Market commentary

Nov 18, 2016

Good morning,

Global fixed income markets have just had the steepest two week loss (prices down, yields up) in 25 years.  More than $1-trillion has been wiped from the value of bonds around the world as President-elect Donald Trump’s policies are seen boosting spending and quickening inflation.

Here at home the 5 and 10 year Government bond benchmarks are trading 30 and 40 basis points higher than two weeks ago, and yield 0.95% and 1.53% respectively.

Up to the moment economic news

Canadian Consumer prices rose 0.2% in October, in line with consensus and enough to move the annual inflation rate up to 1.5%.  Headline and core CPI are coming in below the Bank of Canada’s forecast for Q4 though, and moderate CPI reinforces the message that the BoC can stand back with a bias to ease for an extended time. 

Mortgage rate news

The Royal Bank of Canada stepped up and moved their residential lending rates this week.  The 5 year ‘special’ rate increased 30bps to 2.94%.  The bank also introduced a 10 basis point premium for mortgages with amortizations longer than 25 years.  It’s one of the first examples of ‘risk-based’ mortgage pricing at a Canadian bank.  Expect to see more of that in the coming year.  TD elected to move its 5 year rate only 10bps to 2.69%.  Other lenders have been slow to follow, but given the sharp move in underlying bond yields this week, capitulation won’t take long. 

We also expect to see a ‘resetting’ of conventional mortgage rates once we cross the November 30th implementation date for new ‘insurability’ rules.  As a reminder, after November 30th, many conventional mortgages (loan to value ratios below 80%) will no longer be eligible for mortgage insurance.   Conventional mortgages must be associated with a new owner occupied purchase (as opposed to refinancing), have less than 25 year amortizations, meet debt service ratios calculated using the Bank of Canada qualifying rate of 4.64% (as opposed to the actual mortgage rate), and have property values below $1 million to be eligible for insurance.  No insurance means no NHA MBS securitization and that could mean higher mortgage rates for some low ratio mortgages. 

CMHC news

Here’s what’s wrong with the media.  “CMHC’s mortgage insurance business vulnerable to sharply rising interest rates”.  That headline from the Globe and Mail would give the impression that the default insurer is on the brink of collapse.  In fact, CMHC was reporting the results of internal modelling that shows it is more than sufficiently capitalized against the most severe stress test scenarios including ones that involve earthquakes, lions, tigers and bears, OH MY.  GET OVER IT.  In their own words CMHC said that they were “searching out extreme scenarios that have a very remote chance of happening and planning for them”.  Canadian borrowers, lenders, and taxpayers have all benefited immensely over the years from our world leading mortgage insurance, securitization and lending policies.  CMHC generates over $1 billion of revenue every year for Canadians and projects another $6.4 billion over the next 5 years.  All while ensuring a liquid, competitive, and secure mortgage market that is envied the world over.   

Mortgage securitization news

Merrill Lynch Canada issued $800million 5yr NHA MBS at GoC+76, upsizing the deal from an initial size of $500 million on strong demand.  The spread is the narrowest since the summer of 2015.  Laurentian Bank issued last week at +80, but had the misfortune of launching the morning after the US elections.  It’s now trading tighter in the secondary market.

Canada Housing Trust was also in the market this week.  The third and final opening of the ’10-year’ Canada Mortgage Bond maturing in September 2026 was met with better than expected demand and the deal was upsized from $2.0 to $2.25 billion but was still smaller than the $2.5 billion issued in August.  The deal was priced at the same spread as the August issuance.  The next ’10-year’ CMB issue is scheduled for February next year and will likely have a new June 2027 maturity date which will be re-opened in May 2017 and August 2017.  CHT also issued $2.5 billion of the March 2022 Floating Rate Note.  That deal will be reopened once in February next year.  CMB issuance this year now totals $35 billion, leaving $5 billion available for the December 5 year transaction.  (Note: CHT has a $40 billion issuance limit).

Central Bank news

Investors are betting that a Fed rate hike in December is a virtual certainty in the wake of Donald Trump’s win last week.  Proposed spending programs and tax cuts are projected to drive US growth and push up inflation.  The Fed meets on December 14th and Fed Fund futures imply a 96% chance of a hike in rates.

The Bank of Canada is not likely to follow the Feds lead.  Deputy Governor Timothy Lane spoke on Wednesday this week and was quoted as saying “We are free to adjust our policy interest rate in the context of Canadian economic conditions – and in particular, do not need to move in step with the Federal Reserve”.  You go girl.  The bank next meets on December 7th with a 0% chance of a hike and a 3.5% chance of a cut implied by overnight index swaps.

Property tax news

The Government of Ontario proposed a number of changes to the land transfer tax (“LTT”) regime this week.   The proposed changes include increasing the LTT rate to 2.50% from 2.00% for purchase prices above $2 million, enhancing the LTT rebate for first time home buyers (effectively canceling the LTT for purchases up to $368,000), and restricting the LTT rebate to Canadian citizens and permanent residents.  In a more nefarious twist, it was also proposed that the Land Transfer Act permit the collection of certain additional information about properties and purchases including residency and citizenship.

In Vancouver, city council approved a new tax on vacant homes.  Beginning in 2018, based on reporting collected in 2017, owners of vacant properties would be subject to a 1 percent tax on the homes assessed value.  And the beat goes on.

Finally, many of you often ask what a typical day is like for Treasury Guy.  It usually involves strategic conversations like the one below:

Commercial Mortgage Underwriter: Treasury Guy, how soon will rates start going up?

Treasury Guy: I can’t tell.

Commercial Mortgage Underwriter: You can tell me.  I’m an Underwriter.

Treasury Guy: No.  I mean I’m not sure.

Commercial Mortgage Underwriter: Well, can’t you take a guess?

Treasury Guy: Well, not today.

Commercial Mortgage Underwriter: You can’t take a guess until tomorrow?

Have a great weekend.

Treasury Guy
Jason Ellis, Managing Director, Capital Markets