Fixed Rates: Up Big... For Now

The Bank of Canada raised interest rates by .25% last week, but the real action has been with the increase in the fixed interest rates, which have gone up by as much as .80%.

From the last Bank of Canada meeting, it was quite evident that the Bank intends on raising the interest rates further and it's not clear on when it might stop.  

The bond market has reacted accordingly.  Following the meeting fixed interest rates have started to increase for all terms.  For example, 3-year fixed rates have risen by .80% at some lenders.  The increases started a few weeks before the Bank's meeting and have conitnued in the week since.  

Instead of moving in lockstep with the Bank of Canada's rates, the fixed rate terms are much more volatile, and can have big swings within a matter of weeks.  Fixed rates are determined based on projections of future Bank of Canada interest rates, rather than the current policy.  The current belief is that the Bank of Canada's policy rate will need to be higher for longer than initially predicted, and this is pushing fixed interest rates higher than we've seen in a very long time.  

A popular narrative about six weeks ago was that the Bank of Canada would consider decreasing the policy rate by the end of 2023.  That idea has been squashed, and the prospect of a near-term rate decrease seems far fetched.  I don't think we will see a rate decrease from the Bank of Canada until the second half of 2024.  

The next swing in fixed interest rates will largely depend on the market's confidence that the Bank of Canada rate will keep rates high.  The Bank is working hard at confirming that it will keep rates high for as long as needed to bring inflation back down to the 2% target.  Since the fixed rates are largely based on predictions and speculation, I expect that news of a slowing economy in Canada and the US will bring the short term interest rates down again.  

When we look at the different parts of the economy that are sensitive to changes in interest rates, like manufacturing, construction, real estate, financial services, retail, and wholesale sectors, we see that they didn't do so well in March. They actually shrank by 0.3 percent compared to the previous month. And this has been happening quite often recently, with 11 out of the past 12 months showing either no growth or a decrease in these areas. Last year, around this time, there was a positive trend of one percent, but now it has swung the other way and is at minus 1.5 percent, which is the lowest it has been since June 2020.

It seems like this data is being ignored in favour of more headline grabbing statistics like the housing market recovery and consumer purchases.  

My original prediction was that the Bank of Canada would not be raising rates in June or July this year, but instead continue to talk the economy down and threaten to keep rates higher.  I believe this would have been the right approach considering that the previous interest rate hikes are still working their way through the economy.  I believe that the Bank has already surpassed the "goldilocks" rate of a balanced economy, which will become evident before the end of 2023, as we stare down a deeper recession than necessary.  

If more of these factors start to become evident over the next few weeks and months, expect fixed rates to come back down to earth in anticipation of the Bank of Canada lowering the policy rate.