by Robert McLister for The Globe and Mail

Mortgage rates are hitting multi-decade highs and pressuring family budgets in ways we haven’t seen since the 1980s.

Heavily leveraged borrowers are understandably anxious for rate relief. There’s probably more interest in when the Bank of Canada will cut interest rates than there has been in decades.

No one truly knows where rates will be next year, but the bond market thinks it knows. Institutional traders continually buy and sell securities and derivatives based on their expectations of where the Bank of Canada’s key rate will land. Those expectations show up in the CORRA market, and will occasionally be referenced in this column.

What is CORRA?

CORRA (Canadian Overnight Repo Rate Average) is calculated by the Bank of Canada and tracks the overnight rate. The overnight rate, of course, is the basis of the bank’s benchmark prime rate and virtually all variable mortgage rates.

What we’re interested in here is the forward outlook for CORRA – what’s known as the CORRA forecast curve. It’s based on market data exclusively compiled by CanDeal DNA, the leading provider of valuations for the Canadian fixed-income market.

McLister spoke with CanDeal DNA on Thursday to get its take on how the forecast curve can help borrowers.

What it reflects

“The CORRA forecast curve mirror’s the market’s view of where rates could go in the future,” said Andre Craig, CanDeal DNA president. “Is it strictly predictive? No. Is it typically directionally correct? Yes.”

He added: “The further out you go, the more speculative it is.”

There are several technical differences between the CORRA forecast and other rate forecasting tools, such as overnight index swaps and forward rates in the Bankers’ Acceptance market. The differences relate to the lack of counterparty risk in its underlying derivatives, the transparency of CORRA’s calculation method, compounding and other esoteric mathematical stuff.

It’s important to remember one thing, says Louise Brinkmann, head of CanDeal Benchmark Solutions: The CORRA forecast curve is much better at predicting rates at near-term Bank of Canada meetings than it is at projecting rates a few years out. For example, whereas the market expectations of a bank rate hike were a coin flip before its last rate announcement, the CORRA forecast curve was “bang on in predicting a hike,” Ms. Brinkmann says.

By contrast, the range of outcomes is drastically wider a few years from now. By then, rates could be affected by significant changes in inflation, another crisis, recession, stagflation and so on – all of which could radically change the path of mortgage rates.

How to use this info, and how not to use it

A rough sense of the direction of interest rates is one small factor to consider when determining the optimal mortgage term.

If rates are expected to fall materially, that may improve one’s implied chances of paying less in a variable-rate or short term. If rates are expected to rise materially, that might improve one’s odds in a medium or longer fixed term.

What the CORRA forecast curve does best is give you an objective baseline for possible rate direction, and the possible timing of rate hikes and cuts.

It tells you roughly where we’re at in the rate cycle, which has value for mortgage term selection. In most cases, for example, you don’t want to be locking in long-term after a big rate run-up, like we’ve had, and when the market is expecting 200-plus bps of rate cuts ahead – like it is.

The market’s outlook is also significantly more reliable than your typical talking head expert. Mainstream economists, for example, tend to follow the market expectations reflected in future CORRA rates. So you might as well just use the leading indicator itself.

Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news.

Source: The Globe and Mail