In an irrational moment of nostalgia and subtle encouragement from well-intentioned but horribly misguided parties, I have decided (for now) to bring Treasury Guy out of retirement. It’s been many moons since my last post, and it remains to be seen if my time as CEO Guy has completely robbed me of my sense of humour. I guess we’ll find out together.
Anyway, my instinct was to make this first edition something of a year in review…but one that is heavy on facts and light on analysis and interpretation. That, alas, would be too much work. Treasury Guy tip: Work smarter…not harder.
Selected data presented graphically for your viewing pleasure
Below is the 2023 journey down 5-year GoC memory lane. The 5-year bond yield is a common benchmark used in setting 5-year mortgage rates. Disclaimer: there are many other variables considered when setting rates, but the GoC bond is a good barometer. One of the other important variables important to setting mortgage rates for your friendly neighborhood mortgage finance company is the spread on NHA MBS pools…a critical source of funding for insured mortgages. The spread on these pools over the GoC bond have steadily widened from approximately +43 to +63 over the course of the year.
It’s been a wild ride for rates this year. After quickly climbing 80 bps to above 3.60% in March (close to a 5-year high), a combination of the regional banking crisis in the US and expectations that central banks were at the end of the monetary policy cycle, caused yields to fall all the way back to 2.75% in the span of just 3 weeks. We then began a steady grind higher (helped along by two more BoC rate hikes) to 4.40% in October (the highest rate in over 15 years!). Finally, a series of encouraging inflation prints restored confidence that rates had peaked. The fourth quarter has seen a precipitous 120 basis point decline in yields back to 3.20%.
Below is the monthly year over year CPI prints for the last 24 months. Rate hikes are painful, but the proof of their efficacy is in the Christmas pudding. CPI has fallen from 8.1% in June of 2022 to 3.1% last month. Recall that while the target range for inflation is 1.0%-3.0%, the Bank of Canada has it eyes firmly set on 2.0% as its happy place.
Selected forward looking rates
Many people like to ask me where I think rates are going. This is my least favourite question. I don’t know. No one does. Not even Chuck Norris. Nonetheless, I can still answer it with precision. I’m just that good…
Below is the Bank of Canada meeting schedule and the implied overnight rate following each meeting based on the current term structure of Overnight Index Swaps (“OIS”). The market is currently projecting five rate cuts of 25 bps by the end of next year, resulting in an implied overnight rate of 3.75% next December. Assuming the banks follow suit, we can anticipate the Prime Rate falling from 7.20% to 5.95%. In practical terms, a borrower with an adjustable-rate mortgage would see their monthly payment fall by approximately 10% or $75 per $100,000 of mortgage balance.
We can also use the magic of forward rates to peek at where bond yields are going. Bonds can be stripped and packaged as a portfolio of zero-coupon instruments and then ‘bootstrapped’ into an arbitrage free series of forward rates. It’s fun…you should try it at home! According to the prevailing shape of the yield curve, we can see below that the 5-year GoC bond yield will fall from 3.21% today to 2.98% one year from now.
WARNING: Even though these forward rates MUST be true today (the market’s propensity to quickly remove any arbitrage ensures this), studies have found that forward rates are generally proven to be poor predictors of future spot rates. Things will change between now and then. Just the way it is. So don’t complain to me if things look quite different than this next December.
Mortgage trends in 2023 worth mentioning
Apropos of the yield curve, future expectations, and borrower propensity to be rate forecasters, we saw unprecedented activity in the 3-year term this year. Despite 3-year mortgage rates as much 90-100 basis points higher than 5-year rates, 25% of funded fixed rate mortgages in 2023 had 3-year terms compared to fewer than 5% last year (and every year before that).
Fewer than 10% of borrowers selected an adjustable rate in 2023 compared to 55% last year. It’s amazing how dramatically things can change.
What hasn’t changed, at least not in a material way yet, is delinquencies. Despite the rapid increase in adjustable-rate payments and fixed rate renewals into higher rates, our borrowers demonstrated their resiliency. The 90-day residential arrears rate increased from 5 basis points one year ago to 6 basis points today. Sure…technically, that’s a 20% increase but practically speaking, it’s just 1 basis point…so that’s good. Like the Lannister’s, Canadians pay their debts.
Other noteworthy industry developments
Two potentially disruptive proposals from the Department of Finance and OSFI earlier this year have not come to fruition.
Concerns that the Canada Mortgage Bond, as we currently know it, would be fundamentally altered created fear and loathing in the mortgage industry but in a spectacular twist worthy of an M. Night Shyamalan script, not only was the CMB left unchanged, but the annual issuance limit was increased by 50% from $40 billion to $60 billion.
Additionally, a consultation paper from OSFI on proposed changes to B-20 mortgage underwriting guidelines, including the introduction of debt-to-income ratios and more prescriptive debt service ratios, has also been set aside.
Despite the notable decrease in housing activity this year, the MLS Home Price Index was still up 0.6% year over year as of November. Even with reduced activity, the underlying supply gap provides a solid foundation for prices.
As for 2024?
Well, no doubt, despite falling recently, rates will continue to provide some headwind against affordability, but I’ve got a good feeling. Don’t take my word for it though. The good people at Royal LePage are calling for normalized conditions and home prices 5-6% higher by the end of 2024. Which is nice.
If you’re feeling less optimistic, remember that worrying won’t take away tomorrow’s problems, but it will take away today’s peace. When in doubt, follow my prescription…put on some Pink Floyd, pour yourself something to drink, and chill out. Either that, or more cowbell. I hear that works too.
Finally, in celebration of the season, I’m happy to announce we will be drawing the name of 10 lucky people to win a 1-year membership to the Jelly of the Month Club… it’s the gift that keeps on giving the whole year round!
Happy Holidays and Happy New Year everyone…and remember, if you’re having turkey, save the neck for me!