The U.S. Federal Reserve’s 50-basis-point interest rate cut on Wednesday is set to have ripple effects north of the border, with experts pointing to implications for both the Bank of Canada and Canadian mortgage holders.
The Fed delivered an oversized step for its first interest rate cut in four years, a move that surprised many economists who had expected a standard quarter-point cut.
To the north, the Bank of Canada is well-entrenched in its own easing cycle, having cut its policy rate by 25 basis points three times since June.
But Nathan Janzen, assistant chief economist at RBC, says the Fed’s moves will be felt in the Canadian bond market as well, an important proxy for mortgage rates in Canada.
Bond yields take their cues from central bank policy rate expectations in both the U.S. and Canada. These also act as benchmarks for key lending rates from Canadian banks, with the five-year government of Canada bond yield closely informing lenders’ five-year fixed mortgage rates, for example.
Janzen tells Global News that “what happens to the U.S. bond yields has implications for Canada.”
Because of how tightly knit the Canadian and U.S. economies are, significant shifts south of the border can impact financial markets to the north, he explains. That includes bond yields seeming to move “in co-ordination” with each other.
“That’s in part reflecting the fact that our economies historically have been closely correlated and so have been monetary policy responses,” he says.
Mortgage rates spotted below 4%
While the five-year GoC bond yield has been largely trending downward as the Bank of Canada charts a path for lower rates, the moment of the U.S. Fed’s half-point cut on Wednesday coincided with a nearly 50-basis-point drop in the yield as well.
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Yields have rallied somewhat since the decision, but mortgage market watchers say they’re already seeing an impact.
Comparator site Ratehub said shortly after the Fed’s decision on Wednesday that its in-house lender CanWise had posted a five-year fixed-rate mortgage at 3.99 per cent. That rate is available to buyers or renewers with a “high-ratio” mortgage, meaning they put less than 20 per cent down up front with a purchase price under $1 million, among other conditions.
Ratehub claims CanWise is the first lender in Canada to offer a five-year fixed mortgage rate below four per cent since June 2022.
Seeing rates drop below that bar clears a “psychological hurdle” for homebuyers and owners, according to Penelope Graham, mortgage expert at Ratehub.
In addition to the U.S. Fed’s half-point cut, Graham pointed to Tuesday’s news that inflation hit the Bank of Canada’s two per cent target as helping to drive down bond yields and, by extension, mortgage rates.
“Bond investors are enthused by the current rate-cutting sentiment from both the Canadian and American central bank,” she said in a statement.
The Bank of Canada is likely to be feeling confident in rate cuts as well as it gears up for its next decision on Oct. 23, according to economists.
The U.S. Fed’s decision to take an oversized step to kick off its rate-cut cycle “opens the door” to the Bank of Canada to follow suit, RSM Canada economist Tu Nguyen said in a note.
Fed easing gives Bank of Canada runway to cut
Bank of Canada governor Tiff Macklem has often said the central bank sets its policy rate based on domestic factors, not movements in the U.S.
The Bank of Canada’s key rate stands lower than the U.S. Fed’s even after the 50-point cut, with Canadian monetary policymakers getting a head start on easing.
But Janzen points out that there’s a limit to how far policy rates can diverge on either side of the Canada-U.S. border, particularly as it relates to the exchange rate. If the Bank of Canada’s policy rate drops too far below the Fed, that will hurt the exchange rate between the Canadian and U.S. dollars, resulting in a weaker loonie and risking an uptick in inflation.
Janzen said the Fed’s half-point cut on Wednesday “limits” risks posed to the Canadian dollar as the Bank of Canada looks to continue cutting.
Heading into the October rate decision, the return to two per cent inflation — months ahead of the Bank of Canada’s forecasts — has calls growing for a larger 50-basis-point cut.
“The pace at which inflation returned to target means the Bank could consider speeding up as well with a 50 basis point cut in October, given rising unemployment and slow business investments,” Nguyen said.
While the U.S. Fed’s dramatic step gives the Bank of Canada more leeway for its own rate-cut cycle, Janzen argues that what’s happening at home and the welcome developments on the inflation front are a “bigger, more encouraging story” for a central bank charting a path to lower rates.
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