More Good News for Canadian Fixed Mortgage Rates

Last week we learned that US inflation slowed by more than expected in October.

The US Consumer Price Index (CPI) fell from 3.7% to 3.2% last month on a year-over-year basis, below the consensus forecast of 3.3%. More significantly, there was no month-over-month change in the US CPI in October, a sharp slowdown after it increased by 0.40% in September.

US core inflation, which strips out highly volatile food and energy prices, also declined from 4.1% to 4.0% year-over-year, marking its lowest level since September 2021.

Bond-market investors responded in dramatic fashion. Here is where things stood after the dust settled:

• US bond yields plunged. (For example, the benchmark US 10-year bond yield dropped by 0.20% on Tuesday, shortly after the inflation data were released.)
• The odds of another Fed rate hike this cycle fell from roughly 30% to 0%.
• The estimated timing of the Fed’s first rate cut was moved up from June to May.
• The number of expected Fed cuts in 2024 was increased from three to four. (The Fed’s most recent forecast was for two cuts next year.)
• Government of Canada (GoC) bond yields fell in sympathy with their US Treasury equivalents.

The current volatility in bond yields is a sign that we are at a turning point in the interest-rate cycle.

Over the summer, we saw a steadily increasing percentage of bond-market investors subscribe to the higher-for-longer interest-rate view, and by early October, that theme was pretty much fully priced in.

From that point forward, the market became less sensitive to stronger-than-expected economic data, such as the US GDP data for Q3 because it merely confirmed the already prevailing view, and more sensitive to weaker-than-expected data, such as last week’s inflation report, because it casts doubt on the consensus forecast.

The bond market’s heightened sensitivity to downside surprises increases the probability that bond yields, and our fixed mortgage rates, will continue to fall over the near term. But that break comes with an important caveat.

Canadian and US inflation in the 4% range certainly represents progress from peak levels last June, but we’re still a long way from our central banker’s mandated 2% target levels. The BoC doesn’t expect our inflation to return to target until the end of 2025. The Fed estimates it will take the US economy until 2026.

Views on when the Fed and BoC will cut their policy rates are going to continue to wax and wane. So, let’s enjoy the current downdraft in our fixed mortgage rates, but let’s also resist the temptation to extrapolate a straight line down to the 2% targets.The Bottom Line: GoC bond yields resumed their downward march last week. If they hold at current levels, fixed mortgage rates will soon follow them lower.

Variable mortgage rates have likely peaked for this cycle, but the timing of when rate cuts will start remains unclear. The bond market now thinks we’re about six months away, but our central bankers are still trying to push expectations farther.