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Rob Carrick

Bad financial predictions? No, just bad timing Add to ...

A lot of what you were told would happen in the financial world this year looks kind of, well, wrong.

You heard for months about how bonds were a trap. As the stock markets have fallen lately, bonds have been beautiful.

You also heard about how interest rates were going to rise. In fact, mortgage rates have fallen twice in the past couple of weeks.

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You further heard about the wonders of the Canadian dollar and how it was on its way to parity with the U.S. buck, or better. Over the past month or so, the loonie is down a whopping 7 per cent or so.

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Bad predictions? No, just bad timing.

The outlook for higher rates, falling bonds and a stronger dollar was based on the expectation that the global economy would continue to recover gradually from the recession and financial crisis that began in the summer of 2007.

A report issued Wednesday by the Organization for Economic Co-operation and Development shows this is actually happening, though not without complications. Debt problems in Greece and other European countries have triggered concern about what happens when a country defaults on its debt. When big financial firms were on the edge of collapse a year or two ago, governments bailed them out. Now, some governments themselves are floundering.

Government austerity is required to address these debt problems, and that's bad for economic growth. Compounding the situation is concern that the Chinese economy, one of the world's most dynamic, could be slowing as the country tries to control inflation. In the United States, meanwhile, there are questions about how the economic recovery will fare once government stimulus is removed.

The big risk here is that the global economy will slip back into recession - the dreaded double-dip, in other words. That's the worst case. A more likely outcome is that the economic recovery holds together, with bumps along the way.

So interest rates are going to rise, even if the timetable could be pushed back. A month or so ago, it was considered a done deal that the Bank of Canada would ratchet up its trendsetting overnight rate on June 1. Now, the thinking in financial markets is that there's a 50-50 chance of an increase.



An Investor's Guide to Understanding the Economy:

  • Part 1: How the money in the economy is managed
  • Part 2: How inflation works
  • Part 3: Avoiding the deflationary spiral
  • Part 4: How much money is too much money?
  • Part 5: How markets and currencies work
  • Part 6: How interest rates affect your investments


If not June 1, then there are four more rate-setting dates left in 2010 and another batch in 2011. Rates must go up at some point because they're at emergency low levels at a time when the economy is growing. Statistics Canada's composite leading indicator, a gauge of where the economy is headed, posted its 11th straight month of gains in April, and inflation during the month edged higher.

Some interest rates have been falling in the past few weeks because investors are flocking to the safety of U.S. and Canadian government bonds. The more people buy bonds, the higher bond prices go and the lower yields go (yes, they move inversely).

Bond yields set the trend for mortgage rates, which explains why the cost of five-year fixed-rate mortgages has fallen by about 0.25 of a percentage point lately. Mind you, five-year mortgage rates are still about three-quarters of a point higher than their lows of earlier this year. That's the trend you need to pay attention to, not the minor pullback of late.

The good news with respect to rates is a potential reprieve for people who will face higher interest costs on their mortgages, credit lines and loans as borrowing costs move up. It may not last long, and it certainly won't be permanent, but this current period does represent an opportunity to curtail new borrowing, pay down what you owe and figure out where you'll find the money to make higher payments later on. That is your action plan if you're heavily indebted right now.

The current bout of financial turmoil has not only disrupted the economic outlook. It has also highlighted the need for basic, boring diversification in your investments.

A month or two ago, the prevailing wisdom was that rising rates would cause government bonds and bond funds to decline in price. Now, as the stock markets fall, government bonds are reprising the safe haven theme of 2008-09. The lesson here is to always own some of these bonds or an equivalent like guaranteed investment certificates. Remember that economic and financial market turmoil is good for government bonds.

Of course, the reverse is true, too, and we're going to see that played out at some point in the months ahead. The timing may have been off with those predictions for rising rates, falling bonds and a soaring loonie, but that doesn't mean they won't come true.

Fouled-up forecasts?

What was predicted, and what has happened in financial markets

THE DOLLAR…

Start of the Year

Forecast

High for the Year

Currently

96.02 (U.S.)

Parity or better

1.009

around 94 cents

MORTGAGE RATES… (5-YEAR POSTED)

Start of the Year

Forecast

High for the Year

Currently

5.49%

Higher

6.25%

5.99%

BOND YIELDS… (5-YEAR GOVERNMENT OF CANADA)

Start of the Year

Forecast

High for the Year

Currently

2.75%

Higher

3.20%

2.50%

Source: Bank of Canada

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