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Robert McLister: Every borrower wants to know what the central bank will do next to raise interest rates, and the bond market could give us those clues
Published on Oct 18, 2024 • Last updated 13 hours ago • 4 minutes reading time
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Pedestrians walk past the Bank of Canada in Ottawa, Ontario. Photo by DAVE CHAN/AFP via Getty Images files
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With Canada's official inflation indicator now well below the two percent target, two-thirds of economists expect the Bank of Canada to cut its key interest rate by 50 basis points on Wednesday. (A basis point is one hundredth of a percentage point.)
As this rate-cutting boom unfolds, you'll want to keep an eye on bond yields. Yields are like the GPS for fixed mortgage rates, and most mortgage buyers choose fixed rates. Every borrower wants to know what the Bank of Canada will do next to raise interest rates, and the bond market could give us those clues.
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To a casual interest rate watcher, one might expect a decline in yields, but bond markets are forward-looking. Finally, they expect looser policy from the Bank of Canada to stimulate the economy and fuel inflation. That's usually enough for fixed interest rates to bottom out for a while before rising yields push them higher.
However, we are probably not there yet. Inflation is still showing the best impression of a lead balloon and the central bank fears it could fall too far below the two percent mark. That's why bond traders are betting on more cuts than a drunken barber – a total of 100 basis points by January and a whopping 175 basis points by December 2025, according to forward rate data from CanDeal DNA.
If we reach this 100 basis point discount by January, the federal funds rate will fall back to 3.25 percent. That's notable because it's at the high end of the Bank of Canada's “neutral rate range” of 2.25 to 3.25 percent. Neutral is the theoretical sweet spot, where monetary policy neither stimulates nor slows down economic growth.
Typically, interest rates fall into neutral territory or below. That's because central bankers tend to cut interest rates too late and overcompensate to ensure inflation doesn't fall too much. But the closer we get to the neutral mean of 2.75 percent, the more likely it becomes that the Bank of Canada will hit the snooze button on rate cuts.
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Bond yields will reach their own bottom at some point, and a Trump victory on November 5th would likely accelerate that process. His policies could drive up inflation in the US by up to a pointsays Goldman Sachs. And let's be honest: US inflation doesn't need a pass to boost Canadian prices.
What happens next?
If the Bank of Canada cuts interest rates by 50 basis points as predicted, expect five likely outcomes:
1. Variable rate borrowers will feel like they've won a mini lottery. While the average Canadian's mortgage debt is about $300,000, variable rate mortgage borrowers will find themselves with an additional $80 to $120 in their pockets each month, depending on the loan type. Most people can use this money to pay off their debts or buy essentials without taking on more debt. Others will use it to finance discretionary purchases. Such spending sprees ultimately create new jobs and increase inflation.
2. More homebuyers will rush into open homes because they believe they need to qualify for a mortgage now or stand out from the crowd. Yes, US commentators have been singing this tune since the first rate cut on June 5th. Ultimately, however, falling interest rates will have their expected effect and make home buying more budget-friendly – at least temporarily. The effect will be largely psychological for now, unless there is a reduction in the government's Minimum Qualification Rate (MQR). These are the tariff banks make Mortgage applicants prove this can afford. For the MQR to fall, fixed rates need to fall, and that depends on how much further rate cuts the market expects after Wednesday.
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3. A 50 basis point reduction would reduce the average new conventional variable rate mortgage from 5.60 percent (prime minus 0.85 percent) to 5.10 percent. That's about $30 in monthly savings for every $100,000 borrowed — enough for a fancy coffee habit or a subscription to yet another streaming service you'll never watch. Additionally, it lowers the annual income required to qualify for this variable mortgage by approximately $5,000 to $117,000 for a 30-year amortized mortgage of $500,000 (assuming a well-qualified borrower has no other debts). For some, this means their dream home may be less of a “dream” and more of an “attainable reality.”
4. Canada's beloved loonie – which depends largely on interest rate differentials and energy prices between the US and Canada – could take another hit (sorry, snowbirds). That could drive up the cost of foreign goods and services. Such imported inflation could potentially reduce the need for further rate cuts.
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5. As inflation creeps up in the next few months, economists may wonder whether the Bank of Canada has overdone its monetary easing. Rate cut expectations could then falter somewhat, particularly as labor markets and spending in North America are still buoyant. That's why a sizable minority of number crunchers on Bay Street are advocating for a more cautious approach to monetary easing.
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Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.
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