Long Term vs ARM? What to advise our clients.

Benjamin Tal updates brokers on interest rates and stresses the importance of staying current on rapidly changing events.

Variable rate mortgages currently make up only about 20% of the Canadian market. We’ve seen a significant shift towards fixed in the past year or so, but now consumers are going back to variable because Prime is falling. I suspect this move to variable will continue for the next few months, but it will be short-lived.

If the Bank of Canada rate is going to fall by another 50 bp, it will happen within the next few months. But that doesn’t mean the 5 year rate will also fall by that much.

Remember, the bond market is already expecting this much of a cut in Prime and is discounting the 5 year rate based on that expectation. So while Prime may drop in the next few months, the 5 year rate will likely be relatively stable or slightly lower.

At some point—and it’s getting closer—we’ll see a situation in which going variable may no longer be the best approach. By cutting rates very aggressively now, the Bank of Canada is planting the seeds for inflation down the road. By the end of the year, it’s possible that we’ll see a significant correction in the bond market as the economy improves and inflation rises. If this happens, spreads will go back to normal and the 5 year rate will actually rise.

Paying close attention to developments at this point is much more critical than at any time in recent history. A few years ago we could predict that short term rates were falling, so taking a variable rate mortgage was the right thing to do. Now, we know that inflation may start rising and therefore the 5 year rate will start rising at some point. But that can happen even earlier than we expect.

Clients need to be aware that while the 5 year rate is currently attractive, it can change quickly. Rates could rise by as much as 75-100 bp in 2009. It’s very difficult to predict. But clients need to understand this risk.

Speculation the loonie may fly higher

May 24, 2008 Julian Beltrame The Canadian Press

Is the Canadian loonie preparing to take flight again?

While betting on the up and down movements of a currency is risky, some economists are beginning to move off their bearish outlook for the Canadian dollar and contemplating that the loonie may be readying a move to higher ground, well above parity.

"One could make the case that the loonie is undervalued at today's oil prices,'' says Bank of Montreal deputy chief economist Douglas Porter. "Partly, this likely reflects the fact that the foreign exchange market, for one, simply doesn't believe today's oil prices will last.

"Another factor may have also been that the Bank of Canada may cut (interest rates) further, but the U.S. Federal Reserve looks done,'' he added.

For several years, the Canadian dollar has generally moved in tandem with prices of commodities Canada has in abundance, particularly oil.

But the Canadian dollar hasn't gathered much strength during the surge from $95 US oil at the end of 2007, Porter noted. It only moved past parity with the U.S. currency when oil cracked the $130 level this week.

A good sign for the loonie's prospects was Scotiabank's commodities report Thursday that forecast crude oil prices in the $135 to $140 range for the rest of the decade, based on a shortage of new non-OPEC production and rising demand from emerging economies in Asia.

Scotiabank currency analyst Stephen Malyon said the bank is forecasting the loonie to finish the year at $1.01 US and 2009 at $1.06, but said it will likely revise the forecast upward next week on the growing perception that high oil and high commodity prices are here to stay.

"I think the Canadian dollar has a lot of things going for it, from a structurally sound economy, and the fact we're a commodity exporter amid a cyclical bull market in commodities,'' he said.

Of course, there are other factors that have come into play in the relative pricing of the loonie.

The Canadian dollar is directly impacted by the interest rate spread between Canada and United States and was lifted last fall when the Fed moved aggressively to cut rates in expectation of a serious economic slowdown.

As important is recent language coming from both central banks which suggests the Fed is heading for the sidelines, while the Canadian bank remains on an easing trend.

There is also the relative purchasing power of both currencies, which suggests that the loonie remains the weaker sister.

Better deals ahead expected for Canadian home buyers

New listings at record high

Alia McMullen, Financial Post Published: Saturday, May 24, 2008

Canada's housing market might still be expensive, but sellers are going to lose some of their negotiating power over the course of the year as housing supply floods onto the market.

The number of homes for sale in April was double that of the number that were sold as new listings reached a record high, the Canadian Real Estate Association's monthly Multiple Listing Service figures showed.

Residential listings for April jumped 2.8% from the previous month to a seasonally adjusted 77,248 units, while home sales rose 1.2% to 36,614 units. It was the first time monthly sales had increased this year.

The rise in supply, which comes on the back of years of under supply, caused house price growth to continue to moderate from recent highs. The national average house price was up 4% from a year earlier to $317,619-- the smallest annual gain in six years.

"Price increases are now maintaining at levels that are historically more consistent with the Canadian real estate market," Calvin Lindber, president of CREA said.

British Columbia remained the most expensive province, with the average house price up 10.7% over the year to $478,004, followed by Alberta, which fell 0.5% to $353,515. Prices rose 4.8% in Ontario to $314,041 and 4.3% in Quebec to $217,683. Prince Edward Island was the cheapest province, following a 9.8% annual decline to an average $121,807.

Amy Goldbloom, economist at RBC Financial Group said the latest results reflected the mid-point of a balanced housing market that was likely to soften gradually this year.

"As we see more supply coming to market, sellers are going to certainly lose some of their negotiating power, so the bidding wars that we've seen over the last couple of years, particularly in markets like the core area of Toronto, they're going to certainly slow," Ms. Goldbloom said.

She said there would be better opportunities for buyers as supply increases amid cheaper finance as a result of recent interest rate cuts. However, the market generally remained expensive and sales would likely continue to slow.

"The hit to affordability has certainly taken a toll on sales. People have simply been priced out of the market and that's become very evident in overheated markets in Calgary and Edmonton," Ms. Goldbloom said.

Although new listings in Calgary and Edmonton declined in April after posting record levels in March.

Derek Holt, economist at Scotia Capital said the ratio of listings to sales in Calgary and Edmonton had declined rapidly since last fall, dropping from about 90% to 40%.

"That speed of adjustment abruptly turned it away from a deep sellers market towards a marginal buyers market, so that's why they've seen prices come off their peak and why we think that they face a further housing correction in Alberta," he said.

Mr. Holt said while supply was expected to continue to enter the market, Canada would not experience the inventory overhang plaguing the U. S. housing sector.

He said Canada has not experienced the same factors that have driven the excess in U. S. supply, including the flood of foreclosed properties that have entered the market.