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9/10 Experts Confirm: Variable Rates are Now Safe

Just when you thought employment figures couldn't get any more interesting, the gods of the economy present two reports perfectly suited for those who favor lower interest rates.


Today's employment data, which is softer than expected, is causing North American bond yields to plummet. With the market's optimistic response to U.S. Treasury supply projections, it appears increasingly probable that yields have hit their peak.


Given the mounting economic decline and the rush of bond bulls away from 5% yields, one might feel inclined to take a bet on variables, as Bruce Buffer might say, "It's time!"


But before diving in, let's examine the latest employment clues:

This morning's Canadian jobs report disclosed...


  • Unemployment: Rose 5.7% (compared to the anticipated 5.6% and last month's 5.5%)

  • Job change: +17,500 (compared to the expected +22,500)

  • Average hourly wages: 4.8% (versus last month's 5.0%)

  • In summary: Unemployment rose once again, primarily due to the significant growth of our immigrant workforce by over 50,000 per month. Interestingly, the public sector has dominated job growth, akin to a vegan in a steakhouse. As for wage growth, it remains higher than a scorching Saharan summer, implying that the Bank of Canada won't be expressing any dovish sentiments anytime soon.

21 month high in unemployment

Interestingly, in Canada, a similar rule to the Sahm Rule indicates that if the 3-month average of unemployment increases by 60 basis points from the 12-month low, it signifies the onset of a recession. Currently, we are 57 basis points away from the low and this number is on the rise, indicating that it's time to prepare for potential economic turbulence. Tracing back to the mid-1970s, this rule has only yielded one incorrect prediction, which occurred in 2001.


Additionally, when unemployment gains momentum before a slowdown, there tend to be no significant retracements. (Considering this, proponents of lower interest rates hope that Trudeau pays attention to the Bank of Canada's advice and refrains from injecting more monetary stimulus in an attempt to "fix" the unemployment issue.)

Unemployment Rate
Unemployment Rate: courtesy of Capital Economics

Now, let's briefly examine the situation in our neighboring country:


  • Unemployment: Increased to 3.9% (compared to the anticipated 3.8% and last month's 3.8%)

  • Job change: +150,000 (compared to the expected +180,000)

  • Hourly wages: 4.1% (versus last month's 4.3%)

  • In summary: Previous employment figures were adjusted downward by 101,000, akin to realizing that you've lost the equivalent of a small city's worth of jobs that you had presumed were secure. Even after accounting for the impact of the strike, today's employment data appears weaker than a Wi-Fi signal in the Outback.

21-month high in U.S. unemployment

Market Response

2-yr yield vs. overnight target
2 Year Yield V.S. Overnight Target (Source: Refinitiv Eikon)

The movement in the 2-year yield, which is notably responsive to the policies of the Bank of Canada, suggests that the likelihood of rate hikes has significantly diminished. Currently at 4.45% (refer to the chart above), the 2-year Government of Canada (GoC) yield has reached its lowest point in 4.5 months, plummeting an impressive 61 basis points within a mere 12 trading days.


Furthermore, the 5-year yield is experiencing a noteworthy decline of 18 basis points today, a striking drop not witnessed since the banking scare in the United States back in March.


This notable yield reversal serves as strong evidence to bolster confidence in the theory of reaching the peak rate.


Moreover, the false surge to a new high last month increases the likelihood of a rate peak. The reason being that it trapped numerous leveraged shorts who are now compelled to repurchase bonds, consequently driving down yields.


Additionally, the consensus among our reliable economists in Bay Street is leaning heavily towards anticipating cuts in the upcoming actions of the Bank of Canada and the Federal Reserve. This time, their predictions are likely to be accurate.


How to approach it:

It's time to consider the variable option.


Certainly, it remains uncertain whether yields have reached their definitive peak. The realm of possibilities is wide open. However, the most recent indications, encompassing factors such as employment, GDP, leading indicators, consumer sentiment, yield fluctuations, and more, all point towards the likelihood of a peak surpassing the 50% mark.


Coupled with this is the robust historical outperformance of variable rates when the prime rate exceeds 2 or more standard deviations above its 5-year average, which is the current scenario. These factors collectively suggest, or rather strongly advocate, that opting for a variable rate is a prudent decision for qualified borrowers who are comfortable with market fluctuations.


Rate simulations affirm this perspective. Even in the scenario of an additional rate hike, the simulations continue to favor variable rates as the more beneficial choice.


But which variable rate option?

As mortgage professionals are aware, there are two variations of floating rates available:


Variable-rate mortgages (VRMs), with fixed payments unless specific triggers are activated.


Adjustable-rate mortgages (ARMs), where payments fluctuate in tandem with the prime rate.


Given the strain on family budgets, it's plausible that ARMs might capture more than the usual 20-25% market share during this cycle. This is primarily due to a large number of borrowers who are currently seeking relief from their mortgage payments. If the market predictions are accurate, individuals opting for ARMs could potentially witness a reduction in their payments next year.


This shift is anticipated to have a positive impact on mortgage finance companies (e.g., First National, MCAP, Merix, RMG, CMLS, RFA, Radius, Strive, etc.) and banks (e.g., Scotia, National, Tangerine & Equitable) that offer ARMs instead of VRMs.


Moreover, it's worth noting that some lenders continue to use the "variable" label for their adjustable-rate products, adding an additional layer of complexity to borrowers' decision-making process.


In Conclusion...

Navigating the current economic climate demands a strategic approach to mortgage options. With the likelihood of a peak rate in sight and the potential benefits of variable-rate mortgages and adjustable-rate mortgages becoming more pronounced, borrowers are urged to make informed decisions.


Considering the potential for payment relief and the market's inclination towards ARMs, borrowers should carefully evaluate their financial circumstances and risk tolerance. Whether it's exploring the offerings of mortgage finance companies or considering the products of renowned banks, understanding the nuances between VRMs and ARMs is crucial.


Therefore, before making a decision, it is imperative to consult with trusted mortgage advisors and thoroughly assess the terms and conditions of each option. By staying informed and proactive, borrowers can position themselves for financial stability and flexibility in the face of market fluctuations.


Make an informed choice today to secure a stable financial future tomorrow!

I invite you to reach out to me anytime to discuss the implications of a variable rate on your mortgage.

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