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How the U.S. Recovery is Driving up Canadian Mortgage Rates

 

One after the other, Canada’s big banks have all hiked-up mortgage rates this week. Why? In large part, it has to do with the U.S. recovery.

 

There are two major channels in which a healthier and faster-growing economy down south is driving up the cost of borrowing for Canadian homeowners. The first one: Foreign capital that flocked into Canada since the onset of the financial crisis is now flowing out and much of it to the U.S. American banks have repaired their balance sheets. plus, U.S. GDP growth surpassed Canada and is expected to keep up that faster pace for the foreseeable future. Canada’s appeal compared to the U.S., in other words, has diminished both in terms of the perceived safety of the financial system and of economic strength. Investors have taken note and reduced their demand for Canadian debt securities, pushing up bond yields and, consequently, mortgage rates.

 

There is also another way in which this sort of investor pull-back might affect the Canadian housing market: By putting downward pressure on the demand for Canadian homes. If foreigners aren’t so keen on buying up Canadian bonds anymore, they might have also lost interest in investing in, say, Toronto condos. In 2008 to 2009, Canadian housing was relatively cheap compared to the U.S., but after years of breakneck price growth north of the border and declines down south, that’s no longer the case. Canada’s residential real estate market is now cooling, whereas American housing prices are finally back on the rise.

 

It’s hard to know, though, how much a presumed exit of foreign home buyers from the Canadian market actually matters. There is no way of quantifying just how big the influx of capital from abroad has been, says TD economist Sonya Gulati. Sure, there is anecdotal evidence that foreign buyers were snapping up Canadian real estate property in select markets such as Vancouver, she explains, but the phenomenon at large is difficult to track. “It can be cash sales, where you don’t necessarily have to put down your information.” And if we don’t know how much money went it, it’s hard to predict what the effects of that capital drying out might be.

 

The second factor linking the U.S. recovery to higher mortgage rates in Canada is U.S. monetary policy. Since the Federal Reserve announced it might start rolling back its quantitative easing policy in May, yields on long-term U.S. bonds have climbed a whopping 100 basis points-and Canadian bonds have followed. The rise in Canada has been a bit more muted-at about 60-70 basis points-says Gulati, because Canadian bonds were offering better returns to begin with and “the U.S. has more upward room to go.” On both sides of the border, though, the trend is up.

 

The idea behind the Fed’s massive monthly purchases of 10-year treasuries and mortgage-backed securities was to pump demand for such securities and keep long-term interest rates low, allowing consumers and businesses to borrow cheaply. But now widespread anticipation that the Fed is going to scale back its bond-buying activity this fall is driving up interest rates on things such as long-term bonds and mortgages back up. In Canada, fixed-rate mortgage rates tend to follow the trajectory of long-term Canadian bond yields, which, in turn, track U.S. bonds. For the next two years or so, Gulati predicts, U.S. yields will likely continue to climb “a little bit faster” than Canada’s.

 

Still, what if, at one point between now and the end of QE tapering, Canadian long-term interest rates were to have the same kind of knee-jerk reaction seen in the U.S. over the summer? That’s one of the worst-case scenarios TD uses in its stress tests of the Canadian housing market. A series of 100-basis point spikes in the rate of five-year fixed-term mortgages could turn Canada’s current gradual housing market cooling into a hard-landing, says Gulati.

 

Accelerating growth in the U.S., in other words, is sucking out steam from an already saturated Canadian market. But there’s no reason to bear Uncle Sam ill will. The U.S. recovery is also making the loonie cheaper, which should boost sales of Canadian products abroad and, in turn, help exports propel Canada’s growth as the input from the housing market and household consumption weakens, says Gulati. Likewise, Canadian businesses should be getting off their proverbial piles of cash and spending some of it on, say, new machinery and equipment, thus helping to offset the impact of foreign capital outflows. Canada’s demand-driven growth worked well in the first few years after the financial crisis, but continued economic expansion requires re-balancing, says Gulati. The U.S., it seems, is unwittingly helping us turn around.

 

http://ca.finance.yahoo.com

 

 

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