The capitulation

Is it over? Well, almost?

That’s what Mr. Market is asking about that long string of future rate hikes everybody expected a month or two ago. The return on US ten-year bonds has dropped like Tony Clement’s shorts and now sits closer to 3%. The yield on Government of Canada five-year bonds (which influences fixed-rate mortgages) has retreated decidedly from the 2.5% neighbourhood.

On Wednesday stocks surged 500 points after dovish Fed comments. Speculators on futures markets have been betting four more hikes next year are turning into just two. And Donald Trump’s amped up the vitriol when it comes to bank boss Jay Powell. “I am,” he said this week, “not even a little bit happy with him. They’re making a mistake because I have a gut and my gut tells me more sometimes than anybody else’s brain can ever tell me.” Hours later Powell threw in the towel. We’re almost there, he said.

Higher rates would prick Trump’s bubble at the worst moment. His big tax cuts and fiscal stimulus wallop of last year are wearing off.  The one-man global trade war has ended up making investors nervous and goosing input costs for big US corps like General Motors (look what just happened). The decade-long economic expansion grows longer in the tooth. And nine Fed hikes are taking a toll (house prices in bellweather places like Seattle and Dallas are fading). Trump wants greatness at all costs – record stocks, inflating wages, full employment.

Bond yields slip. Mortgage pressure off?

Meanwhile in Canada, yuck. The oil patch is a mess thanks to crappy crude prices, clogged pipes and political constipation. The GM announcement on Monday was taken as a sign the new USMCA may have Trumped us. And the feds just abandoned even trying to balance the books, assuring deficits of close to $20 billion a year will be the Trudeau legacy. Last week Morneau brought in billions worth of corporate tax breaks – something that would be unneeded if the economy needed higher rates to chill.

But, back to bonds. They tell us a lot.

When stock markets were roiling last month, rivers of money flowed into the safe stuff. Now a bunch is flowing back, since equity values are more attractive, sentiment has improved and corporate profits continue to please (RBC just hit it out of the park). If Trump and Xi come to an agreement this weekend at the G20 summit – any deal, even a tepid one – markets could roar into a year-end romp.

What does it mean?

If rates moderate and the trade tantrum fades anyone who bailed out of their portfolio in panic last month will regret it. Unloved equities and oversold preferreds are assets to be bought, not punted. The best strategy of all is to get a balanced and diversified portfolio, then fuggedaboutit.

As for real estate, well, the big banks are having a year from hell in terms of new mortgage originations. The golden goose croaked was sautéed by the new stress test which wiped away about 20% of the market. So while higher interest rates help bank spreads, more costly mortgages erode one of their most important long-term sources of revenue. Rest assured if bond yields continue to back off, a home loan rate cut is coming.

Second, if we’re looking at one, two or maybe three more central bank increases before this cycle ends (instead of five or six), it makes sense to borrow with a variable rate. This now feels less like gambling, and means borrowers can enjoy lower payments for a long time. Those VRMs are still out there for about 2.5%.

In short, interest rate risk is falling. But before you pull your party pants on, be aware market risk is rising. House sales are slowing, prices are under pressure, credit is restricted and family finances are tight. If GM means anything, that’s not cool. And our oil situation won’t turn around fast, which is a threat to the whole economy – just like the feds adding $100 billion to the national debt, guaranteeing (even) higher taxes. At the same time, a quarter of all mortgages come up for renewal in the next few months, and most borrowers will see their payments rise.

So, curb your enthusiasm.

Finally, this pathetic blog yaks about Vancouver and Toronto too much, as you know. This is not all of Canada, as yesterday’s post tried to make clear.

“Just thought I’d send you a note on house prices in our little city,” writes Dan from Saskatoon. “These are CREA stats, I’m surprised they still publish them with their push for the lipsticked pig of HPI.  I saw a lot of articles recently about how Canada has achieved a soft landing (they even called it “Magical”) which seems premature. Tell someone who lost $50,000 in two years (15% so far), that it was soft and even magical!”

Things are not so 'magical' here