Trudeau announces new emergency programme for workers who lost work from COVID-19

Prime Minister Justin Trudeau has announced the federal government is launching the Canada Emergency Response Benefit, a new programme that will provide $2,000 a month for four months to individuals who lost their work as a result of the COVID-19 pandemic.

Speaking outside of his residence where he is self-quarantining with his family, Trudeau acknowledged the dilemma facing Canadians trying to process mounting bills without a steady income, noting that “far too many Canadians are having these tough conversations about their finances and their future.”

With nearly 1 million people applying for employment insurance last week, Trudeau stated the new programme is in the process of being set up.

“An application portal will launch as quickly as possible and people should start receiving money as soon as 10 days of applying,” he said.

The programme will replace a pair of initiatives, the Emergency Care Benefit and the Emergency Support Benefit, that were announced last week. Trudeau said the decision to combine the two earlier programmes into a new endeavour was done “in order to streamline the process.”

by Phil Hall  / 25 Mar 2020

Fed Cuts Overnight Rate One Percentage Point But Markets Plummet

In an unprecedented Sunday afternoon meeting, the US Federal Reserve cut their key policy rate by 100 basis points (bps) to a level of 0%-to-0.25% (see chart below). Also, the Committee announced increased access to the discount window where the Fed makes loans to banks. The Fed is the lender-of-last-resort and is signalling that it will provide liquidity wherever needed. As well, with interest rates already so low, the Fed is well aware that rate cuts can only do so much. Thus, they are returning to quantitative easing–the buying of large volumes of U.S. government Treasury bills and bonds as well as mortgage-backed securities (MBS), to inject liquidity into the financial system.

The Treasury and US MBS markets are usually the deepest, most liquid markets in the world. But over the past two weeks, liquidity has dried up. Financial instability has risen sharply with the high level of volatility. Banks have experienced significant withdrawals as consumers are hoarding cash like everything else. The cost of funds to banks has risen sharply because of the enhanced perception of risk. With the collapse in oil prices, banks exposed to the oil sector are building up reserves for nonperforming loans. As businesses everywhere in nearly every sector shutdown, the risk of delinquencies rises further. Consumers who are housebound spend less money, and those who are freelancers or hourly wage earners might not get paid. Moreover, the shuttering of schools puts an added burden on parents who have no other daycare options for their kids.

All of this disruption, which according to the Center for Disease Control, could last months–the CDC recommended yesterday the shutdown of meetings of more than 50 people for eight weeks–has led to rising concern about the riskiness of banks. Bank shares have plummeted, and the yields on bank bonds have surged. Besides, banks and other mortgage lenders are fearful of being inundated with requests for refinancings, especially in the US, where penalties for breaking a mortgage are much lower than in Canada. Because of the refinancing surge in the US, the price of MBSs has fallen sharply, raising their yields and making the market highly illiquid.

The rising risk premiums, likely recession and illiquidity are causing banks in Canada and the US to raise some mortgage rates. Lenders are tightening the discount off the prime rate on variable-rate mortgage loans. Some fixed rates have edged higher as well. Such spread widening between mortgage rates and government yields happened during the financial crisis. Bank balance sheets will expand as troubled businesses and consumers extend their borrowings on their open lines of credit. Many will be unable to make timely interest payments. Loan loss reserves, already climbing, will rise further. Liquid deposits will be depleted as many are forced to live off of savings while shying away from selling stocks at markedly depressed prices.

These are not normal times. The Fed’s actions did nothing to calm markets. Indeed, stocks and bond yields plummeted in overnight trade, and the stock markets opened sharply lower in North America. The S&P 500 opened down over 8% while the TSX opened down 11%, triggering a circuit-breaker time out. This is the third time in a week the circuit breaker has hit. The TSX is down roughly 35% from its recent high (see chart below). The S&P 500 is down over 20%. The relative underperfomance of the Canadian stock market reflects our out-sized representation of the energy sector. The two weakest sectors in the TSX are the energy and financial sectors.

The world knows that the Fed and other central banks are running out of ammunition. Governor Powell said yesterday that he would not take the key fed funds rate into negative territory but instead would use “forward guidance” and asset purchases (quantitative easing) going forward.

The good news is that the banks are highly capitalized and much more resilient than during the financial crisis. Central banks since that time have put in place measures to monitor financial stability. Last Friday, the Canadian Office of the Superintendent of Financial Institutions (OSFI) reduced the capital requirements for Canadian banks to free up $300 billion for banks to support troubled borrowers. OSFI warned against the use of these funds to buy back stocks or raise dividends.

OSFI also suspended the proposed revision in the qualifying mortgage rate slated to begin April 6. The posted mortgage rate, published weekly by the Bank of Canada, will remain the qualifying mortgage rate. It is currently 5.19%, but it is expected to fall this week to around 4.95%.

But in these extraordinary times, there is a loss of confidence in the financial system. Some are calling for a full shutdown of the stock markets–but imagine the panic if no one could sell assets. There would truly be a run on the banks. Now is not a time to panic.

Dr. Sherry Cooper

Chief Economist, Dominion Lending Centres

Minister Morneau Announces New Benchmark Rate for Qualifying For Insured Mortgages

The new qualifying rate will be the mortgage contract rate or a newly created benchmark very close to it plus 200 basis points, in either case. The News Release from the Department of Finance Canada states, “the Government of Canada has introduced measures to help more Canadians achieve their housing needs while also taking measured actions to contain risks in the housing market. A stable and healthy housing market is part of a strong economy, which is vital to building and supporting a strong middle class.”

These changes will come into effect on April 6, 2020. The new benchmark rate will be the weekly median 5-year fixed insured mortgage rate from mortgage insurance applications, plus 2%.

This follows a recent review by federal financial agencies, which concluded that the minimum qualifying rate should be more dynamic to reflect the evolution of market conditions better. Overall, the review concluded that the mortgage stress test is working to ensure that home buyers are able to afford their homes even if interest rates rise, incomes change, or families are faced with unforeseen expenses.

This adjustment to the stress test will allow it to be more representative of the mortgage rates offered by lenders and more responsive to market conditions.

The Office of the Superintendent of Financial Institutions (OSFI) also announced today that it is considering the same new benchmark rate to determine the minimum qualifying rate for uninsured mortgages.

The existing qualification rule, which was introduced in 2016 for insured mortgages and in 2018 for uninsured mortgages, wasn’t responsive enough to the recent drop in lending interest rates — effectively making the stress test too tight. The earlier rule established the big-six bank posted rate plus 2 percentage points as the qualifying rate. Banks have increasingly held back from adjusting their posted rates when 5-year market yields moved downward. With rates falling sharply in recent weeks, especially since the coronavirus scare, the gap between posted and contract mortgage rates has widened even more than what was already evident in the past two years.

This move, effective April 6, should reduce the qualifying rate by about 30 basis points if contract rates remain at roughly today’s levels. According to a Department of Finance official, “As of February 18, 2020, based on the weekly median 5-year fixed insured mortgage rate from insured mortgage applications received by the Canada Mortgage and Housing Corporation, the new benchmark rate would be roughly 4.89%.”  That’s 30 basis points less than today’s benchmark rate of 5.19%.

The Bank of Canada will calculate this new benchmark weekly, based on actual rates from mortgage insurance applications, as underwritten by Canada’s three default insurers.

OSFI confirmed today that it, too, is considering the new benchmark rate for its minimum stress test rate on uninsured mortgages (mortgages with at least 20% equity).

“The proposed new benchmark for uninsured mortgages is based on rates from mortgage applications submitted by a wide variety of lenders, which makes it more representative of both the broader market and fluctuations in actual contract rates,” OSFI said in its release.

“In addition to introducing a more accurate floor, OSFI’s proposal maintains cohesion between the benchmarks used to qualify both uninsured and insured mortgages.” (Thank goodness, as the last thing the mortgage market needs is more complexity.)

The new rules will certainly add to what was already likely to be a buoyant spring housing market. While it might boost buying power by just 3% (depending on what the new benchmark turns out to be on April 6), the psychological boost will be positive. Homebuyers—particularly first-time buyers—are already worried about affordability, given the double-digit gains of the last 12 months.

Dr. Sherry Cooper

Chief Economist, Dominion Lending Centres