28 Feb

Bank of Canada Holds Steady Despite Economic Slowdown

General

Posted by: Alisa Aragon

In a more dovish statement, the Bank of Canada maintained its target for the overnight rate at 1.75% for the tenth consecutive time. Today’s decision was widely expected as members of the Governing Council have signalled that the Bank still believes that the Canadian economy is resilient, despite the marked slowdown in growth in the fourth quarter of last year that has spilled into the early part of this year. The economy has underperformed the forecast in the October Monetary Policy Report (MPR).

In today’s MPR, the Bank estimates growth of only 0.3% in Q4 of 2019 and 1.3%in the first quarter of 2020. Exports fell late last year, and business investment appears to have weakened after a strong Q3, reflecting a decline in business confidence. Job creation has slowed, and indicators of consumer confidence and spending have been much softer than expected. The one bright light has been residential investment, which was robust through most of 2019, moderating to a still-solid pace in the fourth quarter only because of a dearth of newly listed properties for sale. 

 

The central bank’s press release stated that “Some of the slowdown in growth in late 2019 was related to temporary factors that include strikes, poor weather, and inventory adjustments. The weaker data could also signal that global economic conditions have been affecting Canada’s economy to a greater extent than was predicted. Moreover, during the past year, Canadians have been saving a larger share of their incomes, which could signal increased consumer caution which could dampen consumer spending but help to alleviate financial vulnerabilities at the same time.”

The January MPR states that over the projection horizon (2020 and 2021), “business investment and exports are anticipated to improve as oil transportation capacity expands, and the impact of trade policy headwinds on global growth diminishes. Household spending is projected to strengthen, driven by solid growth of both the population and household disposable income.” Growth is expected to be 1.6% in 2019 and 2020 and is anticipated to strengthen to 2.0% in 2021.

 

Inflation has remained at roughly the Bank’s target of 2%, and is expected to continue at that pace.

Also from the MPR: “The level of housing activity remains solid across most of Canada, although recent indicators suggest that residential investment growth has slowed from its previously strong pace. Demand remains robust in Quebec, where the labour market has been strong.

 

In Ontario and British Columbia, population growth is boosting housing demand. In contrast, Alberta’s housing market continues to adjust to challenges in the oil and gas sector. Nationally, house prices have continued to increase and should strengthen slightly in the near term, consistent with the responses to the Bank’s recent Canadian Survey of Consumer Expectations.”

Bottom Line: The Canadian dollar sold off on the release of this statement and I believe there is a downside risk to the Bank of Canada forecast. Today’s release is a more dovish statement than last month, showing less confidence in the outlook. The Governing Council did express concern that the recent weakness in growth could be more persistent than their current forecast, saying that “the Bank will be paying particular attention to developments in consumer spending, the housing market, and business investment.” They also raised estimates of slack in the economy and dropped language about the current rate being appropriate.
According to Bloomberg News, today’s Governing Council comments “are a departure from recent communications in which officials sought to accentuate the positives of an economy that had been running near capacity and was deemed resilient in the face of global uncertainty. While Wednesday’s decision still leaves the Bank of Canada with the highest policy rate among major advanced economies, markets may interpret the statement as an attempt to, at the very least, open the door for a future move.”

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

19 Feb

Morneau Eases Stress Test On Insured Mortgages

General

Posted by: Alisa Aragon

The new qualifying rate will be the mortgage contract rate or a newly created benchmark very close to it plus 200 basis points, in either case. The News Release from the Department of Finance Canada states, “the Government of Canada has introduced measures to help more Canadians achieve their housing needs while also taking measured actions to contain risks in the housing market. A stable and healthy housing market is part of a strong economy, which is vital to building and supporting a strong middle class.”

These changes will come into effect on April 6, 2020. The new benchmark rate will be the weekly median 5-year fixed insured mortgage rate from mortgage insurance applications, plus 2%.

This follows a recent review by federal financial agencies, which concluded that the minimum qualifying rate should be more dynamic to reflect the evolution of market conditions better. Overall, the review concluded that the mortgage stress test is working to ensure that home buyers are able to afford their homes even if interest rates rise, incomes change, or families are faced with unforeseen expenses.

This adjustment to the stress test will allow it to be more representative of the mortgage rates offered by lenders and more responsive to market conditions.

The Office of the Superintendent of Financial Institutions (OSFI) also announced today that it is considering the same new benchmark rate to determine the minimum qualifying rate for uninsured mortgages.

The existing qualification rule, which was introduced in 2016 for insured mortgages and in 2018 for uninsured mortgages, wasn’t responsive enough to the recent drop in lending interest rates — effectively making the stress test too tight. The earlier rule established the big-six bank posted rate plus 2 percentage points as the qualifying rate. Banks have increasingly held back from adjusting their posted rates when 5-year market yields moved downward. With rates falling sharply in recent weeks, especially since the coronavirus scare, the gap between posted and contract mortgage rates has widened even more than what was already evident in the past two years. 

This move, effective April 6, should reduce the qualifying rate by about 30 basis points if contract rates remain at roughly today’s levels. According to a Department of Finance official, “As of February 18, 2020, based on the weekly median 5-year fixed insured mortgage rate from insured mortgage applications received by the Canada Mortgage and Housing Corporation, the new benchmark rate would be roughly 4.89%.”  That’s 30 basis points less than today’s benchmark rate of 5.19%.

The Bank of Canada will calculate this new benchmark weekly, based on actual rates from mortgage insurance applications, as underwritten by Canada’s three default insurers.

OSFI confirmed today that it, too, is considering the new benchmark rate for its minimum stress test rate on uninsured mortgages (mortgages with at least 20% equity).

“The proposed new benchmark for uninsured mortgages is based on rates from mortgage applications submitted by a wide variety of lenders, which makes it more representative of both the broader market and fluctuations in actual contract rates,” OSFI said in its release.

“In addition to introducing a more accurate floor, OSFI’s proposal maintains cohesion between the benchmarks used to qualify both uninsured and insured mortgages.” (Thank goodness, as the last thing the mortgage market needs is more complexity.)

The new rules will certainly add to what was already likely to be a buoyant spring housing market. While it might boost buying power by just 3% (depending on what the new benchmark turns out to be on April 6), the psychological boost will be positive. Homebuyers—particularly first-time buyers—are already worried about affordability, given the double-digit gains of the last 12 months.

Dr. Sherry Cooper
Chief Economist, DLC

12 Feb

2020 January Starts With Strong Canadian Job Growth

General

Posted by: Alisa Aragon

January follows December in erasing the weak November job numbers providing good news for the Canadian economy. Manufacturing led the way as the jobless rate fell, and wage growth accelerated meaningfully. The robust labour market, coupled with consumer confidence holding firm in January at about historical averages, is a reassuring sign for the resilience of the economy.

Canada’s economy created 34,500 net new jobs in January, all in full-time positions, beating economists’ expectations. The unemployment rate fell slightly to 5.5%, wage growth accelerated to 4.4%, and hours worked rose by 0.5%. This second strong reading of Canada’s job market will reinforce the Bank of Canada’s assessment of the underlying health of the Canadian economy.

Slowing activity in the second half of last year was more a function of temporary disruptions and geopolitical tensions. Some of these factors remain, augmented by the coronavirus, which has disrupted travel and trade and dramatically reduced energy and other commodity prices.

Manufacturing and construction led the job gains, and agriculture picked up as well. Quebec, Manitoba and New Brunswick posted employment gains. Fewer people were employed in Alberta, and the jobless rate spiked in Saskatchewan. The resumed decline in oil and other commodity prices has hit both prairie provinces hard.

British Columbia continued to boast the lowest unemployment rate by province, followed by Manitoba, Quebec and Ontario (See table below).

Bottom Line: Canada’s economy has been boosted by the fastest pace of immigration in the Group of Seven countries, spurring a housing boom that is pushing up demand for everything from plumbers to electricians. Indeed, Bloomberg News recently highlighted the more substantial surge in male employment in Canada relative to the US, where women have eclipsed men as the majority of jobholders.

Female job growth in Canada is also strong, and labour force participation rates are higher in Canada than in the US. The jobless rate for women age 25 and older is only 4.6% in Canada, compared to 4.9% for men.

According to Bloomberg News:

  • Jared Menkes, executive vice president at Toronto-based Menkes Developments Ltd., said finding enough labour is a constant source of angst. Central Toronto posted the fastest-growing population in North America last year with a dozen office buildings and countless condos under construction, along with 25 light rail stations, hospitals and all sorts of infrastructure work (see chart below). “We are short actual labour, whether it’s a crane operator, whether it’s drywallers, electricians, plumbers, drivers,” Menkes said. “We’re short truck drivers, architects, consultants.”

Roughly half of all immigrants to Canada located in Ontario, but as the second chart below shows, Quebec and British Columbia garnered their fair share of new residents as well. The Bank of Canada highlights this factor in suggesting that the economy will continue to grow in 2020 and 2021. Certainly, it is a strong positive for the housing markets in these provinces.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

 

4 Feb

TD Lowers Qualifying Mortgage Rate 35 bps To 4.99%

General

Posted by: Alisa Aragon

Image result for td lowers rates

Market interest rates have fallen sharply since the Coronavirus-led investor flight to the safety of government bonds. The 5-year government bond yield–a harbinger of conventional mortgage rates–now stands at 1.34%, down sharply from the 1.60+% range it was trading in before the virus became global news.

This morning, one of the Big-Six banks finally reacted. TD cut its posted 5-year fixed rate to 4.99%. TD’s posted rate had previously been at 5.34%, making this a 36 basis point cut. Other banks had lowered their qualifying rate to 5.19% last July, leading the Bank of Canada to cut its 5-year conventional mortgage rate to 5.19%. This is the qualifying rate under the B-20 rule introduced on January 1, 2018.

Even the regulators have been questioning the efficacy and fairness of using the big-bank posted rate as a qualifying rate for mortgage stress testing.

On January 24, the Assistant Superintendent of OSFI’s Regulation Sector, Ben Gully, gave a speech at the C.D. Howe Institute suggesting that the B-20 qualifying mortgage rate historically would be no more than 200 basis points above contract rates. He said that OSFI chose the “best available rate at the time.”

He went on to say that for many years, the difference between the benchmark rate and the average contract rate was 200 bps. However, this gap “has been widening more recently, suggesting that the benchmark is less responsive to market changes than when it was first proposed. We are reviewing this aspect of our qualifying rate, as the posted rate is not playing the role that we intended. As always, we will share our results with our federal partners. This will help to inform the advice OSFI might provide to the Minister, as requested in the mandate letter to him.

By keeping posted rates too high, the Big-Six banks have inflated the qualifying rate, making it more difficult than necessary to pass the stress test to get a mortgage.

While TD’s rate cut is welcome news, its posted rate is still too high by historical standards. Given today’s average contract rates, the posted rate should be at least 20 bps lower still.

Banks have a strong incentive to inflate their posted mortgage rate. For one thing, they are the basis for the calculation of big-bank mortgage penalties. Also, they are the minimum qualifying rate.

The posted rate does not appropriately reflect the state of the mortgage market as few borrowers would pay this rate. Interestingly, banks often move this rate in lock-step, or close to it, reflecting their dominant oligopolistic position in the marketplace.

If a couple of the other big banks follow TD’s lead, the Bank of Canada benchmark rate will be below 5% for the first time since January 2018 when the new B-20 rules were adopted. Lowering the stress test rate by 20 bps from 5.19% to 4.99% would require roughly 1.8% less income to qualify for a mortgage on the average Canadian home price (assuming a 20% downpayment), increasing buying power by 2%. This doesn’t sound like much, but it can have a meaningful psychological impact on already improving housing markets. The latest CREA data shows that the national average home price surged 9.6% year-over-year in December. A lower stress test rate would make a busy spring housing market even more active.

Dr. Sherry Cooper
Chief Economist, DLC