5 reasons Canadians should care what the Fed does tomorrow: Don Pittis
U.S. interest rate 'patience' can be a virtue for the Canadian dollar and mortgages
Expect a change in tone from the world's most powerful central banker tomorrow when U.S. Federal Reserve chair Jerome Powell offers his latest outlook on interest rates.
Powell has instituted a new system where he will give a news conference after every policy meeting, providing better insight into his thinking month to month.
Analysts are expecting that a gloomier economic outlook means the Fed will hold off on interest rate increases, continuing to be "patient and flexible" on new rate hikes.
But the Fed's reaction to renewed fears of a global recession could turn out to be good for Canadians. Here are some reasons why.
1. Stronger loonie
Market indicators are telling us that the chance of the Fed chair announcing a rate hike Wednesday is now pretty much zero.
But there is some chance Powell could do more to stimulate the economy, including dropping hints that the pace of future rate hikes will be more moderate.
The growing differential between the Canadian and U.S. interest rate is one factor keeping the loonie soft.
If currency traders foresee a narrower gap between the two rates, the Canadian dollar should remain stronger than if the spread continued to widen — making imports cheaper and winter beach holiday spending go further.
2. Higher wages
In both Canada and the U.S., there are early signs that a labour shortage is beginning to push wages higher. Industries in many places have complained that even unskilled workers are unavailable at current wages.
Most economists seem to think U.S. rates are still low enough to keep stimulating the economy. That means profitable businesses can still afford to borrow and expand, increasing demand for workers that are in short supply.
With the porous Canada-U.S. border, rising wages in the U.S. can flow through to Canada, as Canadian workers take up the slack created by U.S. shortages.
3. Increased inflation
Holding off on a U.S rate hike could well let a little more inflation creep into the economy.
Usually we think of inflation as a bad thing, because the prices of the things we buy go up. But there are a number of reasons why inflation can be good for Canadians, especially if wages keep pace with prices.
For one thing, higher inflation reduces the risk of deflation — falling prices — that many economists say discourages people from spending or from borrowing to invest.
Inflation reduces the amount heavily borrowed Canadians must pay back, because while the total debt is the same, you are paying it back in dollars that are worth less than your rising salary. On the other hand, people with cash assets lose, and inflation causes a small transfer of wealth from savers to borrowers and net spenders.
4. Lower mortgage costs
While the Bank of Canada benchmark rate — set by our own central banker Stephen Poloz — has an immediate effect on variable-rate consumer loans and mortgages, mortgages that are locked in for a longer period are more directly determined by international bond markets.
Generally, for a five-year fixed mortgage, lenders make their calculations based on what money is earning over a five-year period in New York — and those rates are, in turn, based on the Fed rate.
Lower five-year rates are reassuring to homebuyers who have been worried by previous Fed predictions that rates would be rising sharply. That means expectations of a slower path for U.S. interest rate hikes could help to stabilize the Canadian market for new and resale housing.
5. Higher stock markets
At the end of last year, as stock prices were falling, a lot of market watchers, including U.S. President Donald Trump, blamed Powell for raising interest rates more quickly than necessary.
While keeping markets from falling is not officially part of the Fed's mandate, a plunging market could hurt jobs and prevent the U.S. central bank from hitting its two per cent inflation target — two things that are part of its mandate.
A "dovish" tone — one that seems to expect rates to stay lower for longer — might boost share markets.
Ending the gradual and predictable process of unloading those bonds would, in theory, add a little more stimulus to the economy. But Powell may be reluctant to interfere with a system that has been working well ever since it was put in place by his predecessor Janet Yellen 16 months ago.
Follow Don on Twitter via @don_pittis