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Robert McLister: Higher fixed mortgage rates – or at least sideways fixed mortgage rates – are now a bigger possibility in 2025
Published on November 8th, 2024 • Last updated 2 days ago • 5 minutes reading
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Donald Trump's Republican Party could gain control of all branches of the U.S. government and have free rein to increase spending, cut regulations, deport cheap workers and impose tariffs. Markets fear that all of this will be inflationary. Photo by Matt Rourke /The Associated Press
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Fixed mortgage rates are tied to interest rates in the Canadian bond market, which in turn follow interest rates in the U.S. bond market. In fact, there is a statistical correlation of 0.95 between five-year American and Canadian bond yields, so they typically move like railroad tracks.
Therein lies the problem.
Over the past seven weeks, the U.S. side of these tracks has risen sharply, with the five-year Treasury yield rising 65 basis points. Canada's five-year growth has lagged because our economy is weaker – and that's to be expected, since we typically lag behind U.S. economic turns. Today, we also face more headwinds with the high cost of living and high debt.
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But for all the experts writing Canada's economic obituary, this concern is largely a rearview mirror analysis. When thinking about interest rates, you don't want to bet on tomorrow's weather by looking at last week's weather forecast.
Instead, it helps to look forward and recognize that the United States is not just our neighbor, but our economic sugar daddy. BMO Capital Markets economist Shelly Kaushik summed it up in a research note on Thursday: “The old adage: 'What's good for the U.S. economy is good for the Canadian economy' remains true.”
That's crucial because America was the fastest growing in the G20 last quarter, with gross domestic product of 2.8 percent. Despite all they've been through, unemployment in the U.S. remains remarkably low, at 1.73 percentage points below the 20-year average.
Furthermore, leading economic indicators for the US and Canada are both pointing upwards, not downwards. According to the Organization for Economic Co-operation and Development, Canada's leading indicator just crossed the 100 mark, predicting expansion for the first time in 27 months.
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And now we're getting the biggest boost to the US economy in years: Donald Trump 2.0. Since the probability of Republicans taking control of Congress is 97 percent (according to prediction market Kalshi), markets fear that Republican victory will be like telling an impulsive daughter who just stopped shopping online discovered, give a credit card.
Team Trump could therefore have free rein to increase spending, cut regulations, deport cheap workers and impose tariffs. Markets fear it will all be inflationary, and rightly so – depending on the level of its tariffs and “promised” cost cuts. This is one of the reasons why yields have risen so sharply. (The other reasons are the surprisingly resilient U.S. economy and fears that Trump will pile on the debt and increase the supply of Treasury bonds despite his promise to “pay back the debt.”)
Meanwhile, the Fed's preferred inflation indicator, the core personal consumption expenditures index, is still 0.65 percentage points above the 2 percent target. At this point, higher prices are exactly what the doctor didn't order. Nine percent US inflation and eight percent Canadian inflation are still too fresh in people's minds and inflation expectations are fulfilling themselves.
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So if we boil that down, we get decent US growth, loose monetary policy, above-target core inflation, a weakening fiscal balance and stimulating new spending. What do you get with this recipe? A cocktail for higher returns, both in the US and (eventually) Canada.
In his press conference yesterday, Federal Reserve Chairman Jerome Powell gave no one confidence that markets should rely on further easing of more than 50 to 75 basis points. He shouldn't do it either. So it's no surprise that economists are rushing to remove US interest rate cuts from their 2025-2026 forecasts. Most are currently cutting last week's forecasts by 25 to 50 basis points.
And then there is the trading aspect. The U.S. buys three-quarters of our exports, so Trump's threats of global tariffs pose a risk to Canada's mortgage rate prospects. Many hope the president-elect can leave behind the rule of Justin Trudeau, whom he once called a “left-wing madman,” and a can negotiate a deal with the more like-minded Pierre Poilievre. As of this writing, Poilievre has an 86 percent chance of becoming prime minister next year, according to Kalshi – who predicted the US election like a champ.
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Conclusion? While Canada's economy could continue to slow for a quarter or two, the long-term view is that higher fixed mortgage rates – or at least sideways fixed rates – are now more possible in 2025. And yes, fixed rates can rise while variable rates fall, as they did in parts of 2003, 2008, 2009, and 2015.
How to play it
Many people are waiting for lower fixed interest rates to refinance or buy a home. Unfortunately, there is no way to know how much deeper we go from here.
The only sure bet at this casino: The odds of fixed rates going down are now less than a supermodel's eyebrow. Canadian futures markets are predicting a five-year decline in fixed funding costs of a paltry six basis points next year – it's like being happy about finding a crazy person on the couch.
For borrowers concerned about interest rate risk in 2025, variable mortgage rates are not a solution. It's true that markets expect further cuts from the Bank of Canada of more than 100 basis points. And it's true that variable interest rates perform best when you assume the forecasts are accurate. But the interest rate outlook can change quickly if the market realizes that it is lagging behind on inflation risks.
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Of course, people can vary their approach and commit to it if necessary, but the timing is tricky. Those who do it well often trade bonds on a yacht entering the port of Monaco or St. Barth.
For mere mortals who like to sleep at night, a fixed price of as close to four percent as possible makes perfect sense. Terms of three, four or five years are found in the mid to low four range, just 75 basis points above the 20-year average.
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Or you can play off this uncertainty with a hybrid mortgage, where you can choose how much risk you want to take on – e.g. B. 50 percent, 33 percent or 25 percent variable. When the future is cloudier than a Vancouver morning, spreading the stakes makes more sense than doing everything.
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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