Penelope Graham, Director of Content
Memo 1: A hold – and hint of cuts – from the US Fed
The American central bank pointed to the “strong and resilient” US banking system, slowing economic and jobs activity, as well as easing inflation, for the impetus behind its third consecutive rate hold, which keeps the federal funds rate in the 5.25% - 5.5% range.
While the hold was widely expected – all 109 of the forecasters surveyed by Bloomberg were unanimous in their call – it was the Fed’s 2024 projection that whipped markets into a frenzy. According to the forward-looking “dot plot” released along with the statement, the Fed is likely to cut rates by 0.25% a total of three times next year, followed by four more in 2025, and three cuts in 2026. That would bring the Fed’s benchmark rate range down by a total of 2.5%, in turn significantly cooling consumer variable borrowing rates.
“The big takeaway? Barring a major surprise, the Fed is done raising rates,” writes Francis Généreux, Principal Economist at Desjardins, in a monetary policy note.
“The economic slowdown it’s anticipating in 2024 is slightly more moderate than the one we called for in our recent forecast,” she adds.“The Fed is also expecting an uptick in unemployment next year along with slower inflation. The gradual rate cuts suggested by today’s economic projections reflect the continued uncertainty surrounding the US economy.”
Fed Chair Jerome Powell further cemented expectations that cuts are imminent in his post-announcement press conference, stating, “Inflation has eased from its highs, and this has come without a significant increase in unemployment. That's very good news. But inflation is still too high; ongoing progress in bringing it down is not assured; and the path forward is uncertain.”
However, Powell was careful to hedge expectations with the fact that the FOMC remains data-dependent and will “continue to make our decisions meeting by meeting.”
While not directly impacting Canadian interest rates, the Fed’s hold has great influence on both global and domestic markets; both US treasuries and bond yields dipped significantly following the announcement. As of December 14, the five-year Canadian government yield sat in the 3.2% range, meaning lenders could slash their fixed mortgage rate pricing in the days to come.
Memo 2: No change for Canada’s mortgage stress test rate
Despite sharply rising interest rates over the course of 2023, Canada’s banking regulator has opted not to lower the threshold for the mortgage stress test in the new year. In its annual review, the Office of the Superintendent of Financial Institutions (OSFI) left the Mortgage Qualifying Rate (MQR) at 5.25% or a borrowers’ contract rate plus 2% – whichever is higher.
This means borrowers applying for new mortgages, or who are looking to switch to a new lender upon renewal, must prove they can carry their monthly payments at that elevated rate, regardless of the interest rate they are given by their lender. While OSFI’s MQR applies only to uninsured mortgages (where more than a 20% down payment is made by the borrower), its criteria is mirrored by Canada’s Department of Finance, which regulates the stress test for insured and insurable mortgages.
The MQR is part of OSFI’s efforts to protect Canada’s banking system, and to reduce overly-risky borrowing behaviour. When it was first introduced in 2018, mortgage rates were among their lowest levels in history, prompting concerns that borrowers would easily become over-leveraged if safeguards were not put in place.
While the borrowing environment has dramatically changed since the start of 2022 – today’s fixed and variable mortgage rates are roughly 5% higher than their historic lows – the regulator feels sticking to status quo is a prudent approach.
“OSFI is confident that the MQR under its current formulation will lead to lower residential mortgage delinquency and default rates than would otherwise be the case if lenders did not apply the MQR when originating mortgages for homeowners,” states the regulator’s announcement.
“The MQR increases the likelihood that homeowners will still be able to pay their mortgages, even when events like an increase in interest rates or unexpected loss of income occur… Canadian lenders have a big stake in residential mortgages. Making sure borrowers can repay their loans even in the face of economic difficulties is crucial for keeping Canada's financial system resilient.”
Currently, the only way for a borrower to avoid being stress tested is to take out a mortgage from a non federally-regulated financial institution (such as some credit unions and alternative lenders), or remain with their existing lender at renewal time. Insured borrowers are also exempt from being stress tested when switching to a new lender when renewing their mortgage.
“The minimum qualifying rate for uninsured mortgages has produced a more resilient residential mortgage financing system characterized by low default and delinquency rates. Holding the MQR at its current rate helps ensure that lenders and borrowers effectively manage the risks associated with residential mortgages. This discipline contributes to the resilience of Canada’s financial system,” stated Peter Routledge, Superintendent of Financial Institutions.
Memo 3: Canadian debt-servicing ratios hit record high in Q3
The latest numbers are out on Canadians’ net worth and debt levels – and they aren’t pretty. According to Statistics Canada, not only were households less wealthy in the third quarter of 2023 – with the value of all financial assets shrinking by $301.2 billion – borrowers now owe more than ever for every dollar they earn.
The new national debt-service ratio now sits at 15.22%, meaning Canadians must put 15 cents on the dollar toward paying off debt. That’s up from 15.08% in Q2, reflecting just how impactful rising interest rates and overall cost of living have been on Canadian households.
According to StatCan’s numbers, credit market borrowing rose to $24.5 billion between July and September, reversing the previous four-month trend of deceleration. The culprit was largely ballooning mortgage loans, which increased to $19.4 billion from $13.8 billion quarter over quarter. Overall, mortgage debt accounts for nearly three-quarters of total outstanding debt, states the report.
“Since the Bank of Canada started raising interest rates in the first quarter of 2022, the amount of total mortgage interest payments has increased 89.6%,” writes StatCan. “During that same period, the amount of mortgage principal paid has declined by 16.8%. The third quarter of 2023 marked a deceleration in mortgage interest payments (+3.6%) compared with the previous quarter (+5.9%), while mortgage principal payments increased slightly (+0.2%) after five consecutive declines.”
And those debt loads are only poised to rise in the new year, particularly as borrowers stare down the barrel of renewing their mortgages at higher interest rates. That in turn will further weaken the economy – the silver lining of which being rate cuts are looking increasingly certain.
“Canada’s household debt levels are high, and increases in interest rates continue to pass through to debt payments with a lag. The household debt service ratio is already at record levels and will move higher as debt payments continue to rise alongside wobbly looking labour markets,” writes RBC Economist Carrie Freestone, in an economic update.
“And the Canadian economy has already contracted for five straight quarters on a per-capita basis with consumer spending softening. Against that backdrop, further interest rate hikes from the Bank of Canada have become increasingly unlikely and we look for a pivot to gradual rate cuts by mid next year.”
Penelope Graham, Director of Content
Penelope has over a decade of experience covering real estate, mortgage, and personal finance topics and her commentary on the housing market is featured on both national and local media outlets.