US Inflation Threatens Canadian Mortgage Rates

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Last December, Bank of Canada Governor Tiff Macklem suggested that we would face an economic rollercoaster on the way back to two percent inflation. “We cannot rule out bumps in the road,” he warned.

Federal Reserve Chairman Jerome Powell struck a similar tune, announcing a “bumpy ride” back to the 2 percent target. Yet for whatever reason, most people either missed the memo or ignored these caveats.

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Lo and behold, on Wednesday we experienced another bump in the road, and not in Canada. It was south of the border, where U.S. inflation posted a strong 3.5 percent, eclipsing forecasts and coming in 0.3 percentage points higher than the previous month.

The news caused a stir among low-rate hopefuls and economists, who expected Wednesday’s BoC meeting to announce rate cuts and lower yields. The central bank actually assured us that there would be a rate cut, but the US CPI drama stole the attention.

The spike in Uncle Sam inflation and the appearance of a bond auction sent five-year Treasury yields up a staggering 23 basis points. Given the close connection between our countries’ bond markets, rising U.S. yields led to a 14 basis point increase in Canadian five-year yields. It was the sharpest increase since October and a reminder that Canada doesn’t control its fate when it comes to mortgage rates.

The fact that our yields follow US yields like a minted duckling is not a new problem for borrowers. Five-year returns from the US and Canada are practically financial BFFs, with a correlation of 0.96 (out of 1). So when U.S. yields skyrocket, they drag down a whole host of borrowing costs, including Canadian fixed-rate mortgage rates.

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Given that our mortgage market is tied to the US star, two questions arise. First, how likely is it that US inflation will be more than just a drag in March? And secondly, How likely is it that Canadian inflation will follow suit?

About inflation

This is the third rise in U.S. inflation since it began trending sideways last summer. Investors are worried it’s more than just a rise, but they experienced the same problems in August and December – except inflation went down each time.

Looking back, inflation rarely falls in a straight line. It is known for scenic side trips that can last from a month to a year. That’s why central banks don’t want us to get too excited about a few months of gloomy data.

Unfortunately, even the world’s most powerful banker, Jerome Powell, doesn’t know whether Wednesday’s worrying inflation data is a shock or a new trend. More than once he described inflation trends as “highly uncertain” and complained that central bankers had little control over externalities such as war and rising oil prices.

All Powell, Tiff Macklem or any of us can do is wait for more data and hedge some or all of our borrowing costs by locking ourselves into today’s interest rates – If appropriate for our circumstances.

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Otherwise, we have to trust that high real key interest rates will serve their purpose. And so far they are working – although more so in Canada. The BoC says its core inflation indicators show good downward momentum. Fed Chairman Powell was also optimistic, but after Wednesday’s data he will be less optimistic.

As for inflation, remember that the Fed primarily goals the less volatile core PCE inflation, not CPI inflation. And core PCE is already in the Two percent zone Stateside – it’s something of a comfort blanket.

On the other hand, the Fed’s new favorite gauge, “supercore inflation,” which excludes food, energy and real estate, rose to an 11-month high of 4.8 percent. This is an eyebrow-raising area and well above the two percent target.

All in all, unless inflation in Canada and the US breaks through towards four percent, the BoC and the Fed will ride out these swings without raising interest rates.

On America’s influence on the Canadian CPI

Some of the same forces that have corrupted the CPI party in the United States are also affecting Canada’s inflation rate – think commodity prices, fiscal support, wage strength, global supply conflicts, and so on.

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Still, BoC Governor Tiff Macklem said in Wednesday’s press conference that he sees “no major direct imported inflation effect” from the US. This is essentially because Canada mainly imports American goods and the prices of goods have cooled down. The rise in inflation in the US is more concentrated in services, of which Canada does not import as much.

The Bank of Canada says it has “increased confidence that inflation will continue to decline gradually even as economic activity increases.” In fact, the inflation forecast for the end of the year was reduced to just 2.2 percent. Meet the forecast and mortgage rates go down – period.

That’s a big if, of course, but if we take the central bank’s statements at face value and there are no black swans like oil above $100, there is reason for optimism. That confidence will grow if Canada’s CPI report on Tuesday doesn’t disappoint.

Currently, bond markets are pricing in the likelihood of a cut at the Bank’s next meeting on June 5 almost like a coin toss and a 95 percent chance by July. These are good chances, but the chances can change.

To all mortgage buyers out there, keep the faith that lower Canadian inflation will lower mortgage costs later this year. But if your mortgage is due to expire in the next 120 days, you should still secure a rate lock – because if we hit any further “bumps,” including in the US, rates will temporarily rise.

Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X below @RobMcLister.

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