Predicting mortgage rates is like juggling spaghetti – hard and messy.
But there are two exceptions. Below, I’ll dive into each.
First, let’s start with the challenge at hand.
Even the Bank of Canada’s crack forecasters can’t foretell inflation with a high degree of long-term accuracy. “And it’s the largest such team, the best trained, has every shred of data that’s available,” former Bank of Canada governor Stephen Poloz told me in an interview earlier this year.
The bank’s staff constantly engage in “a major debate about the pluses and the minuses and what the risks are – a very informed debate,” he said. “It doesn’t get any better than that. That’s not the same as saying it’s accurate.”
“I think any economist, if you really pin them down on this, will tell you, the confidence intervals around the things … are pretty wide,” Mr. Poloz said. “Weather forecasters are better than economists by a long shot.”
Okay, so here’s a brilliant economist – the man who used to steer interest rates for the entire country – telling us to take even the Bank of Canada’s rate forecasts with a giant rock of salt. Consider that the next time you devise your own analytical methods while trying to pick a mortgage term.
Now, back to my point about there being exceptions to the don’t-put-much-weight-on-forecasts rule. Here are two scenarios worth noting when trying to ascertain where interest rates are headed.
Exception #1: Short-term trends
Mortgage rates generally follow movements in the bond market, and a popular indicator for the direction of mortgage rates – in the short term – is the five-year Government of Canada bond yield. Usually, when the five-year yield moves 20-plus basis points and stays there, most fixed mortgage rates will follow.
For that reason, a jump in bond yields can help when assessing rate risk over the near term. Soaring yields, as we’ve seen lately, warn fixed-rate mortgage shoppers to secure a rate hold with a lender if they haven’t already.
But even in the short term, yields can mislead us. Case in point: On Sept. 1, surging U.S unemployment and unexpectedly negative GDP data dragged bond yields down to a three-week low. That gave borrowers a glimmer of hope.
Unfortunately, that hope was promptly extinguished when fears related to U.S. deficits, debt issuance, and creditworthiness, another Fed hike and outsized Canadian job growth pushed interest rates back up.
But financial decisions are about probabilities. Sustained material changes in bond yields are one of the better forecasters of changes in fixed mortgage rates over the near term. The problem is, the forecast window is so short, that this is of little value in helping you pick a mortgage term.
Exception #2: Rate cycle predictions
There are few valuable truisms when it comes to interest rate outlooks, but one of them is this: rates move in cycles.
Picture an endless roller coaster where rates go up when inflation is expected to climb above the Bank of Canada’s target and rates drop when inflation risks falling below target.
That’s an oversimplification, but the point is that rate-cycle turning points are eventually guaranteed when the Bank of Canada raises or lowers rates significantly. What we don’t know is when that roller-coaster will peak and when it will bottom out.
But the fact that cycle-timing is difficult, at least with consistent accuracy, doesn’t make cycles useless for mortgage planning.
The long-term research is clear. Variable and short-term rates have outperformed longer-term fixed rates over extended periods. Some notable exceptions exist, as short-term borrowers found out the hard way in the late 1970s. But, along as there’s a business cycle, most well-qualified risk-tolerant borrowers should disregard the exceptions and lean on historical probabilities.
History shows that the probabilities shift even more in variable’s favour when the prime rate is meaningfully above its five-year average, as it is today. What is meaningful? Certainly more than one standard deviation above the five-year average. (A standard deviation is a measure that quantifies how much individual values in a dataset vary or “deviate” from the average.) And, ideally, you want to see the prime rate topping out for more than one Bank of Canada meeting, as well as confirmation from leading indicators that inflation is heading in the right direction.
Officially, this strategy is not empirically conclusive because the sample size of such occurrences is not statistically significant enough to draw scientific conclusions. However, the data we do have suggest this approach corresponds well to the business cycle and has a degree of predictive value.
The main problems are that you’ll never get the timing perfect, and there are exceptions.
Looking ahead, this rate cycle will roll over like so many before it. Nonetheless, there is a risk that fiscal imprudence, massive government debt issuance, and structural inflation factors keep rates higher than any borrower would like, for much longer.
Ultimately, recessions hammer rates. And the longer Canadian rates stay elevated, the more likely that recession.