Market Update – Hard Truths
Ryan La Haye
Oct 04, 2022
After a hectic summer both personally and economically I thought it may be a great time to dust off my trusty laptop for another economic update. Truth be told, this is the 6th version of this article – I destroyed the previous five. I’ve struggled regarding how to present and deliver a message that is both tempered and helpful.
Before diving into the hard data and what it could mean, I think it’s appropriate that I take some time to discuss the spirit of the article and my state of mind.
We are currently in an election cycle in my beautiful province for just over a month. Politicians and party leaders have been vigorously debating and proposing policies and platforms to ‘’win’’ your vote. Voters have had the opportunity to consider a variety of new and old propositions that would individually and/or collectively affect our lives. Democracy in action! Really?
You might have noticed that the Bank of Canada along with most other Central Banks have aggressively been attacking inflation by hiking interest rates. Not only that, but central bankers have also been rather direct in their speech regarding what it will take to rein in inflation. In exchange they have been blamed for much of the economic pain that has been inflicted. I feel however that many of them have been merely filling a vacuum left by politicians and leaders unwilling to simply tell voters the truth.
We now live in an age where truth itself may be dead because the only true truth is the search for it. There are no absolutes, only vigorous and open debate in the search of truth. Today, I fear that truth is defined by any and all information that simply validates one’s biased and egocentric existing opinion. In other words, I know I am right, let’s go find information that confirms it. This short-sighted approach to politics, governance, media, finance, and many other aspects of our lives has brought us to a potential breaking point.
The following is not the absolute truth, simply some hard facts to consider. The choices you, the reader, will have to make afterwards are not easy nor simple. Each situation is so different and each person’s risk tolerance varies measurably. I am just a mortgage broker, but my hope is that the information presented below clearly and without personal bias will help you make a choice that is right for you.
Market data
The consensus among economists was that the BoC was approaching the end of the rate hike cycle. Most put the ceiling of the BoC’s overnight rate at 4.25% (currently 3.25%). For mortgage holders, that means the Prime rate ceiling would be 6.45% (currently 5.45%). That consensus is now dissipating quickly.
Consumer Price Index (CPI) in Canada after reaching a peak in June at 8.1% has fallen only about 1%, hovering just around 7% now. This after the BoC has already increased interest rates by 2.75% since its first increase in March 2022. Inflation is a lagging indicator, I agree, but consider that if you remove gasoline from the CPI index inflation has not fallen, in fact its still rising. This means this inflation is very sticky and resistant.
A recent published study by the Bank of America finds that from 1980 to 2020, when inflation rose above 5% in rich economies, it took on average 10 years for inflation to fall back to target. (What’s the target? Should you indicate it? Not everyone knows.)
More concerning when you correct for inflation, actual real interest rates are still at the lowest level since 1975. This adds fuel to the argument that we are far from close to the end of the rate hike cycle. Consider as well that as a rule of thumb, most economists would agree that to tame this type of inflation (Volcker period, Burns period) the Central bank must raise rates above the CPI level (currently 7%).
On the fixed side, credit spreads, another indicator of market sentiment around risk and volatility are not looking any better. The CDX Investment Grade Index that tracks 125 equally weighted credit default swaps on North American investment grade entities across multiple sectors currently stands at 98. Its 52-week high is 102 (June) and low back in December 2020 is 49. Higher is worse than lower. Banks’ and lenders’ cost of funds are increasing and this will seep into the consumer rate market. In short, rates will rise.
For those that believe a recession could be the savior to tame inflation and bring rates back to neutral levels, some data supports this. The yield curve is officially inverted. Meaning that long term bond yields are lower than short term. Historically this means a recession is pending, but not always. But probably. Maybe. However, the arrival of a recession does not guarantee inflation will fall. Worse than that, most can’t even agree on what a recession is! With a vast scarcity in human capital worldwide, an aging population in many rich nations and other factors like climate change, supply chain disruptions and geopolitical conflicts all contributing to affect inflation, a recession may not be the cure one hopes for.
Its time to consider converting fixed your variable rate to a fixed rate. HOLD ON – I said consider. The data is very volatile and staying variable for many may be a good idea. However, if ever there was a time to consider going from variable to fixed, the time has arrived.
If you’re considering switching your variable rate for a fixed product, here’s what to do :
- Please call your existing bank and obtain the offers to convert your variable to fixed.
- Send us this information by email, we will provide you with an individual assessment.
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