Getting Past the Next Three Months

• The bad news: COVID cases have exploded, hospitalization numbers are surging and most people may be slow to get vaccinated.
• The good news: the fatality rate is dropping and vaccine distribution could start next month.
• The question is, which news will the bond market pay more attention to? Our guess is the latter.
• Black swans aside, markets often discount major economic trend shifts over a year in advance. While we may see rate volatility near-term, investors will ultimately look past the short-term rising death toll, knowing things will improve in 2021. Rate predictions and 5 cents will get you 5 cents, but vaccines, a steepening yield curve and ongoing government support do suggest that 5-year yields are at or near their bottom.

Inflation Watch

• Above-target inflation drives mortgage rates higher. But central banks are telling borrowers not to fret until core inflation runs above the 2% mid-point target. The experts don’t expect that for months. The key word being “expect.”
• A handful of prominent investors, like Stan Druckenmiller, have made headlines projecting that inflation could overshoot the 2% target by a long shot. Why? He and others say investors aren’t paying enough attention to:
  • Astronomical government spending
  • Deglobalization
  • Pandemic/trade-related supply bottlenecks.
  • Record savings (much of which will be spent in 2021).
  • Firming commodity prices.
• Institutional rate analysts are also on alert. In the bond market, “the inflation risk premium has risen to around a five-year high,” Bank of America says. Capital Economics adds: “an upside risk for core inflation is brewing given the relatively strong recovery so far in the labour market.” It projects “the economic recovery will far outperform consensus expectations.” TD also reports that “price growth is likely to continue to edge up…”
• Meanwhile, not a single economist surveyed by Bloomberg thinks Canadian inflation will exceed 2% next year. “…Eventually, what is likely to dominate is the weakness in demand,” BofA concedes. And with lingering unemployment from structural economic damage, wage inflation seems far-fetched in the short- to medium-term.
• The Fed itself projects no rate hikes until 2023, until inflation is “modestly” above 2%. But it has been quick to remind people that this is not “an unconditional commitment.” Many economists don’t expect consistent 2% inflation for at least 2-3 years. In fact, only three of 55 economists surveyed by Bloomberg currently predict core U.S. inflation will exceed 2.1% next year.
• All that said, almost no one seems worried about inflation risk, and in financial markets, when nobody seems worried, that’s when we worry. It’s unlikely that inflation will soar in the next five years. That’s a fact. But inflation doesn’t need to skyrocket for mortgage rates to pop 100+ basis points. That’s why managing rate risk with a fair-penalty 5-year fixed remains a valid play for the majority.

BMO Update

• Curiously, BMO pulled its 5-year fixed rate specials this week.
• It has added the following special fixed rates:
  • 4yr (high ratio): 1.94%
  • 4yr (conventional): 2.09%

The 40-year-old (Homeowner) Virgin

• Even his half-million-dollar action figure collection wouldn’t be enough to buy Andy Stitzer an average Toronto home. Chronic price escalation is making our youth wait longer and longer to consummate their first purchase. That story…