Heavily indebted Canadians need to watch U.S. interest rate announcement: Don Pittis

A rise in U.S. interest rates Wednesdayis so confidently expected by nearly everyone that a failure to hike rates would shockworldmarkets.

In hisfirst official press conference since taking over for Janet Yellen, Federal Reserve chair Jerome Powell is expected to set the direction for interest rate increases this year and into the more distant future.

What he says will matter to investors around the world. It will also matter to Canadian borrowers.

Trump appointee

One reason market watchers are so confident Powell will raise the key U.S. federal fundsratefrom 1.5 to 1.75 per cent, with a target of three per cent by 2020,is that he wants to demonstrate continuity of purpose atthe Fed despite the ejection ofYellenafter a single term.

As a Trump appointee, Powellhas attractedspeculation that he might be lax about putting the lid onsurging U.S. growth.

Certainly others in theadministration, including President Donald Trump himself, have seemedunworried by a sliding U.S. dollarthat would result if Powell slowed expectedrate hikes.

"Obviously a weak dollar is good for us as it relates to trade and opportunities," said Treasury Secretary Steven Mnuchinat the World Economic Forum earlier this year, prompting a sharp decline in the currency.

Combine that with the repeatedpromise byTrump to boost U.S. growth to four per cent a level likelyto launchserious inflation down the road and signs of a pliantcentral banker could be seen as ominous. As Yellenrepeatedly warned, letting the economy overheat in the short term could lead to sharp and disruptive rate increases once inflation kicks in.

In recent statements Powell has hinted at rate hikes, but continuityin setting tomorrow's rateis assured because Powell has only asingle vote in the Federal Open MarketCommittee. The composition of the group, charged with setting rates based on members'individualoutlooks for the economy, remains largely unchanged.

Importing inflation

The longer Powell is in the role,the more influence he will have on the committee's outlook, so the tone set by relatively unguarded responses to media questions may be just asimportant ashis written statement.

Heavily indebted Canadians cannot expect the border to protect them from the policy outlined by the new Fedchair.

While the Bank of Canada makes its own policy separate from the U.S. Fed, there are a number of ways that what happens in the U.S. will affect the Canadian lending market.

One is throughwhat is called imported inflation, something recently raised by Bank of America economists who warned about rising Canadian interest rates.

Because the two economies areso closely integrated, an outlook for risingprices and wages in theU.S. presumes higher costs in Canada, too.

The price of U.S. parts andingredients used to makeCanadian products will go up. So will goods like gasoline and oil, priced in U.S. dollars. Retail prices on goods produced or imported through the U.S. also go up with U.S. inflation.

And whileBank of Canadagovernor Stephen Poloz could theoretically hold Canadian rates steady while U.S. rates shoot higher, there are reasons why that becomes complicated.

If the expected hike happens, the difference in interest rates between the U.S. and Canada will be half a percentage point, attracting investors from Canada to the U.S. and pushing the loonie down.

Dog on a leash

A lower loonie makes Canadian inflation even higher as imported foreign goods become once again more expensive.

There will also be a cross-border spillover in bond markets.Canadian companies, including banks, trying to raise money will have trouble attracting international investors with rates below what those investors can get elsewhere.

For all the central bank'spurported independence,historically Canadian rates seldom strayfar from those of the U.S. The Bank of Canada, like a dog on a retractableleash, candelay, but it cannot alter the final path.

For that reason the most important message from tomorrow's Powell news conference will be anindication of how fast the Fed expects to raise rates.

3 or 4 increases this year?

Until now, the majority view has been that there would be three rate increases in 2018.

But on WednesdayFed watchers will be on the lookout for indications that Powell thinksfalling U.S. corporate taxes and a growing fiscal deficit will send the economy into overdrive, justifying four quarter-point increases this year.

For borrowers that would mean the cost of borrowing in the U.S. and eventually in Canada will rise by a full percentage point. A line of credit at four per cent would go to fiveper cent.

How high?

Another changeafoot is that Powell may decide to make a public statement afterevery FOMCmeeting, giving the Fed chair more flexibility in adjusting rates, makingthe path of rates a little less stable.

A final issue that could be raised by the new Fed chair is a slightly more complicated one,something economists call the neutral rate. A theoretical concept whose level is much disputed, the neutral rate is the Goldilocks interest level the point in a stable economy where borrowers areencouraged to borrow neither too much nor too little.

For Canadian borrowers, a rising neutral rate after decades of decline could indicate the long-term path of interest rates in coming years would be higher than otherwise expected.

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