Some Canadian lenders have started to drop their interest rates on five-year mortgages as the U.S. and Canada’s central bank chiefs present differing positions on cuts.

For the first time since May 2023, some rates have fallen below 5%, which is the Bank of Canada’s overnight rate. Most fixed-rate mortgages are tied to five-year bonds, so the two tend to rise and fall in sync with each other.

Bond yields have dropped recently as Canada’s inflation rate remained at 3.1% year-over-year between October and November.

“We are seeing rates in the high fours, around 4.99%, for five-year insured fixed rates, and roughly 5.59% for uninsured,” Victor Tran, a Ratesdotca mortgage and real estate specialist, told The Toronto Star. “We haven’t seen fixed rates this low since the spring. If bond yields continue to dip, we may see lenders lowering rates more in the coming weeks.”

Since the end of October, 10-year Canadian bond yields have fallen by 95 basis points, representing a “big fall,” Royce Mendes, managing director and head of macro strategy at Desjardins, told the Star.

The drop, he added, can be attributed to decelerating inflation and more dovish commentary regarding rate hikes from BoC Governor Tiff Macklem and U.S. Federal Reserve boss Jerome Powell.

“Anyone with a mortgage up for renewal is, no doubt, pleased to see mortgage rates falling,” Mendes told the Star. “Assuming further progress on taming inflation in the new year, it’s likely that bond yields, and by extension mortgage rates, continue on this downward trajectory. That said, progress rarely occurs in a straight line and there are likely to be some temporary increases in yields along the way.”

The sub-5% interest-rate offerings have come from smaller lenders rather than big banks, who are maintaining their rates at least for now.

It is unusual for lenders to offer rates below prime, but some lenders have done so occasionally for buyers that they deem to be qualified. The lenders’ moves appear to indicate that the market expects rates to fall much lower than the BoC and Fed are forecasting.

The BoC held its overnight rate at 5% on December 6 and commercial banks started offering lower rates immediately afterward, The Globe and Mail reported. Macklem said recently that it’s too early to curb hikes as the central bank continues its quest to cool demand and return inflation to its 2% target.

But this week, the BoC released a summary of its governing council’s deliberations leading up to the December 6 rate hold. The summary says that the central bank’s monetary policy rate is “sufficiently restrictive to restore price stability.”

Officials found that federal data on national economic accounts, the labour force and consumer price index “indicated that monetary policy was working as expected to slow economic activity and ease inflationary pressures.”

However, inflation remained too high for officials’ liking and they want to see a further and sustained decline in core inflation.

“Members agreed that the likelihood that monetary policy was sufficiently restrictive to achieve the inflation target had increased,” states the summary. “But they also agreed that risks to the inflation outlook remained, and it may still be necessary to increase the policy rate to secure further disinflation and restore price stability.”

While the BoC tries to give an appearance of a hard-line stance on rate hikes, the U.S. Federal Reserve’s Federal Open Market Committee appears to have softened its position. At its latest meeting the FOMC, which includes Powell and regional reserve bank presidents, agreed to keep its overnight interest rate in 5.25% to 5.5% range.

The FOMC’s latest policy statement in wake of the decision says that officials will consider the extent of “any” additional policy firming that’s needed. The FOMC also acknowledged that “inflation has eased over the past year but remains elevated,” and that economic growth has slowed from the third quarter’s “strong pace.”  

Additionally, median projections for inflation ticked down in 2024 and 2025, while unemployment forecasts are little changed, indicating Fed officials’ growing confidence that they can cool price gains without big job losses.

The Fed’s Summary of Economic Projections (SEP) is calling for three rate cuts next year, up from two cuts in the September SEP.

The market, however, has turned even more dovish, pricing in 100 to 125 basis points (bps) of rate cuts next year, up from 75 bps at the November FOMC meeting.

In the past, the market has maintained an old mantra: Don’t fight the Fed. But it appears the Fed’s new mantra is: Don’t fight the market.

The reaction has not been a surprise as equities continue to rally and bond yields decline as the Fed seems to be moving more in the market’s direction — a situation that potentially widens the path to a soft landing and keeps the Goldilocks narrative (an economy that is just right) alive.

However, in recent days, a number of Fed officials have pushed back on the number of anticipated interest-rate cuts coming in 2024. Chicago Fed President Austan Goolsbee told CNBC that he was surprised by the outsize market reaction to the Fed’s updated quarterly economic projections. And, according to Financial Times and Wall Street Journal reports, Cleveland Fed President Loretta Mester and San Francisco Fed counterpart Mary Daly have warned that rate-cut expectations for early next year were premature.

But, on both sides of the border, the market does not appear to be buying central bank officials’ comments.

“While FOMC members are increasingly moving forward the start of rate cuts, markets are a few steps ahead,” wrote TD Economics analysts in a recent note. “The Fed’s forecast implies that rate cuts would start in the fall of 2024 (assuming 25 bps cuts in consecutive meetings), while market odds are pointing to cuts happening in the spring. We are in the middle of these two views.

“While we think that cuts should come earlier than the Fed foresees, it will take more time for the economy to cool enough to justify a cut in early May.”

Despite Macklem’s recent comments about holding off on cuts, the BoC will be quicker to offer rate reductions, the TD Economics analysts predict.

“In the fight to outstrip expectations this year, the U.S. economy won by a wide margin,” said the analysts in a separate recent note. “But, the tailwinds that drove above-trend growth will die down next year. That, combined with 2% inflation within the Federal Reserve’s sights, should produce rate cuts in the second half of the year as the central bank tries to pull off the elusive soft landing.

“With Canada’s economy already sputtering, the Bank of Canada will be out in front in cutting rates, likely in the spring. Recession risks are higher north of the border, with a bumpier landing in store.”

As investment decisions loom in early 2024, interest rates remain top of mind with commercial real estate investors, particularly those in Canada, as they look forward to getting off the sidelines following a prolonged stay. Although the Canadian and U.S. central bank chiefs appear to have diverging views on rate cuts, it appears likely that BoC and Fed policies will meet in the middle.

The BoC will have to turn more dovish, and the Fed will become less dovish. Fed officials likely will not hike rates, but they will continue to stress that rate cuts are not coming as quickly as the market anticipates them to.

Meanwhile, the market, will strive to chart its own path.

— With files from Joe Palmisano

(Photo: Bank of Canada Governor Tiff Macklem)