American Rate Changes Impact Canada

Category: First Time Buyer,

**I wrote this part before the SVB bank (plus others) collapse of from March 9-10. I’m not sure how this situation will play out yet. It’s entirely possible that we’re looking at no rate hikes in the States. All that being said, the information below is still relevant, but we may not see any rate hikes in the near term in the States if negative financial contagion creeps in.

There has been quite a bit of commentary in Canada about the labour market (tight = wage growth = inflation) and on the CPI price appreciation (household goods costing more = inflation), and what Canada can do fiscally and monetarily to curb this inflation. But, there hasn’t been too much chatter about what is happening below the border… until now!

It’s extremely important to talk about the States and the Federal Reserve (The US Bank of Canada equivalent), specifically due to how their rates affect ours, and why.

As an aside, American interest rate changes do not have the same impact on the US economy as changes in Canadian rates to the Canadian economy.

You may not know this but American mortgages have equal term and amortization lengths. If you get a 25 year mortgage in the States, you don’t have to renew (ever) because your rate is locked for 25 years! You can expect to have the same payment through the entire amortization of your mortgage (unless you get a whole new mortgage).
 In Canada, on the other hand, mortgage terms are, on average, 5 years long.

So, in comparing American to Canadian mortgages, approximately 20% of Canadian mortgages renew each year, whereas in the States, borrowers don’t *have* to change their mortgage unless they buy a new home or refinance. If 20% of Canadian mortgages renew each year, 20% of
Canadian mortgage holders have seen their payments go up by up to two times or more! No wonder changes in the Canadian overnight rate is more effective than changes in the American overnight rate…

Last week, the United States’ Jerome Power, the Federal Reserve Chairman, stated that America is looking to increase the pace and size of interest rate hikes to combat inflation. Recent data was “stronger than expected.” At this time, the market (traders) is pricing in another 1% increase in the US Prime rate by July. Wow and oh no…

Because of the potential for rate increases, the US dollar increased more than 1% against other currencies. 

Why is this an issue?

OK, so Canada… Canada and the US have different inflationary pressures and yes, what happens in the US does trickle down to what happens in Canada. However, sometimes things happen directly, and sometimes the pressures from the States happen less directly. In the case of interest rate hikes by the US, it’s a direct effect.

Here’s what will happen:
1. The US increases rates much higher than the Canadian central bank rates.

2. There will be an outflow of money from Canada to the US
(Investors will seek higher returns and higher rates = higher returns)

3. Demand for the Canadian dollar will decrease.

4. The Canadian dollar will decrease in value.

5. Our
imports from the States will be more expensive. And we import a LOT. 
This will cause further inflation on consumer goods.

6. Our
exports to the States will be cheaper for Americans. 
Our exports are large ticket items from large corporations (see crude oil and cars).
This will cause inflation on corporate profits and wages.

*In 2020, Canada exported $270B to the US and the US exported $255B to Canada.

Long story short,
Canada may be forced to increase the overnight rate in lockstep with the United States due to how a disparity in rates can affect the currency markets.

We are not isolated from the US and even if our fundamentals show that an increase in rates is not required, the fact that the US continues to increase rates might require Canada to follow suit.

Food for thought… I’ll have some ice cream… maybe it’ll make me feel better about potential rate increases.

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