Last week the U.S. Federal Reserve raised its policy rate by 0.25%, as expected.
The market’s reaction to the Fed’s second rate hike since last December was tempered by its accompanying statement, which reassured anxious bond-market investors that additional rate hikes would be “gradual”.
In today’s post, we’ll take a look at the highlights from the Fed’s latest statement (in italics) with my comments added, and then discuss the implications for both Canadian fixed and variable mortgage rates.
Highlights From the Fed’s Latest Policy Statement
- “The labor market has continued to strengthen” and, “job gains remained solid and the unemployment rate was little changed in recent months”. Headline unemployment remains below the Fed’s 5% target but broader measures of U.S. labour-market health that count under-employed workers and people who have given up looking for work are still above their pre-Great Recession levels. Also, average U.S. wage growth is barely keeping pace with overall inflation, and that doesn’t bode well for U.S. consumer spending, which drives about two-thirds of overall U.S. economy activity.
- “Economic activity has continued to expand at a moderate pace” as “household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat”.S. GDP growth fell to 1.6% in 2016 and the recent data for early 2017 imply that first-quarter 2017 growth could come in lower still. The Fed sounds encouraged that business investment has “firmed somewhat” after noting that it had “remained soft” in its January statement, but if businesses don’t see a return on that increased investment, it won’t last. And while average U.S. household spending has “risen somewhat”, consider that average U.S. household debt rose by $226 billion in the fourth quarter of 2016, which marked its largest quarterly increase since 2013. I’m sure that U.S. policy makers would be much more reassured about the rise in household spending if it were fueled by rising incomes instead of by rising debt levels.
- “Inflation has increased in recent quarters” but, “excluding energy and food prices, inflation was little changed and continued to run somewhat below 2 percent.” Furthermore, “market-based measures of inflation compensation remain low; [and] survey-based measures of longer-term inflation expectations are little changed, on balance.” The Fed doesn’t sound to worried about overall inflation and indicated as much when it explained that it was maintaining a “symmetric inflation goal”. This means that it will continue to focus on the risks of both above and below-target inflation and in her accompanying press conference, Fed Chair Yellen reassured market watchers that the Fed would allow inflation to rise above its 2% target level over the shorter term without initiating additional rate hikes.
- Market watchers also pay close attention to the Fed’s dot plot projections that show where each of the sixteen voting members think the Fed’s policy rate will be headed in the coming years. The latest dot-plot forecast showed that, on average, the Fed’s voting members continue to expect a total of three policy-rate hikes in 2017. That gives some comfort to bond-market investors who had worried that the Fed might now be leaning toward a total of four policy-rate hikes this year. To be clear, the Fed’s dot plot is typically out-of-whack with the Fed’s actual rate hike timetable, but changes at its margins are still considered material.
- The Fed’s latest statement reassured markets that President Trump’s rhetoric about imminent tax cuts and massive fiscal-policy stimulus have not caused it to accelerate its rate-hike timetable. Note the key phrases in the following statement (emphasis mine): “The Committee expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term.” The Fed’s dovish language explains the market’s muted reaction to its latest policy rate hike.
If you’re in the market for a fixed-rate mortgage, the Fed’s latest statement came as a relief because it didn’t trigger a spike in U.S. bond yields that would have almost certainly taken their Canadian bond-yield equivalents along for the ride (which our fixed-rate mortgages are priced on). Instead, both U.S. and Government of Canada (GoC) bond yields traded lower after the announcement and this allayed fears that another round of fixed-mortgage rate increases might be imminent.
Variable-rate mortgage borrowers were less concerned about any immediate impact from the Fed’s statement last week, but they too can take some comfort from the Fed’s mostly dovish statement because the U.S. dollar sold off following the Fed’s announcement. The Bank of Canada (BoC) wants the Loonie to weaken against the Greenback in order to provide a boost to our beleaguered export sector, so the falling Greenback should make the BoC incrementally more dovish in its own right.
That said, although I don’t think the Fed’s latest statement raises the odds that the BoC might decide to cut its policy rate in response, it probably does push the timing of the BoC’s next rate hike a little farther off into the future.
Five-year GoC bond yields fell by six basis points last week, closing at 1.21% on Friday. Five-year fixed-rate mortgages are available at rates as low as 2.44% for high-ratio buyers, and at rates as low as 2.49% for low-ratio buyers. If you are looking to refinance, you should be able to find five-year fixed rates in the 2.69% to 2.84% range, depending on the terms and conditions that are important to you.
Five-year variable-rate mortgages are available at rates as low as prime minus 0.80% (1.90% today) for high-ratio buyers, and at rates as low as prime minus 0.60% (2.10% today) for low-ratio buyers. If you are looking to refinance, you should be able to find five-year variable rates in the prime minus 0.45% range (2.25% today), depending on the terms and conditions that are important to you.
The Bottom Line: The Fed raised its policy rate last week but the market’s reaction was tempered by the its accompanying press statement, which confirmed that the Fed would remain cautious before initiating further rate increases. As such, the spike in our fixed mortgage rates that some had feared did not materialize, and that means its steady-as-she goes for both our fixed and variable mortgage rates.