December 26, 2022
To no surprise, this is the number one question I have received since August by a landslide, from both clients and friends alike. In relation and while no one truly knows the answer to this question, I am happy to provide my two cents on the topic. However, before I address this question head on, an important disclaimer is required. Please note that by no means is my predication guaranteed to occur. As previously mentioned, I believe that no one truly knows the answer to this inquiry (myself included) as it is both forward-looking and dependent on futuristic data that no one currently has access to. Therefore, you should not take the contents of this write-up (nor my prediction within it) as any form of mortgage advice, financial advice, or advice of any kind. Additionally, do not take this predication as a foregone conclusion pertaining to the future. Rather, it is simply a collection of my honest thoughts about the current situation in Canada while acknowledging that I cannot predict the future. If this is understood, please continue reading.
With that said, let’s get into it. The short version of my prediction: I believe we are in a fiscal mess here in Canada and that this environment will get worse before it gets better. How much worse? With respect to the topic of interest-rates exclusively, not much. However, in the context of broader macro economic realities? Potentially a hell of a lot worse. Let me explain.
First, while I understand the Bank of Canada’s (BOC) mandate in their perceived fight against inflation and near-unitary focus towards getting Canada back to the 2% target while attempting to avoid a meaningful recession, I believe they will fail. Why? The short answer is essentially ‘death by a thousand cuts’. The long answer involves highlighting the constant slew of mistakes that have occurred since December of 2019, which saw the BOC already begin increasing their purchase of Canadian bonds. For those unaware of what this process does to interest rates, it generally causes them to drop as the bond market becomes increasingly more expensive and their yields/returns become lower. This process is widely known as a form of quantitative easing and should more simply be labelled as a type of market manipulation on the part of the Bank of Canada. The manipulation itself is not inherently negative; sometimes it is necessary depending on how the economy is operating with particular emphasis on inflation figures. However, like virtually every form of market manipulation, it must be done with exceptional caution for there not to be drastic (and often negative) longer term repercussions. This process of quantitative easing was ramped up to extreme levels during the pandemic and continued steadily even as inflation data was showing a strong uptick (remember that the BOC originally referred to the rise in inflation as ‘transitory’). Consequently, this was the first major event of significance that needs to be highlighted. The second occurred when the Bank of Canada simultaneously lowered their key interest-rate to historically low levels. If you are unfamiliar with the significance of their key interest rate, this is the rate tied to virtually every major lender’s prime rate. When the BOC’s key interest rate is low so too generally is the interest rate associated with your variable-rate mortgage, home equity line of credit, and personal line of credit (assuming we are talking about a prime or near-prime lending product). With these two factors combined, prospective Canadian borrowers were presented with historically low fixed AND variable interest rates on a plethora of mortgage products. This is the second event of significance. To add fuel to this fire even further, the BOC did something unprecedented when they echoed the sentiment that “interest rates would remain low for a long time.” To their defence, they did not quantify what ‘a long time’ meant in the moment, but it nevertheless sent bullish shockwaves through the Canadian residential real estate market. This was the third major event, as it presumably created the notion that this rate environment was here to last in many Canadian’s minds. Who could blame them? After all, when the very entity that has the power to manipulate interest rates tells you they will remain low for a long time, you might be inclined to believe them. Therefore, is it any wonder we saw the complete real estate frenzy that we did in 2020, 2021, and the very beginning of 2022 when the cost of borrowing was so low? In hindsight, not at all.
But then something happened, something swift and completely to the contrary of the dialogue and policy decisions that were on full display during the pandemic. Interest rates across the board started to rise and FAST. The BOC’s communications also transitioned sharply to being focused on fighting inflation, which was already well outside of the 2% target and clearly NOT ‘transitory.’ As 2022 progressed, they expressed that the fight against inflation would be both long and hard (a sharp contrast from the previous two-year period). Safe to say the remainder of 2022 has reflected this long and hard battle. And I wish I could tell you that I believe we are imminently close to victory, but I do not. So what happens next?
I believe we will see a confused market for the first quarter of 2023 as it pertains to interest rates; one that reflects an abundance of conflicting data points surrounding the topic of domestic and international economic strength, the labour market in Canada, as well as inflation. I expect minimal fixed-rate movements in both directions at various points of Q1 that collectively result in rates dropping (on average) slightly in the first quarter in comparison to where they are now. This will not be a meaningful change, nor one that causes a drastic uptick in purchase activity. From there, I believe rates will begin dropping more meaningfully in Q2 in response to weaker domestic and international economic data, a wounded labour market (not good) combined with lower inflationary figures. This trend of fixed-rate drops should continue for the remainder of the year, but it will be slow paced with AAA insured fixed rates being somewhere in the mid to high 3% range by year-end (meaning 3.50-3.99%). This will be seen in one sense as a victory, but in another as not enough to combat the challenging economic environment present at the time fixed rates drop. Why? When you infuse the economy with the level of stimulus that was created during the pandemic and are not careful with the intensity or duration of quantitative easing policies what happens? You end up paying the piper. I believe that the process of paying the piper as Canadians will continue throughout 2023.
How about changes to the BOC’s key interest rate in 2023? This will be fascinating (and potentially scary depending on your perspective) to watch unfold, as the battle with inflation to this point has been anything but smooth. First, let me say that I see a minor increase (or two) to the already-high key interest rate in the first quarter of 2023. The reasoning behind this predication is that inflation is still nowhere near their 2% target and, in my opinion, the BOC appears more concerned with their image in the context of combatting inflation rather than on substance. What I mean by this is that policy rate changes take time to experience their full economic effect on inflation and I suspect that they are well aware of this reality. Nevertheless, virtually every time the BOC is met with less-than-stellar economic indicators towards their fight against raging inflation, rather than promoting patience combined with the sentiment that it will take time to witness the real effect of many previous increases, they also speak the apparent ‘need’ to increase their key interest rate further and fast! This poses the inherent risk of increasing too much too quickly, which is a risk that I believe will be realized in 2023. I predict that this realization will occur sometime in Q3 of 2023 when I believe (and sincerely hope) that the key interest rate begins coming down based on then-current data. However, I expect this drop will be frustratingly slow for all variable mortgage holders because the Bank will not ditch their ‘tough’ attitude towards fighting inflation and will speak to the 1970’s lesson about not loosening rates too soon. What do I mean by ‘frustratingly slow’ you might ask? A 25-basis point drop per rate announcement starting in Q3 so long as the incoming data continues to speak positively about the inflation battle. Therefore, I predict a lengthy period for high variable-rates with a very gradual decrease, even in spite of economic indicators that might otherwise suggest a faster return to ‘normalcy’.
So for 2023, yes I expect rates to eventually come down (both fixed and variable) in comparison to where they are now. I predict that this process will not be perfectly linear by any means and that the situation as whole for interest rates probably gets worse before it gets meaningfully better. What does this mean for you? Do everything in your power to live a financially lean life. Try to pay off your high-interest debt in a careful and methodical way. Be risk-adverse, as you do not know if a layoff and/or challenging job-market awaits in 2023. It is truly better to be safe than sorry (I believe) and as we all reflect on 2022 and look to the year ahead, I believe we should brace for near-term economic challenges. Even if my prediction is not accurate (and I sincerely hope it isn’t) and we see a soft-landing early in 2023 and a great economic bounce-back, this still appears to be the more conservative approach. Stay safe and look out for one another.
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