The Power of Prepayment
April 27, 2011Review of the Latest Canadian and U.S. Employment Reports
May 9, 2011
Ben Bernanke’s press conference after the latest U.S. Federal Reserve meeting was the big story last week. The Fed’s Board of Governors have now decided to hold press conferences immediately after they meet in order to provide more immediate feedback on their thinking (probably not a bad idea under the current circumstances).
Chairman Bernanke confirmed that the Fed would stop its latest round of quantitative easing (QE) in June, 2011, and would keep short-term rates at near zero for the foreseeable future. He also announced that the Fed was lowering its GDP growth expectations for this year from 3.9% to 3.3%, and his tone was generally cautious, particularly as it related to the U.S. housing and labour markets.
One might infer from these comments that U.S. inflation will remain benign – and Mr. Bernanke was probably hoping that people would draw that conclusion. Except for one problem: the Fed doesn’t actually control inflation – the markets do.
PIMCO, the world’s largest bond investor, estimates that the Fed has been buying about 70% of U.S. treasuries of late, with foreigners buying the other 30%. With so much U.S. federal debt financed using short-term bonds that have to be constantly rolled over, will foreign investment really pick up all of the slack when the Fed stops buying treasuries through QE?
If the end of QE creates an over-supply of treasuries, will investors demand higher yields, or to avoid this happening, will the Fed be forced into a third round of QE? Another round would further weaken the U.S. dollar, leading to higher commodity prices and more inflation. Keep in mind that when it comes to determining the rate of inflation, the Fed can win a few battles, but the market will always win the war. The only real question is one of timing.
Five-year Government of Canada bond yields finished the week lower and if the current trend continues we could start to see fixed-mortgage rates dropping by the end of the week. A lot will depend on what’s in this Friday’s Employment Report. Stay tuned.
Profit margins on variable-rate products have been skinny for a while now, and last week several lenders decided to reduce their variable-rate discounting. In one such case, a lender reduced their discount by .25%, surprising industry insiders. Others have since followed with lesser reductions.
The bottom line: If you’ve been eyeing a variable-rate mortgage at prime minus .80% or better, grab it while you still can.