Canada, with its tightly linked economy, often experiences indirect ripple effects that influence mortgage rates, the housing market, and borrowing costs for Canadians. This week, we’ll explore the relationship between U.S. and Canadian interest rates, helping you understand how changes south of the border can impact your finances.

How the U.S. Fed and Bank of Canada Are Connected

The U.S. Federal Reserve (Fed) and the Bank of Canada (BoC) each set their country’s benchmark interest rates. While their decisions are based on domestic economic factors, their policies are often intertwined due to close trade ties and the influence of global financial markets.

1. The Role of U.S. Treasury Yields:
   • Canadian fixed mortgage rates, particularly 5-year fixed terms, are heavily influenced by the yield on U.S. Treasury bonds.
   • When the Fed raises rates, Treasury yields often climb, prompting similar increases in Canadian bond yields. This, in turn, pushes up fixed mortgage rates in Canada.
2. Exchange Rate Dynamics:
   • Higher interest rates in the U.S. can attract global investors to the U.S. dollar, strengthening its value against the Canadian dollar.
   • A weaker Canadian dollar can increase import costs, adding inflationary pressures that the Bank of Canada may need to address with its own rate hikes.
3. Economic Parallels:
   • Both countries face shared economic challenges, such as inflation, labor shortages, and supply chain disruptions. Similar economic conditions often lead to aligned rate policies, but the Bank of Canada does adjust based on uniquely Canadian factors.

Why the Bank of Canada Doesn’t Always Follow the U.S. Fed

While there is a connection, the Bank of Canada operates independently and doesn’t blindly follow the Fed’s lead. Here’s why:

1. Different Economic Conditions:
   • Canada’s housing market plays a larger role in its economy compared to the U.S. As a result, the BoC may prioritize housing stability over broader economic trends that drive Fed decisions.
   • For example, even when the U.S. Fed raised rates aggressively in 2022–2023, the BoC opted for smaller increments to avoid destabilizing Canadian households carrying high mortgage debt.
2. Policy Lag Effects:
   • The Bank of Canada often waits to assess how previous rate changes impact the economy before implementing further adjustments. This lag can create temporary divergence from the Fed’s approach.
3. Export Dependency:
   • Canada’s reliance on exports means that exchange rate fluctuations play a more significant role in monetary policy decisions. The BoC may adjust rates differently than the Fed to stabilize trade competitiveness.

How This Impacts Canadian Borrowers

For Canadian borrowers, understanding these dynamics is crucial when planning for mortgage decisions. Here’s how U.S. Fed rate changes can affect your finances:

1. Fixed Mortgage Rates:
   • If the Fed signals future hikes, Canadian fixed rates may rise in anticipation, as bond yields increase. Borrowers considering a fixed-rate mortgage may want to act sooner to lock in lower rates.
2. Variable Mortgage Rates:
   • Variable rates are directly tied to the Bank of Canada’s overnight rate. While the Fed’s actions influence Canadian monetary policy indirectly, variable-rate borrowers are more insulated from immediate changes.
3. Refinancing and Renewals:
   • For homeowners nearing a mortgage renewal, watching U.S. rate trends can provide early indicators of potential rate movements in Canada. This can help in choosing between fixed and variable options.

Staying Ahead of the Curve

To navigate these complexities, borrowers should keep an eye on key indicators, including:

• Fed Announcements: Watch for changes in the Fed’s benchmark rate or guidance on future policy moves.
• Canadian Bond Yields: Monitor movements in bond markets, as these often signal shifts in fixed mortgage rates.
• Bank of Canada Updates: Pay attention to the BoC’s commentary on inflation, employment, and GDP growth, which influence rate decisions.

Conclusion

While the Bank of Canada operates independently, the economic and financial ties between the U.S. and Canada mean that the Fed’s rate decisions have a significant indirect impact on Canadian borrowers. Understanding this relationship can help homeowners and prospective buyers make informed decisions about their mortgages. Whether it’s locking in a rate or considering variable options, staying informed is the first step toward financial security.