Surprise!

SURPRISE modified

For some time this pathetic blog has  warned you to get ready for higher interest rates. Lock into a five-year mortgage at a cheapo 2.4%. Buy some preferreds because they’ll reward you as the cost of money rises. And be careful about peak house, since there’s an inverse relationship between prices and rates.

Of course, everyone ignores me. Nobody believes it’ll happen. Especially the Millennials who were back-stroking down the birth canal the last time mortgages cost double-digits. The universal refrain goes something like this: the government will never let it happen since we’d all be screwed. Nobody can afford to pay more. It’d be a disaster. No way Justin’s allowing it. Grow up.

Well, here’s the truth.

Interest rates are going to rise. First in the US, and then here. Not immediately, and not severely. But enough to rattle a few million complacent Canadians who have driven household debt to historic levels without increasing their incomes. Oops.

Any lingering doubt was erased this week when the American central bank released its latest set of internal minutes showing most decision-makers there was to raise rates in June or July. This comes after the last increase in December, and means there’ll be at least two rounds in 2016. Big news.

The bond market was caught off guard, so yields spiked and prices dropped. The stock market was flummoxed, too. Prices fell to six-week lows. Forex guys were jolted. The greenback surged in value and our loonie sank to almost 76 cents US. Commodities slumped. Like the moist Millennials, financial guys had talked themselves into a status-quo-forever mindset in which cheap money keeps fueling asset values.

That’s exactly why it’s going to end. The Fed has a lot of smart people in it, determined to take away the punch bowl before we all get too pissed to walk. (Vancouver’s already hammered.) Besides, the US is doing great despite weak first quarter growth numbers  – already starting to be reversed (April consumer spending rebounded sharply).

Inflation’s returned to exactly the level the central bankers want (around 2%). Unemployment’s plunged by half from post-recession levels and at 5% is considered to be right on target. Stock markets are just a hair off record levels, and lots of resiliency there. Car, house and retail sales are robust. Over 2.5 million new jobs were created in the last year alone. So the Fed document said it “would likely be appropriate” that the next increase happen in June. In fact it used the word “June” six times – just to hammer the point.

That doesn’t mean an increase on Wednesday June 15th is a slam-dunk. It ain’t. If the jobs numbers coming out in the meantime (or the trade data or consumer spending stats) suck, the increase will happen in July. But it seems evident now a summer rate hike is a done deal, which means there’ll be at least one more in the autumn and possibly another come winter.

Here, look at the latest odds after the release of this week’s doc. They went from 4% to 30% for a rate rise in June, while the odds for another later this year are touching 80%.

ODDS

So, the Fed has achieved its mandates of (a) restoring inflation plus growth and (b) achieving what it calls ‘full employment’. Whether you agree with this or not is moot. Up she goes. Any doubt of that was removed by key Fed official William Dudley. “If I’m convinced that my own forecast is on track, then I think a tightening in the summer, the June-July time frame, is a reasonable expectation,” he told reporters.

So what does it mean here?

Likely higher five-year mortgage rates later this summer and into the autumn, whether the Bank of Canada follows suit or not (and it won’t in 2016). That’s because lenders set those rates in the bond market, based on five-year Government of Canada bond yields, which certainly follow the US debt market. So, get used to that idea.

Second, the Fed never moves once and stops. The ‘one-and-done’ chorus we’ve heard from the macroeconomists in the steerage section of this blog is just as credible as their former cry that QE (government stimulus spending) would never end. It did. And now rates will rise for the next couple of years. Get used to that, too.

Third, history shows us that 92% of the time the Bank of Canada eventually follows US monetary policy because not to do so whacks the dollar, fosters trade issues and fuels inflation. This time it’s a sure thing, since we have a new T2 government committed to massive deficit spending for at least the next four years, which is as stimulative as, say, the Trivago guy. Especially if oil stabilizes (Goldman is calling for $50 average this year) and the PM stops hitting people.

So, there it is. I told you. And you scoffed. Bad dogs.

Think again

LONELY modified

Yesterday I offered a few nuggets. Like not getting divorced and throwing your adult kids out of the basement. But two caused a stir – leasing cars and taking CPP early. Let’s dig in a little.

The car thing is easy. Buying used (or new) with cash and riding the wheels off seems to save money over the high monthly cost of leasing. But that’s not the point. Cars are depreciating assets and almost all of them eventually go to zero. Leasing makes sense, but only if you take the money you don’t spend and invest is instead. That twenty grand in a growth-oriented TFSA over thirty years will end up being $132,000.

This is money you can withdraw free of tax. Better still, at 6.5% return it will provide you with more than $700 a month income for the rest of your life – money not added to your taxable income which doesn’t affect CPP or OAS. Over 20 years of retirement, that’s more than $171,000 in cash flow, plus you still have the $132,000 left. This is a $293,000 reason why you should have leased that car.

No, how about taking that CPP at age 60 instead of 65? I said it was a non-brainer decision, and it is.

Shockingly, most people need the pittance the CPP delivers (along with the OAS pogey, to which nobody contributes directly). A survey by one of the banks found that 89% of Canadians believe they’ll require these bucks to make ends meet. A third of those said they’ll lean on CPP “heavily.” It’s an indictment of us all that the number is so large. If you’ve lived six decades and still can’t support yourself, you probably made bad choices.

Well, you can start getting pension cheques now at age 60 even if you’re still working, and pocket the money until death. No longer does anyone have to give up a paycheque to get public money – a decision the federal government will long regret (and may some day reverse).

In order to stem the tide, the feds have built in a financial incentive to wait, so at age 60 you receive less than you would at 65 or age 70 – when the amount augments by about a third. Like buying a car versus leasing one, people do the wrong math when it comes to CPP. They studiously contemplate the point at which you’d be better off waiting (around 73), then conclude that because they’ll live forever, it’s more profitable to wait and get more later.

It isn’t. Here (again) are some of the reasons why everyone should collect at 60.

  • Any time the government gives you money, take it. Handing over pensions five years before most people think of retiring, when they are still employed, is idiocy. This could, and probably will, be changed on a whim in the future.
  • But what about the 30% more if you wait five years? If you absolutely know you’ll live to 95, delay. And don’t eat red meat. Or Hoverboard. But for most of us it makes way more sense to collect the largesse as soon as possible, and invest it. Sixty monthly payments of $600 from age 60 to 65, for example, equals $36,000. That amount invested for a decent return becomes almost $60,000 in ten years, tax-free if inside your TFSA – turning out enough income to increase your OAS by 50%. That sure beats waiting to get an extra $150 a month.
  • Delaying until 65 or 70 to get more CPP income might also edge you into a higher tax bracket if you’re drawing from RRSPs. That would pretty much wipe out any benefit. Remember that during the year you turn 71 all RRSPs must be converted into RRIFs, meaning you’re forced to start taking the capital as taxable income. Why not bank your pension cheque for 11 years before that happens? Put the loot into a TFSA and when it comes out, no impact on your tax bracket.
  • You can split your CPP payments with your spouse, reducing the tax bite.
  • Finally, you’ve contributed to this plan your entire working life, so it makes sense to suck out cash the moment you have a chance. That way you’ll drain far more from the plan than you ever contributed, which is excellent revenge for being, like, really old.