What was supposed to be a march back to normalcy for interest rates began just about two years ago.
Rates did grind a fair bit higher in the ensuing months, but we’re still nowhere near what would have been considered normal levels prior to the last recession. Now, it’s looking like rates are at or close to their peak for this economic cycle. The hammer of much higher rates may never fall on the many people who have over-borrowed to buy houses, cars, renovations and sundry other things.
Don’t celebrate quite yet, borrowers of the nation. Financial markets are expressing a distinctly pessimistic view of what’s ahead for the economy. Job security, hours worked and raises and bonuses could be at risk in a slowdown. For borrowers, that’s potentially as dangerous as higher rates.
The optimistic view on the economy comes from the Bank of Canada, which last week suggested that conditions were improving after a bad patch late last year and into 2019. Yet the bank wasn’t confident enough in this trend to signal that interest rates could rise sometime soon.
You can also get a reading on what’s expected for the economy by looking at what’s happening in the bond market. Nothing good is happening right now, unless you’re looking at a five-year fixed rate mortgage.
When there’s worry about the economy, interest rates in the bond market fall. The yield on a five-year Government of Canada bond, the benchmark for five-year fixed rate mortgages, has dropped to about 1.3 per cent from 1.9 per cent at the start of the year. That’s a big move in bond land.
Last October, five-year bonds had a yield of 2.5 per cent. Remember that, savers and conservative investors? It looked back then like rates on guaranteed investment certificates and savings accounts were finally going to deliver meaningful returns. So much for that.
Another negative beyond falling rates in the bond market is the unusual situation of interest rates on short- and long-term bonds sitting at pretty much the same level. Long rates should be higher than short rates to reflect the greater risk investors take on with a bond maturing many years down the road. When short rates are the same as long rates – or higher – it means investors are worried about longer term growth prospects.
The Bank of Canada and the bond market aren’t as far apart as they seem. Both acknowledge that there’s no pressure to send interest rates meaningfully higher right now. Borrowers who weathered the rate hikes that began in July, 2017, have very likely seen the worst.
The Bank of Canada’s benchmark overnight rate opened the summer of 2017 at 0.5 per cent, an exceptionally low level that reflected the panic generated by the global financial crisis. Five staggered increases of 0.25 of a percentage point followed, bringing the overnight rate to 1.75 per cent.
You can see the impact of this cumulative increase in the way growth in new borrowing has declined. Rates on a wide range of borrowing increased significantly, leaving people with less room to add new debt.
Here’s an indication of how much worse things could theoretically get on borrowing costs: Between 2000 and 2009, the overnight rate peaked in the 4-per-cent to 6-per-cent range, double or triple current levels.
It’s been apparent for years now that we are not getting back to those levels any time soon. While the economy is still growing and creating jobs (of varying quality), there’s nowhere near enough vitality to create the problem of too much growth and, in turn, too much inflation.
Today, the question for borrowers is whether interest rates now are at or close to their peak for this cycle. Increasingly, it looks like the answer is yes. If you overborrowed, the threat of rates rising beyond today’s levels is receding.
You’ve got some breathing room if you’re worried about how much you’ve borrowed. Use it to trim the amount you owe and reduce the risk that a slowing economy will hurt your ability to pay your debts. There are signs people are doing exactly this, which calls for some rarely heard words in a personal finance column. Well done, people.
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Rob Carrick