally, I do think on balance what I’m hearing, the flow that I’m hearing, is a little too dire, a little bit overblown.”

In the greater scheme of things, the coronavirus will not be a fatal roadblock, Poloz said. While the national economy is still on track to decline at least 15% this year, “you should see a very rapid return to production” once the economy restarts in late 2020, he said. “I’m relatively optimistic, what I find, compared with what the talk is.”

These predictions dovetailed with other observers’ forecasts of speedy post-pandemic recovery across the board, pointing at the Canadian financial system’s robust fundamentals.

However, the pace of this recovery will depend on homeowners not selling their assets, according to TD Economics.

“Absolutely key to our forecasts is the assumption that listings mirror sales by dropping substantially in the near term and recovering gradually thereafter,” said TD economist Rishi Sondhi. “This puts a floor on prices and sustains relatively tight supply-demand balances across most markets, allowing for the resumption of positive price growth as provincial economies are re-opened.”

Retailers go broke, property and oil fall but maybe the economic pain will speed beneficial changes

By: Don Pittis

As people are thrown out of work, as businesses fail and as the oil and housing sectors weaken, there is a branch of economics that insists it all may have a silver lining.

Just last week the retailer Pier 1, familiar to many Canadians, gave up attempts to refinance and announced it was shutting its doors for good. Almost simultaneously, the venerable Canadian fashion chain Reitmans went into bankruptcy protection.

Those are just some on the list of famous names that are in financial trouble during this COVID-19 lockdown, including J.Crew, JCPenney and Cirque du Soleil.

As people stop flying, the head of Boeing has suggested a major U.S. airline may fail, and globally, many smaller carriers are at death’s door.

As the CMHC worries Canadian real estate prices will crash by as much as 18 per cent, the oil industry struggles to recover from negative pricing and unemployment rises toward Depression levels, it is hard to see the bright side.

But according to the theory of creative destruction derived by Austrian economist Joseph Schumpeter in 1942 from ideas proposed by Karl Marx, economic and technological progress demands that businesses must die and industries and paradigms must be swept away to make room for new ones.

Canadian economist Peter Howitt, recent winner of the Frontiers of Knowledge Award for his work proving Schumpeter’s principles in the real world, said that while the creative destruction process is happening all the time, economic crises speed the process along.

“When old firms or technology or skills or whatever are hanging on, they can last a long time until things get really bad,” said Howitt. “It’s typically during a recession that a lot of the destruction takes place.”

The implication is that while those in retail or the oil business or the real estate industry may insist that the COVID-19 lockdown has been the cause of their failure, the economic crisis may instead be a trigger, a catalyst for a process already underway.

We already knew traditional retail was being challenged by tech giants Shopify and Amazon or by big-box discounters like Costco, but it was the downturn that pushed struggling companies like Pier 1 over the edge.

Part of a reset

Many have suggested in the past that the overleveraged housing market was an accident waiting to happen. In a broader sense, some economic thinkers say the current backlash against China and against globalization or even against the social structure of rich and poor is part of a reset for which pressure was already building.

According to Stephen Williamson, an economist at Western University, it may be dangerous for governments to try to push too hard against the economic forces at work in dying industries such as the fossil fuel sector.

“It doesn’t look like, at least the exploration and extraction part of the industry, is really viable a long time into the future,” said Williamson. “It seems hard to justify a huge bailout for those guys.”

From the smallest businesses to the largest, the rigours of recession can act as a torture test.

For businesses like that of Sean Davey, who after losing his job with the Royal Bank as a stock analyst in 2016 turned his mathematical skills to founding Rithmetic Math Club, surviving recession can mean prosperity afterwards.

Slipping into the language of his former job, Davey said his idea was to create “a cash-flow positive, low-risk business” that could grow slowly.

By converting his after-school sessions to Zoom, Davey said the vast majority of his 100-odd clients remain on board and he expects business to grow despite the disruption.

“What is in little doubt is that the COVID-19 crisis, which has turned so many people’s lives upside down, will eventually produce a wealth of new business opportunities,” The Economist magazine said earlier this month in its Schumpeter column, named after the famous Austrian.

Putting on a happy face

Responding to a complaint from some critics that creative destruction is merely a way of putting a smiley face on economic destruction, even as a proponent of the idea, Howitt does not minimize the notion that economic change is a painful process.

“Since the industrial revolution, people’s lives have been destroyed by new technologies,” he said, and while there are winners, workers and investors in the so-called “sunset industries” such as dying retail pay a price.

Both Williamson and Howitt say that even while it may pave the way to future innovation, a recession hurts innovators, too, as investment capital dries up and lenders withdraw from risk.

Turning science into business

At the University of Toronto’s Creative Destruction Lab, that gloomy view cannot stand in the way of Mara Lederman, who is firmly focused on the creation side of the creative destruction dichotomy.

Founded by artificial intelligence pioneer Ajay Agrawal at U of T’s Rotman School of Management, CDL has been turning “deep science” generated by university scholars into businesses that help transform the economy.

Lederman said a motivation for the non-profit lab was that Canadian universities were doing incredible science that only other scientists would see.

“What we need to do is take the science that’s being discovered and turn it into businesses, products and services for the betterment of humankind,” she said.

As an economics professor, Lederman is well-versed in Schumpeter’s ideas but she sees the current volatile times as an incentive to develop new ones. That’s why the group founded a new division called CDL Recovery to address health or economic recovery challenges created by the global COVID-19 crisis.

The group has already helped accelerate projects, including a wristband to determine if employees fail to maintain physical distancing, a system to monitor long-term care in a time of pandemic and a technology that uses artificial intelligence vision to keep track of care residents with a tendency to wander, to mention just a few, said Lederman.

“Are we in the kind of situation that is going to unleash creative destruction? I think the answer is yes.”