Market and Interest Rate Update
The Bank of Canada’s upcoming rate announcement this week follows several remarkable world events. The annual World Economic Forum held in Davos took place after a 2-year sabbatical due to Covid restrictions and the world marked the 100th day of the Russian-Ukrainian conflict.
The former is a gathering of world leaders that began in 1971 founded by Klaus Schwab a business professor at the University of Geneva. This period in history was marked by difficult economic times and the goal of the European Management Forum (its name at the time) was to gather to discuss economic and world issues that impacted the economic development in Europe. The conference has transformed into a gathering of world leaders, economists, central bankers, and business elite discussing the issues that impact the global economy.
The latter highlights a conflict that has been the focus of most Western countries over the last 3 months and has served as a sort of an accelerator on issues that were already a major problem across the globe.
Let’s review the current state of things to frame the current economic context, how the Bank of Canada will be proceeding within this context and what it means for you.
The topics most discussed during the WEF (World Economic Forum) were inflation, global supply chains, climate change and finally the ongoing effects of the pandemic on the world economy (notably China). All these topics are not new, and we have been mentioning them in length over the last 6 months as they directly impact the decisions of Central Banks like the Bank of Canada. Here are some key points:
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The reduction of fossil fuel subsidies around the world over the past 2 decades has potentially accelerated the inflation of this commodity.
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Climate change across the world has had a major impact on 60% of global food production. Major heat wave in India for example has ravaged wheat stocks and similar events across the world have had similar effects. Global food prices were expected to rise significantly even before the Russia-Ukraine conflict. The IMF predicts a major global food crisis over the next 5 years, perhaps permanently.
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Inflation is now entrenched in the economy. Most companies expect to announce major wage increases to workers over the next 12-24 months. They intend to pass this on to consumers.
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Although most Central Bankers hope to avoid triggering a recession to topple inflation, the consensus is this will be very difficult.
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China’s ‘’no Covid’’ policy is creating major supply chain issues and has slowed the Chinese economy measurably.
The Russian-Ukrainian conflict has served as an accelerator to most of the issues already plaguing the global economy. Food stocks of grain in wheat stored at the port of Odessa are unlikely to be permitted to leave affecting over 12% of the Global wheat supply already under duress. Oil shortages across Europe are expected as early as the Fall of 2022 and the embargo on Russian oil exports by the West is accelerating the increasing cost of oil globally. Due to a reduction in global oil subsidies the world economy is unable to react swiftly to increase production to compensate.
Before discussing the impacts on interest rates and the Canadian economy I can’t help but point out the irony of the above situation. Global food prices are exploding because of climate related issues mainly due to the burning and usage of fossil fuels across all sectors in the economy. While at the same time because of the tackling of climate change and the reduction subsidies toward fossil fuels the world is unable to compensate for the shortage of the commodity sending oil prices through the roof and exponentially increasing inflation.
Here is the takeaway in my opinion. Current inflation, changes to monetary policy, geopolitical unrest, post pandemic supply chain stress are all new strains with few to no points of reference from past economic turmoil the world has experienced. One should expect the unexpected and demonstrate existential flexibility as forecasting what will happen over the next few years will be a dubious task. The challenge for economies and markets going forward will be to find its footing and eventually having a lot of these unknown factors become more ‘’known’’.
The Bank of Canada and Interest rates in Canada:
The Bank of Canada is expected to announce a 0.50% rate increase for the second time in a row this week on June 1st. This is almost a certainty. All variable rates in Canada will thus jump by 0.50% and this will impact the payment for many mortgage holders.
Fixed rates are currently hovering on average close to 4.5%. We have seen bond yields stabilize over the last 2 weeks hinting that perhaps the increases to fixed rates are slowing. This is in my view is very presumptuous. Inflation was 6.7% in March and 6.8% in April well above the 2% target of the BoC. Nothing indicates that the Bank of Canada will cease or slow is current monetary policy. Most borrowers should in my opinion expect fixed rates to hit 5% on average by the end of the summer and close to 6% by end of year.
If you are currently in a variable rate fixing that rate comes with many risks as prior to the current BoC’s rate announcement most variable rates still hover around 2.5% to 2.9%, well below the 4.5% fixed rate average. Addditionnally, fixed rate mortgages in general have much heavier penalty conditions.
In a tornado, you don’t go out for a walk. It is our opinion that any borrower that already has a mortgage at this time should remain with the status quo and not make any major decisions.
Any new borrower looking to get a new mortgage should consider perhaps a shorter fixed term or an out of the box strategy to discuss based on their needs.
We recognize that making difficult choices during volatile times is extremely strenuous. We are committed to providing as much information and advice as we can to allow you to remain informed. We invite any reader to reach out by email should you have any questions or require advice.
With appreciation,
Ryan La Haye
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