Why the US Fed could have a big impact on Canada’s future rates

The US central bank is in no hurry to start cutting rates

Why the US Fed could have a big impact on Canada’s future rates

With central banks across the world seemingly pivoting towards a rate-cutting bias this summer, plenty of Canadian mortgage market watchers will be keeping a close eye on the approach of the Federal Reserve south of the border in the months ahead.

The livelihood of the US economy and the outlook of its central bank are key factors influencing Canada’s economic performance and the Bank of Canada’s own approach, especially because significant divergence between the Fed and the Bank has big implications for the strength of the loonie.

Meanwhile, the fact that the Fed appears to be adopting a more conservative and cautious approach than other central banks could keep fixed rates, which rise and fall in tandem with bond yields, elevated in Canada in the short-to-medium term.

That means many borrowers whose fixed-rate mortgage is coming up for renewal shortly shouldn’t hope for an immediate rate plunge before that renewal arrives, according to Justin Prasad (pictured top), a financial advisor with BlueShore Financial.

He told Canadian Mortgage Professional that the approach of the US Fed, which chose not to cut rates at its announcement last week and has now pencilled in just one cut for the remainder of the year, was an important factor behind that outlook.

“If your mortgage is coming up for renewal in the fall, and you think rates are going to drop dramatically, that’s probably not the case,” he said. “One of the reasons around that when I’m having discussions with clients is that we’re kind of tied to the hip with the US. So we haven’t really seen bond yields come down.

“They have – but not as meaningfully as people may have thought, and that’s because we’re kind of waiting to see with the US Fed, and I don’t think that they’re really going to cut rates this year.”

While the Canadian central bank introduced its first rate cut for more than four years in its last announcement, it’s also unlikely to bring rates down substantially before the end of the year, Prasad said, strengthening the likelihood that borrowing costs won’t see a big decline in 2024.

“Here in Canada, I think they’re going to cut, wait, cut, wait,” he said. “It’s kind of like coming down a mountain slowly – we’re just going to take one step at a time. So I’m trying to temper expectations for clients that you might see a five-year fixed rate go [for example] from 5.3% to 5.1%. It’s not going to drop down to the threes anytime soon.”

US economy remains resilient amid high interest rates

The Fed appears to have a less rosy view than other central banks on the current viability of rate cuts partly because inflation there remains notably above its 2% target and the economy has also continued to defy expectations of a slowdown.

May saw 272,000 jobs added to the US economy, well above the gains of 185,000 expected by the economists, as labour market growth continued in the face of the Fed-imposed high-rate environment.

The US central bank also dialled back on its rate-cutting plans in last week’s announcement, indicating that it now anticipates just one – or possible two – rate drops before the end of the year, a departure from higher expectations in March.

Canadians shouldn’t take for granted that the Bank of Canada will gladly lower rates multiple times before the end of the year either, according to Prasad.

“People need to temper their expectations,” he said. “This quarter-point rate [cut], it’s really not much, and we haven’t seen rates really come down much… the US situation really puts Canada in a pigeonhole because [the Bank of Canada] will essentially have to crater our currency if they want to go on their own path and forget what the US Fed is doing.

“I really think that rates will come down – but much slower than people think, and we won’t really see a meaningful difference in rates until the first quarter of 2026. At that point, my money’s on a five-year fixed sitting around 4% at that time.”

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