Interest Rate Discussions

[DonCampbell]

Interest rate discussions are often based on guess and rumor. This discussion post is to give us all a place to discuss our thoughts, ideas and research into interest rates and the Bank of Canada policy.

To start it off, here`s an article from the TD Bank`s research team.

Enjoy!

 

[RussellWestcott]

Announcement from RBC ECONOMICS RESEARCH - DAILY ECONOMIC UPDATE - September 5, 2007
Bank of Canada holds the overnight rate at 4.50%

The Bank of Canada met widely held market expectations and kept the overnight rate at 4.50%. The Bank acknowledged that economic growth was stronger than expected in the first half of 2007 and that inflation rates remain elevated. As a result, the Bank said that "it now appears that the Canadian economy is operating further above its production potential than was estimated in July."

On the downside, the Bank pointed to heightened risk that the "ongoing adjustment in the U.S. housing sector could be more severe and spill over to the U.S. economy more broadly" with negative implications for demand for Canadian exports. They also pointed to "uncertainty about the extent and duration of the tightening of credit conditions in Canada and, hence, about the tempering effect this will have on growth in domestic demand."

Given this assessment of the economic environment, the Bank concluded that the "current level of the target for the overnight rate is appropriate" a change from the July 10 statement that "some modest further increase in the overnight rate may be required to bring inflation back to the target over the medium term."

Our assessment is that, on the basis of the economic data, the Bank of Canada would be raising the policy rate to get inflation back down to its 2% medium-term target. However, the Bank expects the volatility in financial markets and attendant tightening in credit conditions to temper domestic demand.

The Bank also highlighted the risks that the "ongoing adjustment in the U.S. housing sector could be more severe and spill over to the U.S. economy more broadly" with negative implications for demand for Canadian exports. The statement removes the implied tightening bias of the July 10 statement.

We remain comfortable with our view that the Bank will hold the policy rate at 4.50% until early next year when an easing in the credit crunch and a return to more benign global financial market conditions will temper the downside risks and see the Bank’s focus return to the upside risks to the inflation outlook and a return to interest rate hikes.

 

[RobInEdmonton]

Here is a fresh Globe and Mail interview with CIBC Economist Avery Shenfeld. There seems to be agreement amongst Canadian economists (a first?) that rates will hold steady for the rest of the year to offset potential impact from the U.S. economy and the money markets.

Globe and Mail Update - September 5, 2007 at 10:40 AM EDT

The Bank of Canada held its key lending rate steady on Wednesday and suggested that the U.S. subprime market meltdown could trickle through to the Canadian economy. It also, however, noted that the Canadian economy has been much stronger than it had expected in the first half of this year.

CIBC World Markets senior economist Avery Shenfeld helped parse the central bank`s statement and suggested that Canada`s in much better shape to weather the storm than its counterpart next door. He doesn`t expect any more rates changes for the rest of this year.



Globe and Mail Update: The central bank left its key lending rate on hold today, as expected. What do you think the bank will do throughout the rest of this year?

Mr. Shenfeld: The Bank will coast for the rest of the year, perhaps even right through 2008. It wants to see a slowdown in the Canadian economy to cap inflation pressures, but it needn`t raise the overnight rate to realize that outcome. Other short term rates have already risen due to the credit squeeze, and a period of sluggish US growth will spill over into Canada.

Here is a link to the full article online: http://www.theglobeandmail.com/servlet/sto...Story/Business/

 

[BMironov]

Hello everyone,

There is an interesting TD Economics report: "The shape of yields to come: an outlook for US and Canadian interest rates to 2020" (Jun 21, 2007). It is available at:

http://www.td.com/economics/special/ca0607_rates.pdf

Just 15 pages of 3 approaches to have a crystal ball

Happy investing in Canada!

 

[RussellWestcott]

This is a good article, helps to explain why banks haven`t dropped their rates.

Feeling the pain
ROB CARRICK

QUOTE Historically speaking, we should be paying somewhere around 5 per cent for a discounted five-year mortgage right now.

The fact that we`re paying close to 6 per cent shows how tough it is to be a borrower of any type in a financial world turned squirrelly by the troubles in the U.S. subprime real estate market. It`s costing banks more to borrow the money they in turn lend out as mortgages and, naturally, this extra cost is being passed along to borrowers.

A good measuring stick for the cost of a five-year closed mortgage is the yield on five-year Government of Canada bonds. Data provided by Bob Dugan, chief economist at Canada Mortgage and Housing Corp., shows that posted five-year rates at major lenders have on average been priced at 2.44 percentage points above five-year Canada bonds for the past 7½ years. In other words, a five-year bond yield of 5 per cent would suggest posted mortgage rates of 7.44 per cent on average.

In September, the spread between posted five-year mortgages and the five-year Canada bonds was 2.9 percentage points, Mr. Dugan`s numbers show. In October, it rose to 3.21 percentage points and this week it reached 3.61 percentage points.


Economists have recently forecast that the Bank of Canada will cut rates as early as next month or in early 2008, but Scotiabank`s Mr. Gampel said it may take a little longer than that for mortgages to fall meaningfully. "If we are going to see rate relief on the mortgage side, it will come later rather than sooner, and that means probably some time in the late winter or early spring of 2008 at the earliest."

Mortgage math

The way to benchmark five-year mortgage rates is to compare them with five-year Government of Canada bond yields. Here are

comparisons for this month, and for November, 2006.

Nov., 2007 Nov., 2006
Posted big bank five-year mortgage rate yesterday : Posted big bank five-year mortgage rate 7.34% at month`s end :
Five-year Government of Canada 6.55%
bond yield: Five-year Government of Canada 3.73% bond yield:
Current spread: 3.85%
3.61 percentage points Year-ago spread:
2.70 percentage points

Click Here to Read Full Article

Cheers
RW

 

[gwasser]

I would like to write about the interest outlook and some long term trends. But for some kind of reason, now for the second time I managed to lose the product of my keystroke manipulations. Three times…

Alan Greenspan, in "Age of Turbulence" attributes the current low interest environment to globalization and improved productivity. Both are interrelated and dependant of many other factors. But mainly globalization results from the tearing down of trade barriers between countries and the inclusion of vast labor pools from developing countries. Globalization, in a `laissez fair` political environment allows us to produce products worldwide in the most cost efficient manner, i.e. it improves productivity. Also technical innovation and the resulting phenomenon `creative destruction` allows innovations that improve productivity to replace older less effective procedures and/or jobs. A clear example would be the cost savings of using word processor software instead of a secretary. Both globalization and technical innovation have increased productivity and as a results we have been producing goods cheaper than ever before, i.e. we`re in a disinflationary environment. Combining low inflation with the high saving rates of developing economies such as China resulted in interest rates decreasing dramatically from the peaks of 1982 and they have stayed low for the last five years. Mr. Greenspan feels that the easy fruits from globalization and technical innovation have been picked and that interests, along with the wages of the now more affluent workers of developing countries, are on the rise.

Jim Rogers in "Hot Commodities" was one of the first authors and investors to call the current commodity bull market, which according to Mr. Rogers started around 1998. Commodity prices move, according to this author in roughly 30 year cycles, with 15 years of low prices alternating with 15 years of high prices. Oil prices are a good example: oil prices peaked in 1982 while we started to pick the fruits from previous exploration programs and technical innovation as well as from energy conservation programs. The result was oversupply and a crash in oil prices. Exploration investment and research dried up during the next decade until the late 1990`s. The Asian currency meltdown, temporarily delayed the start of the pricing surge of oil and gas prices that followed when we realized that these commodities were becoming short in supply. The price increases of the late 1990s and early 2000`s resulted in renewed exploration and technology investments and lately large new discoveries or re-discoveries are made such as in Saudi Arabia`s Dead Quarter; offshore in the Gulf of Mexico (Devon`s Jack field) or offshore Brazil (Santos Basin). This last discovery was large enough that it is rumored that Brazil may join OPEC. It probably will take another five to 10 years to bring those fields on production, just in time to end the current 15 year commodity boom. Traditionally, rising commodity prices indicate rising inflation and thus rising interest rates as was demonstrated in the 1970s and 1980s some 30 years ago.

Combine both theories (Mr. Greenspan`s and Jim Rogers`) with the recent spending increases by many governments and we`ll see a replay of high inflation, high interest rates and burgeoning budget deficits within 5 to 10 years.