Canadian Interest Rate Projections – May 2010

I figure it would be helpful to see what the Canadian interest rate futures are doing and to make some projections as to what the market is saying about future rate increases:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 MA 0.000 0.000 99.375 0.000 0
+ 10 JN 99.150 99.160 99.250 -0.100 14740
+ 10 JL 0.000 0.000 99.365 0.000 0
+ 10 SE 98.730 98.740 98.820 -0.080 22075
+ 10 DE 98.340 98.350 98.410 -0.060 29381
+ 11 MR 98.050 98.060 98.100 -0.050 8873
+ 11 JN 97.740 97.770 97.810 -0.060 2777
+ 11 SE 97.440 97.480 97.550 -0.080 2076
+ 11 DE 97.220 97.270 97.310 -0.070 216
+ 12 MR 96.910 97.150 97.060 -0.250 1
+ 12 JN 96.550 96.930 96.860 0.000 0

My projection for the Bank of Canada overnight interest rate level is the following:

June 1, 2010 (+0.50% to 0.75%)
July 20, 2010 (+0.25% to 1.00%)
September 8, 2010 (+0.25% to 1.25%)
October 19, 2010 (+0.25% to 1.50%)
December 7, 2010 (+0.25% to 1.75%)

What has changed since my last projection is that the initial rate increase in June 1, 2010 will be 0.50% instead of 0.75%. I still see subsequent rate increases of 0.25% at each scheduled announcement. You can probably thank the European debt situation for this change.

Although Canada’s economy is much less linked to Europe than it is to the USA, it is enough to factor into the economic calculation. In particular, the Euro has dropped significantly and this will lessen the competitiveness of Canadian exports into the Euro market.

That said, relative to the US dollar, the Canadian dollar has slipped a little, but this probably isn’t enough to take into consideration other than “wait and see”.

Long-term rate projections, which is more relevant for mortgage pricing, has had rates drop over the past two weeks. 5-year bond rates are 2.74%, while the 10-year is at 3.47%, which is roughly the rates seen in the past three quarters. If the market stabilizes at the existing level, I would not be shocked to see a 5-year fixed mortgage rate offered at 4.00% in the next couple weeks.

Bank of Canada will raise interest rates on June 1

The Bank of Canada released its monetary policy announcement today, and it contained the following paragraph:

In response to the sharp, synchronous global recession, the Bank lowered its target rate rapidly over the course of 2008 and early 2009 to its lowest possible level. With its conditional commitment introduced in April 2009, the Bank also provided exceptional guidance on the likely path of its target rate. This unconventional policy provided considerable additional stimulus during a period of very weak economic conditions and major downside risks to the global and Canadian economies. With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus. The extent and timing will depend on the outlook for economic activity and inflation, and will be consistent with achieving the 2 per cent inflation target.

This means that at the next Bank of Canada meeting on June 1, they are likely to raise interest rates. The futures say it will likely be a 0.75% hike up to 1% in June, and then the rate increases will be 0.25%. My new projected schedule of rate increases will be as follows:

June 1, 2010 (+0.75% to 1.00%)
July 20, 2010 (+0.25% to 1.25%)
September 8, 2010 (+0.25% to 1.50%)
October 19, 2010 (+0.25% to 1.75%)
December 7, 2010 (+0.25% to 2.00%)

Canada Interest Rate Projections – March 2010 – Effect on mortgages

With all the talk about the Bank of Canada wanting to raise rates, it is instructive to look at what the futures market is saying about the issue. It should be noted that the next scheduled rate announcements are as follows:

April 20, 2010
June 1, 2010
July 20, 2010
September 8, 2010
October 19, 2010
December 7, 2010

A rate increase on or before the July 20, 2010 meeting is a guarantee. The question is how much?

The markets currently say the following:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 AL 0.000 0.000 0.000 99.480 0.000 0
+ 10 MA 0.000 0.000 0.000 99.440 0.000 0
+ 10 JN 0.000 99.320 99.325 99.360 -0.040 21736
+ 10 SE 0.000 98.870 98.880 98.910 -0.040 33614
+ 10 DE 0.000 98.400 98.410 98.450 -0.050 19923
+ 11 MR 0.000 97.980 97.990 98.030 -0.040 6402
+ 11 JN 0.000 97.630 97.640 97.690 -0.050 3215
+ 11 SE 0.000 97.320 97.350 97.410 -0.080 1445
+ 11 DE 0.000 97.040 97.060 97.140 -0.090 707
+ 12 MR 0.000 96.810 96.840 96.910 -0.080 50

The three-month interest rate will be:

June 2010: 0.68%
September 2010: 1.13%
December 2010: 1.60%
March 2011: 2.01%
June 2011: 2.37%

Reading my tea leaves, this would suggest that the Bank of Canada will raise per the following schedule:

April 20, 2010 (No change – 0.25%)
June 1, 2010 (No change – 0.25%)
July 20, 2010 (+0.75% to 1.00%)
September 8, 2010 (+0.25% to 1.25%)
October 19, 2010 (+0.25% to 1.50%)
December 7, 2010 (+0.25% to 1.75%)

It is also likely that by June 2011 that interest rates will be around 2.5%.

The only effect these rate increases will have on mortgages are for floating rate mortgages (ING Direct offers them at prime minus 0.4%). This would mean that rates would go up from 1.85% to 3.35% by the end of the year and roughly to 4.1% by the middle of 2011. For most borrowers on floating rate mortgages, they will likely see their interest payments at least double over the course of the year. As an example, for somebody borrowing $300,000, their interest payments will increase from roughly $450/month to roughly $1000/month by the middle of 2011.

In terms of fixed rate mortgages, rates are essentially set by the bond market, and the bond market has already “baked” in these projected rate increases. The best available 5-year fixed rate mortgage is 3.69% currently. Given a choice between these two options, it is a rare time where taking the 5-year rate would be the prudent option.

It is likely once interest rates start to increase that banks will increase the “prime minus” spread from a typical 0.4% currently to around 0.8% – the peak discount which was seen in the last housing rush.

Either way, the lack of ultra-cheap credit will have an effect of slowing down the housing market considerably.

Canadian Interest Rate Projections

The financial media is catching wind that interest rates are going to be increasing. Although I believe the Bank of Canada is fairly firm in holding their overnight rate at 0.25% until the end of June, the question remains how much they will raise rates in July. I thought that it was going to be an evolutionary 0.25% increase over the next scheduled meetings of the central bank, but there might be a larger jump.

Futures markets are signaling the following compared to the same time last month (January 2009):

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 MR 0.000 99.545 99.550 99.550 -0.005 4412
+ 10 AL 0.000 0.000 0.000 99.510 0.000 0
+ 10 MA 0.000 0.000 0.000 99.460 0.000 0
+ 10 JN 0.000 99.400 99.410 99.410 0.000 16860
+ 10 SE 0.000 99.030 99.040 99.030 0.000 19502
+ 10 DE 0.000 98.630 98.640 98.630 0.000 17457
+ 11 MR 0.000 98.240 98.250 98.250 0.000 2335
+ 11 JN 0.000 97.900 97.920 97.910 0.000 1360
+ 11 SE 0.000 97.550 97.620 97.600 -0.010 175
+ 11 DE 0.000 0.000 97.350 97.300 -0.050 56
+ 12 MR 0.000 97.000 97.090 97.050 0.000 0
+ 12 JN 0.000 96.740 96.870 96.810 -0.040 7
+ 12 SE 0.000 96.530 96.670 96.600 -0.030 7
+ 12 DE 0.000 96.320 96.500 96.370 0.030 7

We can see the projected interest rate for December 2010 is 1.36%, while December 2011 is around 2.7%.

Another metric to look at is long term bond rates – 5-year bond rates (which determine how expensive 5-year fixed rate mortgages will be) are currently trading at 2.56%, but this has not changed too much over the past half year.  If the markets were anticipating significant amounts of inflation, they would most likely hit the longer term bond markets first.

The expectation theory states that long term rates are a representation of the short term rates that will existing throughout the maturity of the debt.  As such, the markets are expecting an average of 2.56% over the next five years – since rates for the next 5 months will be at 0.25%, it hints there will be a period of time where we will see short term rates at or around 3%.  Interest rate futures say this will be around March and June of 2012.

My financial crystal ball suggests that the markets are pricing this in correctly.

Since the yield spread (between the 10 year and 2 year bond) is around 2.1%, it does suggest that there will be some sort of economic recovery – my sense in terms of how to play this is to load up on commodities until the yield curve flattens.  When the yield curve flattens, the party is over.

Canadian Interest Rate Projections

This is updated from December 7, 2009. The end of December rate (these rates are 90 day bank rates) has moved from 1.53% to 1.45%, while the end of December 2011 has gone from 2.86% to 2.77%. The market is signaling that rate increases will be less than anticipated from last month.

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 FE 0.000 0.000 99.530 0.000 0
+ 10 MR 99.540 99.545 99.535 0.005 3742
+ 10 AL 0.000 0.000 0.000 0.000 0
+ 10 JN 99.380 99.390 99.370 0.020 19921
+ 10 SE 98.970 98.980 98.960 0.020 13407
+ 10 DE 98.540 98.550 98.520 0.030 6731
+ 11 MR 98.130 98.140 98.130 0.000 3180
+ 11 JN 97.800 97.820 97.810 0.000 918
+ 11 SE 97.500 97.520 97.500 0.010 35
+ 11 DE 97.210 97.250 97.210 0.040 15
+ 12 MR 96.960 97.010 96.960 0.040 16
+ 12 JN 96.730 96.770 96.720 0.030 16
+ 12 SE 96.520 96.570 96.490 0.050 14

Canadian Interest Rate Projections

The following are the projected 3-month interest rates, determined by the 3-month Bankers’ Acceptance Futures… note that these are quoted in 100 minus the percentage rate expected, so 97 would be equal to 3%. My gut instinct would suggest that the March and June contracts are slightly undervalued, but well within a margin of error. Essentially this is a bet on whether the Bank of Canada will stick by its conditional June 2010 deadline before it will consider raising interest rates:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 09 DE 99.560 99.565 99.565 0.000 5301
+ 10 JA 0.000 0.000 99.545 0.000 0
+ 10 FE 0.000 0.000 99.525 0.000 0
+ 10 MR 99.510 99.520 99.510 0.010 3909
+ 10 JN 99.330 99.340 99.330 0.000 13737
+ 10 SE 98.910 98.920 98.910 0.000 5674
+ 10 DE 98.450 98.490 98.470 0.050 2102
+ 11 MR 98.120 98.130 98.130 0.040 945
+ 11 JN 97.720 97.820 97.810 0.030 429
+ 11 SE 97.410 97.500 97.500 -0.010 150
+ 11 DE 97.090 97.190 97.260 -0.040 75
+ 12 MR 96.870 96.950 96.960 0.010 7
+ 12 JN 96.670 96.770 96.790 -0.020 46
+ 12 SE 96.550 96.650 96.690 -0.050 32