Future shock

For a few months the Nobel Prize-winning macroeconomists in the steerage section have told us rates will never rise. Pshaw. It’s more proof even a golden retriever can post here with creds.

Yes, bond yields are rising. We showed you the charts. Inflation is running hot. Employment numbers are huge. The stock market just hit a record on Bay Street. The supply chain is busted. Gas is ridiculous. Corporate profits are running 80% above estimates. The central bank, kids, has completely run out of excuses for not raising rates. And up they shall go.

In fact, thanks to the bond market, mortgages are already on the move. Again.

On October 4th, for example, TD upped the benchmark five-year fixed rate by a third of a point, to just under 2.4%. Today – merely 17 days later (Oct 21) – it went up again, to just under 2.6%. That’s an increase of half a point, or 30% from where it sat last month. In fact, all of the fixed-rate terms have become costlier. More to come.

The impact on real estate prices or sales will not be immediate, especially since buyers still need to clear the stress test at a far higher rate. But we have now seen the end of sub-2% fixed-rate loans. It’s reasonable to think that never again in your lifetime will they return. If they do, it would mean we have (a) another pandemic or (b) a quasi-depression.

Rates can only rise. Get used to this. Ignore those who led you astray. The cost of money is not regulated by ‘the government’ and even the central bank is powerless in the face of the bond market, where investors are demanding a premium to protect them against inflation. Hence, higher yields.

In early September the five-year Government of Canada bond was yielding 0.774%. As I write this, it’s at 1.325%. That’s essentially a doubling in five weeks. Impossible to ignore or brush aside.

Meanwhile the official inflation rate of 4.4% has blown past the Bank of Canada’s 1-3% target range and is the highest in 18 years. But we all understand that’s a bogus Frankenumber. In reality, the cost of living has exploded higher as the virus threat diminishes. Covid caused the whole world to slow, or stop. Now amid surging demand, prices are racing higher. Soon taxes will add to that. It’s unstoppable.

By the way, here’s what the change over the last few weeks means. With a $600,000 mortgage (about average now in urban areas) payments at 1.99% for a five-year fixed would be $2,537. At the new rate of 2.59%, they increase by $200. The real impact comes over the 60 month term as the total amount of interest paid jumps from $54,779 to $71,623. And higher rates mean slower debt repayment. So with the new rate the borrower pays almost $20,000 more in interest yet ends up owing $6,200 more at renewal. Not good.

Of course if higher mortgage costs slow the market, punt some buyers and end up stalling prices in the city plus (along with the end of WFH) diminish them in the hinterland, new buyers can expect an equity drain. Gone will be the days when in-the-bag price increases wiped away the rookie mistake of paying too much for a property. In short, rates are a game changer. There is (and has always been) an inverse relationship between the cost of money and the price of a house. We rode it up. Now we ride it down.

What comes next?

Well, more increases. Everybody on the Street now believes the BoC will hike four times in 2022, with the first one coming in just a few months. Some say eight increases are likely in the next two dozen months (or sooner). The CB rate of a quarter point will be 2.25% or more. Five-year mortgages will be 4%. People renewing a $600,000 loan will see monthly payments rise by $600 (compared with a 1.99% rate) and interest paid over the term will soar to $112,000 – more than double.

The context of this is relatively awesome. We little house-lusty beavers owe $1.76 trillion in mortgages. We added $155 billion in the past year. Actually, mortgage debt is swelling by about $12 billion a month, or $400 million daily. The most ever. The fastest in decades. By the way, the entire economy of Canada is about $2 trillion in size, so you can see what we’re doing to ourselves.

In response, more people are taking VRMs – variable-rate mortgages. They float. When short-term bond yields raise, or the central bank jacks its key rate, VRMs immediately increase the cost of borrowing. These days they’re still available below 2%, but that is absolutely destined to change. Payments will be less now, and more later unless the mortgage is converted to a fixed-rate term along the way. Good luck figuring that out.

So, borrow long, save bigly and brace for renewal.

Now let’s hear from the laureates.

About the picture: “Humphrey is a rescue from Texas,” writes Saul, “he lives with us in Toronto. We love how he crosses his paws.”