Economic Outlook – What This Means for Your Mortgage
Ryan La Haye
Aug 27, 2024
I must admit it’s been quite a while since my last economic update. Truth be told, it was not for a lack of news or economic data but rather a lack of a clear picture to be able to present something that would be actionable. I imagine like myself you have all been waiting impatiently for mortgage interest rates to fall. The last Bank of Canada (BoC) rate hike was a bit more than a year ago on July 12th, 2023, and since then it seems that rate relief was just around the corner but never really came until just recently. Before sending the next economic update, I wanted to have a high level of certainty that rate reductions had really arrived and it seems, finally, that we have reached that point.
If like many you participate in my monthly VIP Club Contest, you probably answered last months’ question about interest rates by stating that it was a major concern for you and your family. I want to take this opportunity to thank all of you for your participation in The VIP Club. The answers you all provide to the questions I ask give me a lot of perspective on what is important to you and help me advise and work more efficiently for you all. I suppose getting a chance to win the monthly Grand Prize may also be a reason I get so many answers.
Over the next few paragraphs, I will detail what is currently happening with inflation and the state of the Canadian economy. Following that, I will provide some advice on what you should expect moving forward regarding your mortgage interest rate and finally, I will provide some guidance on what you should be doing in the current economic context.
As of August 2024 and looking forward, the economic outlook for the growth of the Canadian economy for the end of the current year and 2025 is rather soft. Economic growth remains weak relative to population growth which has been at record levels over the past 18 months. Household spending has decreased measurably since the beginning of 2024 and demand for things like new cars and travel is fading. Canadian families have transferred more money towards lowering household debt rather than towards spending.
The labour market has slowed measurably. Unemployment in Canada sits at around 6.4%-6.5% and is slowly ticking upward. Job vacancy rates have plummeted and are in general no longer a concern as labour shortages are currently below normal levels.
Wage growth is moderating in most sectors but remains a factor to be followed closely. Inflation for shelter cost is still very high due to the ongoing housing crisis and interest rates that are currently above neutral levels (more on this later). Inflation also remains high for services closely affected by wages, such as restaurants and personal care.
From a global perspective, geopolitical risk and uncertainty is very high. Conflicts continue in the Middle East, Africa as well as the ongoing war between Ukraine and Russia. The US elections are hardly a demonstration of a functional democracy from the worlds current number one economy, creating even more uncertainty about the possible policies of the next administration.
The US economy is clearly slowing down (the pace of the growth is slowing). Leading and lagging indicators are now clearly demonstrating a potential recession on the horizon if the trends pursue. The labour (or labor if you are from the US) market has cooled considerably from its formerly overheated state. Unemployment began to rise over 1 year ago and currently sits at 4.3%. This is still low by historical averages, but a full 1% higher than its level in early 2023. Overall, even though the pace of the growth is slowing down, the US economy still continues to grow at a solid pace (by historical measures). But the inflation and labour market data show an evolving, transitioning situation. The upside risks to inflation have diminished. And the downside risks to employment have increased. In a speech at an economic symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming, Jerome Powell (the chair of the Federal Reserve) said: “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.” In other words, expect rate cuts next announcement (September 17-18th).
All the above including the BoC’s first two (2) interest rate cuts of 0.25 (on June 5th and then again on July 24th) mean that interest rates will continue to fall until they have reached neutral levels. For those of you who are asking yourselves what that means, it means that rates must fall to a level where they are not stimulating the economy, but they are not slowing the economy either. This also must happen rather quickly. If rates don’t return to neutral levels fast enough, they may cause the recession the BoC is trying to avoid. (It may still not be enough to avoid a recession; and in that case, rates would fall even further.)
The consensus in Canada is that the BoC should cut rates to about half of the increase that occurred between March 27th, 2020, and July 12th, 2023. This means somewhere between 2% and 2.5%. Therefore, we should expect another 1.5% to 2% in rate cuts over the next 18 months but most likely sooner rather than later. With the US Federal Reserve finally confirming it will eventually be cutting its overnight rate, the BoC should adopt a more aggressive posture.
What does this all mean for you? Its complicated. The first thing you need to understand is that if the variable rates (that follow the BoC rate) fall by another 2%, fixed rates will NOT fall at the same pace. Fixed rates follow the bond market and a lot of the future BoC rate cuts have already been priced in. You should expect fixed rates to continue to fall but marginally compared to the variable rates. Currently the variable rates are 1-1.5% higher than most 3–5-year fixed rates in Canada. This means that variable rates will be catching up to eventually stabilize at a level equal or slightly lower than fixed rates, depending on the rebate you negotiate on your variable rate mortgage.
If you are considering taking a variable rate mortgage, then you should expect to lose money compared to a current fixed rate mortgage for the next 1-2 years. This seems like a dubious bet to me at this time. I would probably suggest a short-term fixed rate of 2-3 years depending on the interest rate that is available to you.
If you are already in a variable rate and want to know if you should fix or ride the wave down, this is a hard question to answer. Its all about timing. In other words, when will the bond market have priced in all the expected variable rate reductions? This is the moment you will want to fix your variable rate – but timing this is very difficult. My suggestion at this time would be to consider, depending on your situation, to fix your variable rate mortgage before the end of 2024 and to take a short-term fixed rate of 2-3 years. (This of course depends on where the fixed rates are at the moment you make this request and the spread that lenders are willing to accept based on the cost of funds available to them.)
Its impossible in an economic article like this to explain the nuances of every aspect of monetary policy and bond market behaviour. The above suggestions are very general and before doing anything, you should consult with us. There is a reason I am suggesting a 2–3-year fixed rate but this may change quickly or not be appropriate for your situation. For the time being I would wait until the Federal Reserve in the US makes its rate announcement on September 17-18th 2024. The BoC may lower September 4th, 2024, but the FED announcement will set the pace for the end of the year. Based on that announcement, a clear choice should be able to be made regarding your mortgage.
As always, we remain committed to providing the best advice possible with the information we have, and we stay available to answer any questions to help you make the most informed choices possible.
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