Mortgage debtors may finally see some relief after months of steadily increasing rates. Five-year fixed mortgage rates have declined modestly over the past week in response to falling bond yields. Moreover, economic indicators suggest we may have already seen our last price peak.
Bond yields on Canada’s five-year government issue have dropped below 3% again, to 2.8% as of January 18th. That’s a drop of 61 basis points from the last day of December, and a change of 22 basis points in just one week. The best mortgage rate in Canada has dropped to 4.39% from 4.54% last week. This has happened as a result of this trend among several financial institutions to reduce their fixed five-year rates. Of course, a difference of only 15 points may not seem like much. However, in the current high interest rate climate, it’s encouraging to see any glimmer of respite. In addition, if the economy continues on its current path, fixed-rate borrowers may see further rate stabilisation.
The Canadian mortgage rate should be at or near its high right now, according to BMO Senior Economist Robert Kavcic’s research paper. The Bank of Canada is widely anticipated to increase rates by another 25 basis points next week. This may halt the ongoing rise in variable mortgage rates. Canadian five-year bond rates have fallen below the lows reached in December. This is due to the recent recovery in the U.S. Treasuries and Government of Canada bonds.
The current interest rates are far higher than the 1.5–2% range that was accessible a year ago. He further says that the “pause in upward momentum should help at the margin, and offer some comfort that the worst of the rate shock is behind us.”
A drop in bond yields
Bond yields are currently falling due to optimistic inflation data due out this week. Moreover, due to the rising views that the Bank of Canada is finishing its rate hike cycle. Reason being, changes in the economy are immediately reflected in the yields. Demand for government bonds tends to rise when economic conditions are favourable. Thus, driving up bond prices and reducing bond rates. Let’s examine the bond market in more detail to help you understand it.
What is a bond?
Bonds are a sort of investment whereby the investor receives a return (sometimes called a yield) in exchange for investing funds for a specified period of time (the most popular are two-, five-, and 10-year terms). When a bond matures at the end of its term, the investor gets their initial investment back plus any interest accrued.
Bonds compete with one another based on the amount of interest income they provide. Any bonds issued following the interest rate increase will be worth more than the existing bonds. That’s because current bonds lose value whenever the Bank of Canada raises interest rates, forcing sellers to cut prices.
Bond yields need to rise as bond prices fall so that they can continue to attract buyers. They have risen by approximately 350 basis points from their lows due to the Bank of Canada’s decision to raise its benchmark interest rate by 4% between March 2022 and December 2022. Thus, bringing its Overnight Lending Rate to 4.25% today.
The effects of inflation on bond prices
Bond yields are lowered by inflation because of the erosion of purchasing power caused by rising consumer prices. The persistently high rate of inflation, which reached a 40-year high of 8.1% this June, has contributed to a rise in bond yields for the year 2022. But the most recent CPI in December indicated inflation rise had slowed to 6.3%. Further suggesting that the Bank of Canada would pause its rising cycle or delay any rate movement in its upcoming January 25th statement. This has lifted bond demand (and hence lowered yields).
To give you an idea of how inflation affects bond yields, consider that in September 1981, when Canada’s CPI was a stunning 12.47%. Moreover, the country’s highest ever five-year yield was 18.78%. In contrast, the lowest yield ever recorded was in March of 2020, when it hit a record low of 0.276 percent due to tepid price increases (0.9 percent). This was due to widespread panic over a potential pandemic.
Why do yields have such an impact on fixed mortgage rates?
Bonds issued by the Canadian government are widely regarded as a safe and lucrative investment option. This is due to their high liquidity and low risk profile.
As such, consumer lenders use them to establish the benchmark cost for fixed-rate borrowing products. Typically a spread of 100 to 200 basis points above the five-year yield (the best five-year rate as of today is 4.39 percent, 159 basis points above the yield). If yields continue to decline, borrowers can anticipate even more substantial reductions in their fixed mortgage rates from their financial institutions.
Conclusion
Today’s fixed mortgage rates are still higher than they were a year ago. However, there is growing hope that inflation’s slowdown will help them stabilize or slightly decrease in the near future. This is wonderful news for anyone in the market for a mortgage. Borrowers should do their due diligence in the coming months. This is to ensure they are receiving the best rates possible. It is because rate conditions can change rapidly in response to shifting economic conditions. Free of charge, you can stay abreast of market shifts by establishing contact with a mortgage broker.