The impact on The US and Canadian Mortgage Markets
What you will learn:
- How long-term and short-term rates impact the market
- If the US mortgage market impact’s Canadian mortgage rates more than Canada’s Central Bank
- How personal income rates and savings rates impact home purchases. Do we need to worry?
- Info on the next Fed Rate Decision
Short- and Long-Term Rates and the Market
What do we know about the current state of the economy? Do we want lower rates or higher rates to drive the market forward? Does it matter, and what will the impact be on housing?
First, we know two core facts over the last few years:
- When rates went up, we hit record market highs
- And of course
- When Rates went down, we hit even more record highs
What does this mean for banks?
- We need to manage interest rate risk and credit risk and focus on those core fundamentals regardless of if rates are going to go up or down.
Let’s dissect the last few years as a baseline before we jump into housing impacts.
The chart above tracks long term rates (US 10-year treasury in purple), short term rates (the effective overnight lending rate in blue) and the S&P500 (orange).
In section A above, from three years ago, on November 25th, 2016, to two years ago, November 22nd, 2017 we saw long-term rates drop from 2.36% to 2.32%. Fairly flat but a decline over the course of 12 months. Over that same timeframe we saw short-term rates spike from 0.41% to 1.16%.
To recap, long term rates went down, and short-term rates went up. What happened to the S&P? It went up almost 400 points, from 2213 to 2597.
Over the following year in section B above, long term rates rose to 3.19% and short-term rates jumped to 2.18%. Again, the S&P rose to new heights during that time period going over $2900.
And finally, in section C, long-term rates plunged, now sitting around 1.73%, with short-term rates at 1.55%. So contrary to the last two sections, both sets of rates dropped, instead of one or both increasing. And as we know the market hit new highs again with the S&P over 3100 and we have been hitting new highs daily. While Monday was a hit to the market, we do need periodic pull backs to avoid bubbles.
The key takeaway is that we worry when rates go up and when they come down, but market fundamentals are solid and are keeping the market moving along. And as we looked at in our previous post bank stocks are rising as well, even with rates coming down, being driven by consumer confidence and housing.
The US and Canada: Can one’s rates predict the other?
Before we circle to the US housing industry let’s take a North American look. Mortgages in the US and in Canada work fundamentally differently. We can explore those overt and nuanced differences in another post, but for now what is important to know is that most US mortgages are 30-year fixed rate mortgages with little to no prepayment penalties to refi. Canadian mortgages are typically 3-5 year instruments where you renew your mortgage at the end of your term, but there are steep prepayment penalties that essentially curtail refi’s/renewals during those 3-5 year periods. Also, you would assume that a shorter duration loan would be cheaper than a longer-term fixed rate loan, but as we will uncover that is not actually the case.
And finally, because terms are shorter in Canada you would assume that short term interest rates from the Canadian central bank significantly impact rates, but as you see below, while the Canadian prime rate correlates to the Canadian 5 year mortgage as this impacts cost of funds, the US 10-year treasury which impacts the 30 year US mortgage rate actually has a much stronger correlation to Canadian rates.
Looking above in orange over the last 10 years, you see that short-term Canadian paper is often more expensive than long-term US paper. Some of this is because of the liquidity in the US mortgage market and the massive secondary market, where as most Canadian loans are put on banks’ balance sheets. But also, what you see is banks globally holding US treasuries which also impacts their cost of funds, and you can see above that not only is the 5-year Canadian rate correlated to the US 30 year, but it often lags the US rate on the downswing and the upswing.
The question I pose is this, is there opportunity and money to be made for banks and investors by understanding this correlation and proving out that the lag is significant. Some of this lag is driven by the fact that US banks change pricing during the day and Canadian banks change much less frequently.
Personal income, spending and saving what does it mean for housing?
Looking at the above chart we see a few very interesting trends.
- US Personal Income is growing at an almost exponential rate. Additionally, the last recession, in gray, hit income moderately hard, but looking back through 1960, none of the previous recessions impacted income growth substantially or slowed its growth trajectory. In January 2010 personal income was $8.3T, so it has increased by over $10T in the last 10 years ending at $18.79T.
- US Personal Spending and Saving has grown in tandem with income growth, but at a slower rate, which is a major positive sign meaning that saving is increasing as you see above. From 2010 to today Savings have gone up from 0.6T to over 1.2T, a 100% increase. So while the saving rate as a % is down compared to the 60’s and 70’s, a lot of this is because income is up so dramatically that while people are saving more on a dollar standpoint, it is down on a percentage basis. But spending keeps the economy going and the fact that people are spending more and saving more, means they can accumulate more wealth while driving the markets up.
- Housing Prices are at all time highs as we have explored in the past and there is a great deal of conversation around housing being unaffordable. I tend to agree that in certain cities this is a large problem as people are priced out of markets. But there are over 20,000 areas classified as cities in the US, so outside of the problematic 5-10, let’s focus on the other 19,990 cities. In these areas income and savings are up in line with housing price increases, creating equity for home owners and giving them more valuable assets. The problem of skyrocketing prices in the cities above is a cause for concern and something that needs to be addressed to keep housing fair for everyone, but elsewhere the housing industry is driving equity and helping to create wealth and push the economy forward.
What have we learned? That when mortgage prices tied to the 10-year treasury go up eventually, maybe tomorrow and maybe years from now, this does not mean the economy will slow in tandem or that the market will slow……..though of course it may, but it is not something that has happened in the last three parts of this economic cycle.
When rates do go up though banks will focus even more on deepening with existing customers and re-fi will start to decline. This we all know, but what can we do about it?
First you need to have a purchase money strategy. How will you generate leads, price loans, and deepen when the purchase buying cycle is 30, 60, or even 180+ days. Technology is key to enabling this. Banks and Mortgage Lenders are focused on lead gen software and point of sale software and new LOS systems. But pricing is key, don’t forget about being customer centric and getting the right price the right customer at the right time. Price is King and Queen, but if you don’t know the right price you better start figuring out your customers segmented price elasticity before the booming re-fi market is a thing of the past.
The Fed Rate Call
The next time the Fed has a decision about rates the consensus is they will hold firm on not moving for the next few quarters. I hope the above has reassured you that the Fed will do what is in the best interest for the economy, but regardless if rates stay the same or decline, the rest of the housing picture is strong and what we have seen in previous posts is that regardless of the short end of the curve, the long end has been held low and we predict low rates are the new normal for the foreseeable future.
Want more insight? Check out my last post on a new integrated approach to lending.