Analysts have revised their expectation for an interest rate cut following the result of the US presidential election.

Experts were talking of early 2018 for any change in the Bank of Canada rate but now believe that a cut could be required sooner if exports are affected by new White House policies according to a Reuters poll.

The Conference Board of Canada addressed the issue of the North American Free Trade Agreement, which President Trump has previously promised Americans he would renegotiated to get a better deal.

“Canada should be concerned about potential protectionist policies, but should not panic,” the Conference Board said, noting that it is not clear which comments made in the election campaign would translate into policy.

Canadian employment rose 44,000 (+0.2%) in October–much stronger than expected. But all of the gain was because of more part-time work, as full-time employment fell. The unemployment rate remained unchanged at 7.0% as more people joined the labour force. 

Compared to one year ago, the total number of hours worked was little changed and employment rose by 140,000 (+0.8%, mostly in part-time work (+124,000 or +3.6%). This will certainly keep the Bank of Canada from following the US Federal Reserve’s likely rate hike next month. Indeed, we cannot rule out the possibility of a BoC rate cut next year, although Governor Poloz would likely prefer to see fiscal stimulus do the heavy lifting, particularly given the concern about out-sized household debt levels. 

By industry sector, construction employment continued to enjoy gains, mostly in Ontario and Quebec–notably, not in BC. Manufacturing continued weak with payrolls down -0.4% last month and down -1.5% over the past year. Natural resource payrolls were up on the month, but still down a whopping -5.6% year-over-year, dragging down the overall goods producing sector of employment.

Job gains in the service sector were better, although still lacklustre. Leading the way in this sector last month were trade, educational services, and public and other services. 

Regionally, jobs were up in Ontario by 25,000 last month as the jobless rate fell two-tenths to 6.4%. In BC, employment rose by 15,000, but the unemployment rate increased 0.5 percentage points to 6.2% as more people entered the labour force. Nevertheless, BC still boasts the lowest jobless rate among the provinces. Year-over-year, job growth in BC was the strongest in the country at 2.4% (+56,000). Employment declined in Newfoundland and Labrador, taking the jobless rate up to 14.9%–the highest among the provinces (see table below).

Despite the strong headline number for employment growth, this report continues to reveal a Canadian economy that is underperforming. All of the gain was in part-time work, the manufacturing sector remains weak, and there is no indication of more than a modest pace of economic activity this year, in line with this week’s fiscal update. 

Although the headline payrolls gain of 161,000 missed estimates slightly, the jobless rate fell back to 4.9%–the cycle low–and most notably, wage gains accelerated to 2.8% year-over-year, their strongest pace since the financial crisis. The prior two months’ jobs gain was revised upward by 44,000, another piece of good news. Most would argue that despite the continued long-term underemployment of some workers, the US economy is at or near full employment. The strengthening wage growth is an indication of this, and it will boost the Fed’s already-high probability of hiking rates in December.

There remains a challenge to fill highly skilled jobs. Workers have been in short supply for 13 consecutive months, according to the Institute for Supply Management survey of service-industry companies, which make up almost 90% of the US economy. 

On the disappointing side, however, was the fall in the labour force participation rate and the weakness in manufacturing employment. The number of part-time workers and the long-term unemployed remain higher than before the last recession. These disaffected workers are an important component of the Trump base of support. The US underemployment rate dropped to 9.5% in October from 9.7%, while the number of people working involuntarily less than full-time remained unchanged. An estimated 5.89 million American employees were among this group. 

Expect a Fed rate hike in December–the first one this year. The Fed last increased the overnight fed funds rate in December of 2015, and many had expected additional rate hikes this year. These were postponed repeatedly owing to weaker-than-expected GDP growth and low inflation. US inflation has edged up recently and the Fed signaled strongly earlier this week that a rate hike is likely when they meet next month. 

Don’t blame TD for being the first to act, argues one veteran, but do expect further interruption to the industry that will make mortgages more expensive for the consumer.

“We’ve been talking about this in the mortgage world for a while now. All these mortgage changes affect the monolines; all these capital requirements require rate increases and there are going to be capital requirement changes on the insurers. “Finally, in the end, there is going to be risk sharing, which requires more capital requirements.  At the end of the day, all of the stuff requires higher rates.”

TD Bank was the first lender to act in response last month’s mortgage rules changes.

The bank announced in a note to brokers Tuesday that it was changing its mortgage rates, including increasing its mortgage prime rate to 2.85%.

And according to Butler, the other banks might follow suit.

“Starting in January, banks are going to be required to assign more capital to mortgages.  All these banks are going to be pushed in some sort of direction to raise rates because of these capital requirements on the hot marketplaces,” he said. “But this is their first step – [TD was] just putting this out there and praying that the other banks will go.”

Raising rates is a natural reaction to the recent changes, Butler argues, and the lenders shouldn’t be blamed for passing the expense onto customers.

After all, no successful business will just eat the cost and settle for less profit.

“This is the result of the government’s moves. The government is increasing capital requirements in different layers and different levels of the mortgage business. And by doing so, they require banks to raise rates,” Butler said. “Every business passes government regulation change onto the consumer. TD is doing this because they feel they have to; there is a logical reason behind it based on capital requirements and other banks may change or may not.

“My position is this was not a TD thing. It’s not like TD is going to grab more profit off this.”

In the wake of stricter federal mortgage rules intended to moderate the overworked pace of Canada’s real estate sector, Finance Minister Bill Morneau said that the government has no further plans to cool down the markets at the moment.

Speaking to reporters on October 28, Morneau assured the public that the ministry will remain watchful of how the market will evolve under the new conditions.

“We will remain on top of this because we know this is a very important risk to our economy,” Morneau said, as quoted by Reuters.

The Finance Minister added that he will work to buttress the economy from the worst effects of any future developments such as housing recessions or interest rate hikes.

“At the end of the day, I am ultimately responsible for supporting financial security, and the stability of our financial system,” Morneau stated.

Last month’s regulatory revisions—which featured, among others, the tightening of mortgage rules, the closing of a loophole on home sales, and the implementation of a new risk-sharing model for major lenders—proved divisive among observers and market players.

Former TD Bank president/CEO Ed Clark argued that the changes are exactly what the Canadian economy needed to maintain its stability over the long term, while the Bank of Canada warned that the national economy will experience slight declines in output amid lower home sales numbers.

Broker fears were confirmed Tuesday, with one big bank raising its prime rate less than a month following new mortgage rules.

TD Canada Trust announced in a note to brokers Tuesday that it is changing its mortgage rates, including increasing its mortgage prime rate to 2.85%.

The prime rate has been held at 2.70% for more than a year, according to the broker who shared the announcement with MortgageBrokerNews.ca on condition of anonymity.

“When a bank changes their ‘version’ of bank prime it also serves as an invitation for the other banks to join in and do the same,” the broker said. “Naturally if they all change the public is screwed and all the banks make more profit.

“You see by effectively changing the goal posts on the rate the bank can continue to say: ‘we are prime less 0.50% which is a good deal.’  So as you can see this a clever move if it works.”

The announcement also confirms what one economist speculated – that big banks could influence the market by altering posted rates.

The new mortgage rate stress test, which forces all holders of insured mortgages to qualify at the Bank of Canada’s benchmark five-year rate.

The Bank of Canada’s benchmark rate is closely tied to big bank posted rates. And that relationship could allow lenders to tinker with their posted rates in a bid to influence the BoC’s, thereby allowing them to also influence the ease with which homebuyers can qualify for an insured mortgage.

“Another possible solution is that posted rates could fall, reducing the impacts of the stress tests. Since they are not set by the market, lenders could decide to lower them if, for example, they find that they are saying “no” to too much good business,” Will Dunning, chief economist of Mortgage Professionals Canada, wrote in a research paper entitled Slamming on the Brakes: Assessing the Impact of Changed Criteria for Mortgage Qualification. “The posted rates are set administratively by the lenders, based on their assessments of what is in their best interests, and their assessments could change.”

The new mortgage rules are certain to result in a slowdown in the Quebec housing market, the body representing the province’s real estate boards says.

The Quebec Federation of Real Estate Boards (QFREB) has significantly downgraded its market outlook for 2017 and says the short-to-medium-term impact of Ottawa’s rules are definite.

“The impact on the number of sales will be, at a minimum, as great as the 2012 tightening of the mortgage rules which reduced the maximum amortization period from 30 to 25 years,” explained Paul Cardinal, Manager of the QFREB’s Market Analysis Department.

The Federation also believes there is a real risk to home prices in the province which would likely result in a negative impact on consumer confidence.

The mortgage stress test will particularly hit first-time buyers, the Federation says, while the risk-sharing rule will mean higher mortgage rates.

A hodgepodge of factors contributed to the current state of Canadian real estate, which has seen an increasing number of affordability refugees fleeing from the hottest markets.

Bank of Nova Scotia vice president of economics Derek Holt stated that a combination of record-low interest rates and careless federal-level actions has led to unprecedented amounts of household debt and a price-growth juggernaut that now has the Liberal government “scrambling to undo it.”

“The rule shifts contributed, as did the long-term decline in rates both through global bond markets and Bank of Canada actions, among other factors,” Holt wrote in his report, as quoted by The Globe and Mail.

Holt added that any moderating effects of stricter federal and provincial policies have been offset by rock-bottom fixed and variable mortgage rates. The analyst further argued that B.C.’s 15 per cent tax on foreign buyers is emblematic of the simplistic approach that Canadian governments take in addressing the affordability crisis.

Such measures since 2008 “did not derail housing or mortgage markets,” Holt said. “Amidst endless fear mongering, tighter rules still gave way to record high household debt and house prices.”

“Much of that was because of the offset from lower interest rates, and here we are once again talking about the possibility that the Bank of Canada could cut rates and further feed market household imbalances assuming – as I do – that the mortgage book is still rate sensitive.”

One of Canada’s largest banks has opined on the impact the portfolio insurance changes will have on mortgage rates.

Starting November 30, lenders will only be allowed to purchase portfolio insurance for loans that cost less than $1 million, are owner occupied, have an amortization period no longer than 25 years, among other stipulations.

This could mean higher mortgage rates, according to TD Bank, which laid out three scenarios that could come to pass as a result of the rule change in its latest report, entitled New Mortgage Rules to Reinforce Soft Landing in Canadian Housing.

Lenders pass the higher cost of funds onto consumers in the form of higher mortgage rates. Under this scenario, mortgage interest rates could rise up to the full amount of 30 to 40 basis points.

Lenders absorb the higher cost of funds due to competition.

Lenders become more stringent on approval guidelines in order to continue to take advantage of the cost savings offered by portfolio insurance. As such, borrowers could potentially be held to a maximum amortization period of 25 years. 

Portfolio insurance helps lenders reduce the cost of raising capital and all monoline lenders utilize it to compete with the big banks.

And portfolio insurance is becoming more ubiquitous.

“Portfolio insurance accounted for 20% of all new mortgage insurance put in force with CMHC in the first half of 2015, but accounted for 40% during the second quarter of this year,” TD Bank said. “In particular, the increased use of portfolio insurance has helped alternative lenders offer competitive pricing on mortgages.”

The governor of the Bank of Canada spoke of the risk to the economy from the high level of household debts and the rising cost of homes when he announced a hold-steady on interest rates Wednesday.

Stephen Poloz said that the bank came close to making a further cut in interest rates but decided that additional stimulus was not required right now with other macroeconomic measures in play.

He referenced the federal government’s newly introduced rules on mortgages which he called a “welcome development” that should “mitigate financial vulnerabilities over time.”

The governor said that housing sales are expected to be reduced in the near term due to the new rules and that it may spur construction of smaller homes.

Although he did not rule out a further cut in interest rates down the line, especially as the bank’s outlook for the economy has been revised down for the coming two years; but he said that the balance of risk is still within the scope of current monetary policy.

It is no surprise to anyone that the Bank of Canada maintained its target overnight rate at 1/2 percent today, judging that the underlying trend in total CPI inflation will edge upward to 2 percent starting early next year. Temporary offsetting factors, such as the fall in commodity prices and the decline in the loonie are dissipating. Slack in the Canadian economy will continue to put downward pressure on inflation. The risks to the inflation outlook are deemed to be roughly balanced.

Consistent with private-sector economists’ expectations, the Bank is expecting a strong rebound the second half of this year as the negative effects of the oil production cuts and the wildfires conclude. Consumer spending in the second half will be boosted by the July introduction of the Child Benefit, government infrastructure spending and accommodative monetary and financial conditions. The non-resource sector in Canada is growing solidly, particularly in the service sector and business investment continues to underperform.

As widely expected, the Bank once again cut its growth forecast for the Canadian economy. The central bank has been repeatedly disappointed by the poor performance of Canadian exports, hoping that the decline in the Canadian dollar since oil prices plunged in mid-2014 would boost manufacturing exports. While recent export data are improving, the bank has revised down its growth expectation for exports in 2017 and 2018 owing to lower estimates of global demand and the “composition of US growth that appears less favourable to Canadian exports, and ongoing competitiveness challenges for Canadian firms.” The US economy is forecast to strengthen from a very weak first half reflecting strong consumer spending boosted by rising employment and strong consumer confidence. Business investment, however, will remain anemic, as evidenced not just in the US and Canada, but globally as well.

Growth this year in Canada was revised down to 1.1 percent (from 1.3 percent in July). As well, 2017 growth is now expected to be 2.0 percent (down from 2.2 percent). For 2018, the growth forecast remains at 2.1 percent. The Bank now believes the economy will reach full capacity utilization around mid-2018, significantly later than earlier expected.

 Housing Slowdown Highlighted

The Bank attributed the downward revision to the economic outlook in large measure to the federal government’s new initiatives “to promote stability in Canada’s housing market”. The Bank of Canada reported that these measures are “likely to restrain residential investment while dampening household vulnerabilities.”

According to today’s newly released Monetary Policy Report, the housing initiatives will dampen this year’s GDP growth by 10 basis points and by 30 basis points next year. Government sources say they expect the growth in housing resales to decline 8 percentage points in 2017 from the forecasted 6.0 percent growth pace this year. Private estimates of the negative impact of the new housing measures on overall economic growth vary, but most expect the contractionary effect to be roughly a 30-to-50 basis point reduction in growth over the next twelve months. Given that baseline potential growth is less than 2 percent, this is a very material dampener.

Many are speculating that the new federal housing initiatives open the door to BoC rate cuts next year. Clearly, Governor Poloz sees the enhanced mortgage stress tests as mitigating his concerns of overextended homebuyers–forcing all buyers to qualify at the posted mortgage rate, well above current contract rates. Nevertheless, I believe it would take a material negative shock to growth for the Bank to cut rates. That shock might come  from a larger-than-expected contraction in housing activity among other sources.