The Greater Canadian mortgage renewal cliff was largely overblown, according to the country’s largest bank. In its latest research note, RBC states that aggressive easing means that not all households will renew at higher rates, and the impact will be smaller than anticipated. They warn that doesn’t mean we’re in the clear, as a much larger risk is forming—rising unemployment and a generally weak labor market.
Canada’s Mortgage Renewals Cliff Is More Like Stepping Off A Curb
Canadian households won’t experience the rate renewal armageddon that many feared. The global rate hike cycle saw the BoC hike at one of the fastest paces on record, rising from 0.25 points to 5.0% over a little more than two years. This created fear of a “mortgage renewal cliff”—people who were enticed by record low borrowing costs would renew at a much higher rate.
Now it’s being reversed at a similar rate, leading RBC to believe this fear is now overblown. The easing cycle kicked off about 4 months ago, and the BoC has already cut 0.75 points from its policy rate, bringing it down to 4.25% as of today. By the end of the month, experts see the central bank cutting another 0.5 points, returning the policy rates back to post-Great Recession-levels. That’s going to provide signifcant relief for those with variable rate mortgages.
Fixed rate mortgages aren’t directly impacted by rate cuts, they move with government bond yields. Luckily, those are also falling—in some cases faster than the overnight rate. The bank notes the 5-year government bond yield has fallen sharply, bringing down the cost of the 5-year fixed rate mortgage. However, the biggest shift is for two year bonds, which influence 1 to 3 year fixed rate mortgages. These borrowers went from risk of a mortgage renewal shock to likely seeing their costs fall at the next renewal.
“A large chunk of one to three-year mortgages will likely renew at lower interest rates and variable rate mortgage holders are already seeing some relief—either from lower debt payments (for variable rate, variable payment mortgages) or lower interest costs and larger principal payments (for variable rate fixed payment mortgages),” explains Nathan Janzen, assistant chief economist at RBC.
Source: RBC.
Janzen notes that payments will still rise for 4 and 5-year fixed-rate mortgage renewals. He warns the risk for these households experiencing some form of shock still exists. However, it’s much smaller risk than previously anticipated.
At the macro level, the shock will be virtually non-existent. RBC’s forecast now sees the renewal cliff shedding just 0.1 points of disposable income for households. To be blunt, it went from an economic risk, to a rounding error at the national level.
Canada’s Rising Unemployment Is Turning Into A Much Bigger Risk
The bank warns that we’re not in the clear yet. Another, more significant risk has since emerged—the labor market. Janzen’s research estimates that a 1 point rise to the unemployment rate lowers household disposable income by 0.5%. That’s 5x greater than the mortgage renewal shock is expected to deliver.
Their current forecast has the unemployment rate hitting 7% by early 2025. “That’s a significant increase and more than a percentage point above pre-pandemic levels. But, we’re watching for deterioration that might extend beyond that,” explains Janzen.
Source: RBC.
Job vacancies will play a major role in how their forecast evolves over the next few months. RBC’s base case assumes job vacanancies hold the current level of decline of 25% from last year. If this worsens in the coming months, that would have a much bigger impact.
“Initially, there were more job vacancies than people looking for work, so the drop in openings didn’t have a material impact on the economy. But, that’s no longer the case,” explained Jansen.
Adding, “The unemployment rate is now above pre-pandemic levels, and the job vacancy rate is lower. Any further drop in hiring demand raises the risk of the unemployment rate rising more.”
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