SVB instability could drive some Canadian mortgage rates lower. Here’s why – National

SVB instability could drive some Canadian mortgage rates lower. Here’s why – National

The fallout from the collapse of Silicon Valley Bank has spread to the Canadian mortgage market, with some forecasters now expecting the Bank of Canada to cut interest rates sooner than previously thought.

But some experts say that while the recent shakeup in financial markets could drive fixed-rate mortgage rates lower in the near term, whether the disruption is enough to shake the Bank of Canada off its rate path remains to be seen.

SVB’s collapse late last week, followed by the folding of Signature Bank on Sunday, has sent shockwaves through the global financial system amid fears of contagion sinking other banks.

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Ratings agency Moody’s on Monday cut its outlook on the U.S. banking system to negative from stable “to reflect the rapid deterioration in the operating environment.” Meanwhile, the VIX volatility index, Wall Street’s “fear gauge,” neared six-month highs overnight.

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Despite these concerns, American bank stocks have rallied on Tuesday as officials in both the U.S. and Canada moved to reassure market players that their respective financial systems are safe from wider market collapse.

That instability has had major impacts on Canada’s bonds market — an important gauge for mortgage rates in the country.

Anytime there’s major risk in capital markets, investors will “run for cover,” says Shubha Dasgupta, CEO of Toronto-based digital mortgage agency Pineapple.

That “cover” came in the form of Canadian bonds to start the week, he says, specifically the five-year bond. The rush to these safe-haven investments drove down the pricing of these bonds, which are directly correlated to fixed interest rates in Canada.

For Canadians shopping for these kinds of mortgages or coming up to renewal, this could lead to discounts on their quoted rate in the week ahead, Dasgupta says.

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While it can take a bit of time for lower bond rates to filter into mortgages on offer, he says that, if yields stay where they were around midday Tuesday, fixed rates could drop by a quarter or even a half a percentage point by Monday.

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That’s the difference between a mortgage rate around five per cent to one in the “mid-fours,” he adds.

Variable mortgages rates are determined differently than their fixed-rate counterparts, and rise and fall immediately in line with the central bank’s policy rate.

Dasgupta says that for Canadians in a variable-rate mortgage who have seen their rate rise substantially amid the Bank of Canada’s aggressive tightening cycle, this could become a window to lock in an affordable fixed-rate product.

He cautions, however, that there’s no certainty in the market right now — the collapse of SVB and Signature Bank could prove contained to a few regional players and pass by as an episode rather than a trend.

“Just as easy as this has changed over a weekend, that may change back,” he says.

Expectations for interest rate cuts on the rise

The SVB drama has also given rise to new market expectations for interest rate paths from the Bank of Canada and its counterpart south of the border, the U.S. Federal Reserve.

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The Bank of Canada last week held its benchmark interest rate steady for the first time in over a year. The central bank maintained its conditional pause on rate hikes but reiterated it would be prepared to raise rates again if inflation does not show signs of meaningfully slowing.

Dasgupta says that the weekend’s turmoil in the financial system has flipped expectations in the market for the Bank of Canada’s rate path.

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He says that money markets have priced in a 40-per cent chance that the Bank of Canada could see an interest rate cut at its next decision on April 12 with even higher odds of a cut of some kind by the summer.

“Obviously, just as easy as this has changed over a weekend, that may change back, but that’s kind of the expectations given the current situation,” he says.

The U.S. Fed is in an even tighter situation, with fresh data out Tuesday showing inflation is easing but remains elevated and a decision to make on its own rate next week.

Traders currently see a 50-per cent chance of no rate hike at that meeting, with rate cuts priced in for the second half of the year, according to Reuters. Early last week, a 25-basis-point hike was fully priced in, with a 70-per cent chance seen of 50 basis points.

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CIBC Capital Markets senior economist Katherine Judge said in a note to clients Tuesday that unless the banking situation alters significantly from now, she sees a quarter-percentage-point hike from the Fed on Wednesday with another step of that size later in the year.

“The banking issues will mostly have served to take a more aggressive path off the table,” she wrote.

A less-aggressive tightening cycle for the U.S. Fed might take some pressure off of the Bank of Canada. Some economists theorized last week that the Fed’s hawkish stance might push Canada’s central bank to further hikes this year, lest it fall too far behind and cause the loonie to sink compared to the U.S. dollar.

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Some big bank economists think the market speculation of rate cuts from the Bank of Canada coming sooner than later are premature.

“I think pricing rate cuts is a huge over reaction,” said Derek Holt, Scotiabank’s head of Capital Markets Economics, in an email to Motorcycle accident toronto today on Tuesday morning. He said the U.S. regulators seem to have the SVB-related concerns contained, which will let central bankers focus on taming inflationary pressures.

“To ease at the first whiff of trouble would frustrate the ability to durably get inflation under control,” he wrote.

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Benjamin Reitzes, BMO’s managing director of Canadian rates and macro strategist, told Motorcycle accident toronto today in an email that, assuming there’s not much further fallout in the U.S. banking system, “this is likely a bump in the road, and the focus will shift back to inflation.”

He noted that markets are still pricing in about 50 basis points of cuts from the Bank of Canada before the end of the year.

“However, given market volatility that could change in a hurry.” he said.

Given the SVB uncertainty, Reitzes said that the Fed will “likely be more cautious going forward.”

“For the BoC, that just makes them that much more comfortable staying on hold at 4.5 per cent for now.”

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Dasgupta compares today’s uncertainty to the beginning of the COVID-19 pandemic three years ago. It was then that the Bank of Canada dropped its benchmark interest rate to rock-bottom levels in an effort to stimulate the economy.

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Should the banking situation worsen and spread, he says the central bank would have the power to drastically lower its policy rate again to protect the Canadian economy against the mounting uncertainty.

Dasgupta says this incident, so far, appears smaller in scale than other recent financial disruptions in history. The last major banking collapses were more than 15 years ago, he says, and there’s no roadmap for how these failures resolve and the kind of impact they leave.

“It could just be a blip in the radar. It could be something bigger,” Dasgupta says.

— with files from Reuters