TL;dr: On Wednesday, October 28, the Bank of Canada and the US Federal Reserve announce rate decisions on the same day, and the market expects them to move in opposite directions. The Bank of Canada is priced at roughly 78 percent odds of a 25 basis point hike that would take its policy rate from 2.25 percent to 2.50 percent, while the Fed is priced at roughly 90 percent odds of holding its target range at 3.75 to 4.00 percent. Those are expectations, not outcomes, and the template below lets you plug in the actual decisions on Wednesday and see what they do to prime, to a variable mortgage payment, and to a US dollar cost in Canadian dollars.

Two weeks ago, we looked at how fixed mortgage rates rose while the Bank of Canada did nothing, because fixed rates follow the bond market rather than the policy rate. Wednesday is the other side of that story, because variable rates do follow the policy rate, and the policy rate is the thing that might actually move. The Bank of Canada has held at 2.25 percent for seven straight meetings, so a hike would be its first move in a year. The Fed, meanwhile, is coming off a September hike and is expected to sit still, with December the real question for its next move. The interesting part is not either decision on its own. It is the gap between them, because that gap is what moves prime, variable payments, and the loonie, and the gap is about to get wider or narrower depending on what actually happens Wednesday morning and afternoon.

How prime actually works, since this is the mechanical link most commentary skips: the banks set their prime rate as the Bank of Canada policy rate plus a spread, and that spread has been running at about 2.20 percentage points, which puts prime at 4.45 percent while the policy rate sits at 2.25 percent. If the Bank of Canada raises by 25 basis points on Wednesday, prime goes to 4.70 percent, mechanically, usually within days of the announcement, because the banks move prime when the policy rate moves and the spread does not normally change on decision day. Your variable mortgage rate is then prime minus whatever discount you negotiated, so a borrower at prime minus 0.50 percent is paying 3.95 percent today and would pay 4.20 percent after a hike. That is the whole chain, policy rate to prime to your rate, and there is no other step in between.

Worked example, because the basis points only matter once they hit a payment: take a $500,000 balance on a 25 year amortization at prime minus 0.50 percent. At today's 3.95 percent, the monthly payment on an adjustable payment variable mortgage is about $2,625. After a 25 basis point hike, at 4.20 percent, the same mortgage costs about $2,695 a month. That is about $69 more per month, or about $832 per year, from a single quarter point move, and it lands in the payment within a billing cycle or two. One detail worth knowing is that not every variable mortgage works this way. If your payment adjusts with the rate, the amount you pay goes up, which is the example above. If your payment is fixed, the amount stays the same but less of it goes to principal, your amortization stretches out, and if rates rise far enough you can hit your trigger rate, which is the point where the payment no longer covers the interest and the lender calls you to fix it. Check which type you have before you model anything, because the same rate move produces two very different outcomes.

The exchange rate channel works on the same gap, just in the other direction. When Canadian rates rise relative to US rates, Canadian dollar assets pay relatively more than they did, which tends to attract capital and support the loonie, all else being equal. All else is never equal, and oil, risk appetite, and the wording of the two statements matter as much as the decisions themselves, so treat this as a tendency rather than a prediction. The practical version is simple: a stronger loonie, meaning a lower USD/CAD number, makes a US dollar bill cheaper in Canadian dollars, which helps anyone paying US suppliers or US dollar subscriptions and hurts exporters whose product just got more expensive for foreign buyers. Right now the gap between the two policy rates is about 1.63 percentage points with the Bank of Canada below the Fed, and a Bank of Canada hike with a Fed hold would narrow it to about 1.38 percentage points. That narrowing is the divergence trade in one number, and it is the number worth watching on Wednesday rather than either rate on its own.

What to watch in the statements, since the decisions themselves are mostly priced in and the surprises usually live in the language: from the Bank of Canada, watch whether the statement and the Monetary Policy Report frame a hike as the start of a series or as a one time move, and watch the inflation forecast, because the whole case for hiking rests on inflation not coming back down on its own. From the Fed, watch whether December stays live as the next decision point or gets talked down, and watch the language on the labour market, because that is what would give them room to hold. If either bank surprises, the divergence story flips. A Bank of Canada hold would leave prime exactly where it is and would probably soften the loonie. A Fed hike would narrow the gap from the other side. Either way, the template below handles it, because you are typing in the actuals rather than betting on the expectations.

Setting up your decision day sheet: first, open the template and make a copy, because the template itself is read only and your copy is where the numbers live. Second, go to the Decision day tab and edit the yellow cells to match your own mortgage, meaning the balance, the amortization in years, the prime spread, and your discount off prime. The defaults are a $500,000 balance, 25 years, a 2.20 percentage point prime spread, and prime minus 0.50 percent, which reproduce the worked example above. Third, on Wednesday, after the announcements, type the announced Bank of Canada rate and the Fed target midpoint into the yellow Announced column. The Bank of Canada announces at 9:45 AM Eastern and the Fed at 2:00 PM Eastern, so you can fill in the Canadian side in the morning and finish the sheet in the afternoon. Fourth, read the payment change rows, which show the monthly and annual difference against today, and read the BoC minus Fed row, which shows the gap in percentage points. Fifth, go to the CAD-USD readout tab, type in any US dollar amount and any USD/CAD assumption, and read the Canadian dollar cost. That tab only converts at the rate you type in, so if you want to test a stronger or weaker loonie, type in 1.35 or 1.45 and watch the cost move. It does not forecast the rate, and nothing in the workbook pretends otherwise.

On Wednesday, replace the expectations with the actuals and let the sheet do the rest. If the Bank of Canada hikes and the Fed holds, your variable payment goes up by roughly the amount in the example, scaled to your balance, and the rate gap narrows. If either bank surprises, the same sheet tells you by how much, without needing a new model.

Template: template: Rate divergence decision-day scenarios (Google Sheets, make a copy to use it)

- Francois