The Mortgage Rules They Are a Changin’
June 25, 2012Economic Data Doesn’t Support Bank of Canada Forecasts
July 9, 2012
Stop me if you’ve heard this one before. Seventeen euro-zone leaders walk into a bar…
Just kidding. Sort of.
Last Friday the euro zone’s leaders emerged after an all-nighter at the latest European summit in Brussels and announced new measures to address the most immediate threat to euro-zone stability, or more accurately, to re-address the most immediate threat.
When Spain’s banking bailout was announced two weeks ago, instead of restoring investor confidence and lowering Spanish and Italian bond yields it produced the opposite effect, stoking investor fear and causing ten-year bond-yield surges to just under 7% in Spain, and to almost 6.2% in Italy, by close of business last Thursday.
Here is what investors didn’t like about Spain’s first bailout announcement and what the euro-zone leaders did to address those concerns in their latest go around:
- The first Spanish bank bailout was structured so that money would initially be lent to the Spanish government before it was passed on to the country’s insolvent banks. But investors rightly concluded that any bailout which added to Spain’s already crippling debt load would increase the likelihood of future haircuts to their Spanish sovereign bonds – and they pushed Spanish bond yields higher to offset this heightened risk. To address this design flaw, euro-zone leaders agreed last Friday to restructure future bank bailouts so that the emergency funds would bypass governments and instead flow directly to imperiled banks.
- In the initial bailout, the new emergency loans were ranked ahead of other outstanding Spanish sovereign debt. This meant that all of the bailout money would have to be reimbursed before other Spanish sovereign-debt holders saw their first dime. Investors felt that this increased both the likelihood and size of their potential haircut if Spain were to ultimately default. To address these concerns, Friday’s revised bailout terms removed that provision and put the emergency funds on an equal footing with other forms of Spanish sovereign debt.
- Euro-zone bailouts had so far been conditional on adherence to onerous austerity conditions that many investors felt were severely limiting the bailed-out country’s potential for economic recovery. The salve of emergency balance-sheet relief was being more than offset by the corresponding pain of increasingly rigid fiscal restrictions. After last Friday’s meeting, euro-zone leaders announced that countries that needed additional bailouts but were complying with long-term budget goals would not be subject to increased austerity. To stimulate jobs and growth, the broader European Union went a step further at the summit by pledging a 120 billion euro stimulus package for the region.
The latest agreements were steps in the right direction and investors showed some renewed confidence on Friday as Spanish ten-year bond yields fell 58 basis points to close at 6.36% and Italian ten-year bond yields fell 46 basis points to close at 5.74%.
That said, while any short-term relief in the euro-zone crisis is welcome news, we are still in the middle innings of a nine-inning game that is long on announcements and hope but still woefully short on detail and positive economic data.
Five-year Government of Canada (GoC) bond yields were headed sharply lower for the week until they surged in response to the European Summit announcement on Friday. When the dust settled we were still 7 basis points lower for the week, closing at 1.24% on Friday. Five-year fixed-mortgage rates are still available in the 3.09% range and shorter fixed-term rates are also attractively priced.
Five-year variable-rate discounts were unchanged for the week and the rates offered only a shade below fixed rates. Because of that, I still don’t think variable-rate mortgages are compelling at this time.
The bottom line: The latest European Summit announcements once again pulled the euro zone back from the brink and investors responded by shifting out of the relative safety of GoC bonds, pushing our five-year yields a little higher as a result. But the region’s recovery and bailout plans still feel like they are being held together with duct tape and bailing wire. For that reason, I believe any near-term run-up in GoC bond yields will fizzle out before exerting significant upward pressure on our fixed-term mortgage rates.