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Bond yield inversion: the case for calm

Anyone who has been watching knows that bond yields are falling and taking fixed rate mortgages with them.  The recent economic slowdown in both Canada and the U.S. has pushed down yields on five year government bonds on both sides of the border.  Those yields are used as the basis for setting interest rates on fixed mortgages.

An economic indicator known as the yield curve is has been getting a lot of attention lately.  The curve tracks the difference in the yields of short-term and long-term bonds.  Short-term can be as little as three months while long-term is 10 years or more.

Market watchers use the yield curve as a way to judge investor optimism about the future.  Long-term bonds traditionally offer better yields than short-term bonds.  The greater the difference between the short-end and the long-end of the curve, the greater the optimism about the future.

Occasionally though things get turned around and the yield curve “inverts”, with short-term bonds offering better yields than long-term.  Much is being made of this right now because it has happened, in both Canada and the United States, and it is widely viewed as bad news.

In the U.S., bond yield inversions have routinely been followed by a recession, in about a year.  But, like so much of what has happened over the past decade, this time is different.  Economists are nearly unanimous in downplaying the risk.  They point out that the inversion was not big enough and did not last long enough to trigger any alarms.  They also remind us that any possible recession will not happen overnight and is still a year away – plenty of time for action or a correction.

 

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Budget Help for First Time Home Buyers

 

The new federal budget certainly got the attention of house hunters, realtors and mortgage professionals.  Unfortunately the announcement turned into a cliff-hanger and we will have to wait for the next episode to find out what is really going to be delivered.

The budget contains two key components aimed at addressing affordability concerns and making it easier for first-time buyers to get a home.

The first is a straight-forward expansion of the current “Home Buyer’s Plan” that allows the use of RRSP money for a down payment.  The maximum amount of the RSP withdrawal has been bumped up from $25,000 to $35,000 – but the 15-year pay-back period is unchanged.

The second component is more complicated and some important details were left unexplained in the budget.  The “First Time Home Buyer Incentive” amounts to an interest-free loan from Canada Mortgage and Housing Corporation.  There are several conditions but it allows CMHC to take an equity stake in a qualifying mortgage.  The money will be paid back to CMHC when the property is sold, or sooner if the owner chooses.

The cliff-hanger is: how much money will go back to the housing agency.  Does the homeowner pay back the amount borrowed, or does CMHC get a share of the increased value of the property?  Conversely, if the property value drops does CMHC share in the loss, or is the owner still liable for the full amount of the original loan?  The answers are supposed to come in the fall.

Several prominent economists point out, that neither program actually makes housing more affordable.  They merely add to the options for taking on debt that will have to be repaid.  By some calculations the FTHBI might even decrease the maximum amount a buyer can qualify for.

 

   

Federal Budget 2019--Actions for Homebuyers

In its fourth fiscal plan, the Trudeau government spent its entire revenue windfall leaving the deficit projection little changed. In this election budget, Finance Minister Bill Morneau announced $22.8 billion over six years in new spending initiative mostly for homebuyers, students and seniors. Trudeau promised in his first budget to have eliminated all red ink by this year. He will instead head for an October election with an annual deficit of nearly $20 billion. Ottawa is projecting a string of double-digit deficits through the end of 2022.

The key debt-to-GDP ratio is expected to be 30.8% this fiscal year and edges downward only very slowly to 30% over the four-year forecast horizon.

Today's budget offered help to young homebuyers, many of whom find it very difficult to afford to purchase in some of our more expensive cities. There were two measures targeted at first-time homebuyers:

Maximum Withdrawal from RRSPs Is Increased

The simplest to understand is the $10,000 increase in the federal Home Buyers' Plan (HBP) maximum tax-free withdrawal from RRSPs to $35,000, effective immediately. This allowable withdrawal for first-time buyers will now also apply to people experiencing the breakdown of a marriage or common-law partnership who don't meet the usual requirement of being a first-time homebuyer.

The new limit would apply to HBP withdrawals made after March 19, 2019.

Those taking advantage of the higher HBP limit will have to keep in mind that the repayment timeline is unchanged. Home buyers must put the money back into their RRSP over 15 years to avoid full ordinary income taxation on HBP withdrawal. Now Canadians using these funds will have to repay a maximum of $35,000 – instead of $25,000 – over the same period.

The Boldest Move: The CMHC First-Time Homebuyer Incentive

A $1.25 billion fund administered by the Canadian Mortgage and Housing Corporation (CMHC) over three years will provide 5% of the cost of an existing home and 10% of the price of a new home through what amounts to an interest-free loan to be repaid when the property is sold. The money would go to first-time home buyers applying for insured mortgages. The key stipulations are:
• Users must have a down payment of at least 5%, but less than 20%;
• Household income must be less than $120,000;
• The purchase price cannot be more than four times the buyers' household income.
For example, say you’re hoping to buy a $400,000 home with the minimum required 5% down payment, which works out to be $20,000. With the new incentive, you could receive up to $40,000 (for a new home) through the CMHC. Now, instead of taking out a $380,000 mortgage, you’d need to borrow only $340,000. This would lower your monthly mortgage bill from over $1,970 to less than $1,750. The incentive is 10% for buyers purchasing a newly built home and 5% for existing homes.

Homeowners would eventually have to repay this so-called 'shared mortgage,' likely at resale, though it is unclear how this would work. CMHC might share in any capital gain (or loss)-- receiving 5% or 10% of the sale price (not the purchase price). At the time of this writing, these details had not been hammered out.

These stipulations effectively limit purchases under this plan to properties priced at less than $500,000 ($480,000 maximum in insured mortgage and incentive, plus the down payment), which is close to the national average sales price of $468,350 (which is down 5.2% from the average price one year ago). However, the national average price is heavily skewed by sales in Greater Vancouver and the Greater Toronto Area, two of Canada's most active and expensive markets. Excluding these two markets from the calculations cuts close to $100,000 off the national average price, trimming it to just under $371,000. What this tells us is that the relief for first-time homebuyers is pretty meagre for young people living in our two most expensive regions.

Arguably, the max price point of $500,000 for this plan is where the affordability challenge only really begins in our higher-priced housing markets. The most acute affordability problems surround medium-sized and larger condo units or single-detached homes in the GTA and GVA; yet, most of these are beyond the price range covered by the CMHC plan. The impact, of course, would be broader in other regions, but affordability in many of those is historically quite normal. The most significant impact will be in low-priced new builds.

Also, mortgage applicants under this plan still have to qualify under the federal stress test, which ensures that borrowers will be able to keep up with the payments even if interest rates rise by roughly two full percentage. The incentive, however, would substantially lower the bar for test takers, as applicants would have to qualify for a lower mortgage.

Before the budget, many stakeholders had been arguing that with the rapid slowdown in the economy and the Bank of Canada unlikely to raise interest rates this year, the B-20 stress test is too onerous and should be eased.

The government is hoping to have the plan up and running by September.

Bottom Line: These housing measures are focused on the demand side of the market, rather than encouraging the construction of new affordable housing. And while the budget does earmark $10 billion over nine years for new rental homes, it does not propose tax breaks or reduced red tape for homebuilders.

 

 

 

 

 

Which direction are mortgage rates headed?

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In a very dovish statement, the Bank of Canada acknowledged this morning that the slowdown in the Canadian economy has been deeper and more broadly based than it had expected earlier this year. The Bank had forecast weak exports and investment in the energy sector and a decline in consumer spending in the oil-producing provinces in the January Monetary Policy Report. However, as indicated by the mere 0.1% quarterly growth in GDP in the fourth quarter, the deceleration in activity was far more troubling. Consumer spending, especially for durable goods, and the housing market were soft despite strong jobs growth. Both exports and business investment were also disappointing. Today's Bank of Canada statement said, "after growing at a pace of 1.8 per cent in 2018, it now appears that the economy will be weaker in the first half of 2019 than the Bank projected in January."

As was unanimously expected, the Bank maintained its target for the overnight rate at 1-3/4% for the third consecutive time and dropped its earlier reference for the need to raise the overnight rate in the future to a neutral level, estimated at roughly 2-1/2%. The Bank also added an assertion that borrowing costs will remain below neutral for now and "given the mixed picture that the data present, it will take time to gauge the persistence of below-potential growth and the implications for the inflation outlook. With increased uncertainty about the timing of future rate increases, the Governing Council will be watching closely developments in household spending, oil markets, and global trade policy."

At the same time, Governor Poloz seems reluctant to abandon entirely the idea that the next step is likely higher -- making him a bit of an outlier among industrialized economy central bankers.

We are left with the view that the Bank is unlikely to hike interest rates again this year. The global economy has slowed more than expected and central banks in many countries, including the U.S., have moved to the sidelines. Market interest rates have already dropped reflecting this reality.

According to Bloomberg News, "swaps trading suggests investors are giving zero probability that the Bank of Canada will budge rates, either higher or lower, from here. The Canadian dollar extended declines after the decision, falling 0.7 percent to C$1.3438 against the U.S. currency at 10:04 a.m. Yields on government 2-year bond dropped 6 basis points to 1.68 percent."

If you have a variable rate mortgage and are undecided to lock in or not, and would like to discuss specifics... give us a call for a free, no-obligation consultation.

   

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