25 Oct

Bank of Canada’s Rate Hike Had A Hawkish Tone (meaning more to come)

Economy

Posted by: Garth Chapman

The article ‘Poloz Rate Hike Had A Hawkish Tone’ originally appeared on the DLC website Poloz Rate Hike Had a Hawkish Tone

Note: All the Banks have already follow suit with 0.25% increases to their Prime Rates.

As was universally expected, the Bank of Canada’s Governing Council hiked overnight rates this morning by 25 basis points taking the benchmark yield to 1-3/4%. This marked the fifth rate increase since the current tightening phase began in July 2017 (see chart below). The central bank stated it would return the overnight rate to a neutral stance, dropping the word ‘gradually’ that was used to describe the upward progression in yields since this process began. Market watchers will certainly note this omission. For the first time in years, the Bank has acknowledged it expects to remove monetary stimulus from the economy entirely.

So what is the neutral overnight rate? According to today’s Monetary Policy Report (MPR), “the neutral nominal policy rate is defined as the real rate consistent with output sustainably at its potential level and inflation equal to target, on an ongoing basis, plus 2% for the inflation target. It is a medium- to long-term equilibrium concept.” For Canada, the neutral rate is estimated to be between 2.5% and 3.5%, which implies that at a minimum, three more 25 basis point rate hikes are likely over the next year or so.

The Bank of Canada emphasized that the global economic outlook remains solid and that the U.S. economy is particularly robust, but is expected to moderate as U.S.-China trade tensions weigh on growth and commodity prices. The new U.S.-Mexico-Canada Agreement (USMCA) eliminated a good deal of uncertainty for Canadian exports, which will reignite business confidence and investment. Business investment and exports have been of concern in recent quarters, and the Bank is now looking towards a resurgence in these sectors, augmented by the recently-approved liquid natural gas project in British Columbia.

A continuing concern, however, is the decline in Canadian oil prices. Western Canada Select (WCS), a local blend that represents about half of Canada’s crude oil exports, has declined about 60% since July as global oil prices have risen (see chart below). WCS plunged below US$20 a barrel last week posting the biggest discount to West Texas Intermediate (WTI) on record in Bloomberg data back to 2008. WCS generally tracks heavy oil from Canada, which typically trades at a discount to WTI because of quality issues as well as the cost of transport from Alberta to the refineries in the U.S.

Canadian pipelines are already filled to the brim. The inability of the Canadian oil industry to build a major pipeline from Alberta to either the U.S. or the Pacific Ocean is increasingly dragging down domestic oil prices. Oil-by-rail shipments to the U.S. are at an all-time high, but this is an expensive and potentially unsafe option and precludes Canadian oil exports to China and Japan.

An even broader concern is the impact of higher interest rates on debt-laden consumers. The Bank is well aware of the risks, as the MPR cited that “consumption is projected to grow at a healthy pace, although the pace of spending gradually slows in response to rising interest rates… Higher mortgage rates and the changes to mortgage guidelines are affecting the dynamics of housing activity. Housing resales responded quickly to the new mortgage guidelines, and the level of resale activity is expected to continue on a lower trajectory than before the changes. New home construction is shifting toward smaller units, although stronger population growth is estimated to raise fundamental demand for housing.”

Household credit growth has slowed, and the share of new mortgages with high loan-to-income ratios has fallen. The ratio of household debt to income has levelled off and is expected to edge downward (see chart below).

Low-ratio mortgage originations declined by about 15% in the second quarter of 2018 relative to the same quarter in 2017 (see charts below). The MPR shows that “while activity fell for all categories of borrowers, the drop was more pronounced for those with a loan-to-income ratio above 450%, leading to a decline in the number of new highly indebted households”.

Bottom Line: The Bank of Canada believes the economy will grow about 2% per year in 2018, 2019 and 2020, in line with their upwardly revised estimate of potential growth of 1.9%. The Bank asserts that mortgage tightening measures of the past two years have “reduced household vulnerabilities,” although the “sheer size of the outstanding debt means that vulnerability will persist for some time”. That is Bank of Canada doublespeak. What it means is expect three more rate hikes by the end of next year. 

18 Oct

New mortgage Stress test to be imposed on Canadians effective Jan 1, 2018

Economy

Posted by: Garth Chapman

On October 17th Canadians awoke to the news that the nation’s banking regulator (OSFI) has announced that they will in fact go ahead on Jan 1, 2018 with a stress test for all conventional mortgage borrowers (those with more than 20% down).

This new Stress test will require that home-buyers (and those refinancing existing homes) who do not require mortgage insurance because they have a down payment (or existing equity) of 20% or more, will have to prove they can continue to make payments if interest rates rise by 2.0%. In fact it even goes a little further than that. “THE MINIMUM QUALIFYING RATE FOR UNINSURED MORTGAGES TO BE THE GREATER OF THE FIVE-YEAR BANK OF CANADA BENCHMARK RATE (that rate today is 4.89%) OR THE CONTRACT RATE PLUS 2.0%

The impact on buyers will be a reduction in their maximum mortgage amount of at least 20% and as high as 25%.

So if you are currently considering the purchase of a home, it is important to know that a purchase that closes after Dec 31, 2017 will have to qualify under the new rules, unless (maybe, we’ll know soon) you have a firm contract and a signed mortgage commitment in hand prior to Dec 31. Barring your having that, the mortgage amount you now qualify for will not be the amount you qualify for on Jan 1, 2018.

As has happened with past rule changes we expect that there will be clarifications issued around these dates to ensure that banks will honour the mortgage commitments signed by buyers, borrowers who have a home under contract and have waived all conditions. If so then buyers with firm purchase contracts and signed mortgage commitments should be able to close those purchases after Jan 1 as planned.

As to new-builds, well the question there is “how far out will they be able to close those deals under the terms of the mortgage commitments they have signed”.

On that front, Jencor has access to new-build mortgage commitments for 12 months at 3.29% where the appraisal can be done prior to signing the mortgage commitment and removing the finance condition, with an inspection just before possession to confirm completion of the build only.

This is huge, as there is thereby no risk of a lower future value wreaking havoc with the financing at time of possession.

If you are a pre-qualified purchaser you should now call your Mortgage Advisor or Banker and find out what your new maximum purchase price is effective Jan 1, 2018.

Garth