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Robert McLister: If the market's crystal ball deviates by just two rate cuts, borrowers' projected variable rate savings could evaporate
Published on Oct 25, 2024 • Last updated 15 hours ago • 4 minutes reading time
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A scene from the 1971 cult classic Dirty Harry starring Clint Eastwood. Photo by Handout/Windsor Star
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After the Bank of Canada's rate hacking attack on Wednesday, five-year variable mortgage rates are now just 46 points below rock-bottom fixed rates. This difference between variable and fixed interest rates has shrunk by almost 100 basis points since March.
Looking ahead to 2025, the bond market crystal ball shows a further easing of 100 basis points. That would equate to a total of nine quarter-point rate cuts since June 2024.
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But, you know, Canada's interest rate outlook is a little too consensus-driven. It's as if everyone has shifted to one side of the canoe when it comes to their 2025 tariff projections.
I can't help but imagine that if Clint Eastwood's “Dirty Harry” were an economist analyzing this market, he would just squint at the data and snarl, “I know what you're thinking.” Will the bank of Canada fire nine shots or just five?”
Staring down at a mortgage buyer with his trademark icy stare, he would probably croak, “You have to ask yourself one question: 'Do I feel lucky?'”
“Well, mortgagor? In this economy?”
You can't blame anyone for wanting to lower prices. Bank of Canada Governor Tiff Macklem is essentially telling us to grab our spending weapon, go out and borrow. He promised yesterday that “we will continue to cut the key interest rate if inflation persists.”
The question is, how much further? With inflation 40 basis points below the two percent target and gross domestic product stagnant, there is no argument from economists that Canada needs at least 50 basis points more easing.
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And what if that's all we get? Or what happens if the central bank cuts the entire 100 basis points (or a little more) and inflation returns in 2025?
That's not the baseline expectation of a mainstream economist, but relying solely on economists' forecasts to decide your mortgage term is like relying on a fortune teller at the fair to tell you who you are will get married. Both may sound convincing, but let's be honest.
There's no question that now that the Bank of Canada is swinging its rate-cutting machete harder, more mortgage borrowers will start embracing variables. And that's historically a sensible play at this point in the interest rate cycle.
But here's the sobering reality: If the market's crystal ball deviates by just two rate cuts, borrowers' projected variable rate savings could evaporate.
Of course, some top economists like David Rosenberg believe we'll get more cuts than expected, not less. He wrote in a bulletin yesterday that the current economic slowdown “suggests a ratio of no more than two percent and possibly even less, considering that it was at 1.75 in early 2020, before COVID-19 entered our lives.” percent.” a time when there was no disinflationary output gap – a time when economic growth and inflation were much lower and unemployment much higher than today.”
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On the other hand, core inflation – what the Bank of Canada pays most attention to – is still 35 basis points above target, and interest rates face the possibility of runaway fiscal stimulus (particularly south of the border, which will eventually spread north), a very real one stable situation market and continued growth through almost 395,000 new permanent residents (the government's target for next year).
Even though economists are more right than wrong with their estimates of more than 100 basis points, choosing a mortgage term is a risk management exercise. Many borrowers will manage the risk of a rise in interest rates by resorting to leading three-year fixed rates rather than playing roulette with a variable rate.
If you look further down the street you will see a large elephant doing backflips in the room. I'm talking about the precarious trajectory of deficit spending in America. If the US fiscal circus develops into a full-blown financial market crisis, yields could rise by well over 100 basis points – potentially putting those who extend their three-year terms in a difficult position in 2027/2028. I suspect that people who are worried about impending financial failure will opt for fixed five-year terms in part for this reason.
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All of this ties into Dirty Harry's iconic question. People who don't feel “happy” cannot be blamed for their financial preservation instincts and for holding on. This is despite the market's implied likelihood that such a move will cost them – even if it's not a life-changing amount.
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If you just want to push your luck a little, you can always opt for the fence builder's mortgage of your choice, the five-year hybrid mortgage. Part fixed, part variable, it's a compromise tailored to uncertainty.
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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