With the Bank of Canada offering little hope to those aching for interest rate relief, experts say some Canadians might be able to get a break on their mortgage by paying closer attention to the bond market.
While the central bank sets the benchmark interest rate broadly for Canadians and their lenders, bond yields can have a substantial — if indirect — influence on the rates borrowers pay.
Recent cooling in the bond market over the past month could eventually mean savings for Canadians renewing or taking out a new fixed-rate mortgage, says James Laird, co-CEO of Ratehub.ca.
“It’s exciting that bond yields are coming down, if you require a mortgage in the near-term,” Laird tells Global News.
Why does the bond market matter for mortgages?
While variable-rate mortgages rise and fall immediately in line with the Bank of Canada’s target for the overnight rate, fixed-rate products typically use the bond market as their benchmark.
A bond is a traditionally conservative investment tool with a set yield over a particular timeframe. While bond supply is one factor affecting prices, yields also have close links with inflation and the Bank of Canada’s policy rate, and will typically fall when price pressures and the cost of borrowing drop — or are expected to drop.
“It’s all about expectations. That’s what the bond market is predicting,” Laird says.
Banks and other lenders also use bond yields as a basis for what they should be offering on their fixed-rate mortgage products, Laird says, usually with a one to two percentage-point premium on top.
“It’s a bit oversimplified, but people can think of when they get a five-year fixed-rate mortgage that there is a bond in the background,” he says.
The five-year Government of Canada bond yield, which informs that popular five-year fixed mortgage, ran up to a 16-year high of 4.42 per cent in October and remained elevated for much of that month, according to the Bank of Canada’s tracking.
As of Nov. 30, however, that yield had dropped to 3.64 per cent — a low not seen since the early summer.
Bond yields surged globally in early fall, led by benchmark U.S. treasury bonds. Laird says the spike in the bond market was tied to market expectations that interest rates might stay higher for longer.
Weaker economic data and cooling inflation figures in Canada, alongside expectations of a possible peak for rates in the U.S., have helped to reverse that trend in November, with forecasters bringing forward calls for rate cuts.
While some large banks such as RBC are still eyeing the second half of 2024 for the first rate cuts in Canada, some including TD Bank and CIBC are calling for the central bank to start lowering rates in the spring.
If bond traders’ forecasts for rate cuts are to be believed, Laird says lower yields could prompt some Canadians to reconsider variable-rate mortgages that were popular during the pandemic.
Borrowers with variable-rate debt have borne much of the pain in the central bank’s rapid rate hike cycle to-date, but he says it’s possible they can see their payments drop over the coming months if predictions for lower rates come to pass.
But Laird is quick to caution that no one knows the Bank of Canada’s rate path with any degree of certainty, and the whipsaw in the bond market from September and October to November shows how quickly narratives can change.
He adds that while lenders are usually in a hurry to adjust their fixed rates on offer when bond yields are rising, they’re typically slower to lower rates on their mortgage profits when there’s a dip in the bond market.
But if trends continue, he says that “eventually the savings will be passed along and rates will drop.”
Lower bond yields are ‘good news’ for consumers
Randall Bartlett, senior director of Canadian economics at Desjardins, tells Global News that bond yields are a bit lower north of the border than in the U.S. right now, largely reflecting Canada’s strong fiscal position.
He says that lower bond yields in general are “good news” for consumers and can affect loans of any maturity, whether they’re looking to renew a five-year mortgage, take out a new loan for a car or just pay down debt.
The hope for more affordable mortgages could get some Canadians thinking about diving back into the housing market, Laird says, noting the correlation between lower rates and higher home sales.
He expects an “incremental” impact on demand and affordability if bond yields drive mortgage rates lower, but also warns that there could be a similar degree of appreciation in home prices.
Bond yields also declined earlier this year when the Bank of Canada announced a “conditional pause” to the rate hike cycle, which spurred market chatter about eventual rate cuts. The five-year GoC bond dropped to a low of 2.75 per cent in March, though global banking instability at the time also dragged down the bond market.
Housing market activity picked up significantly in the spring as a result of the relative affordability, Laird notes.
“We should watch for that similar trend to unfold if this narrative continues,” he says.
The Bank of Canada has been trying to keep economic growth on the backburner during its rate hike cycle in an effort to cool demand and, by extension, inflation. An uptick in housing activity as seen in the spring could threaten to reignite that sector of Canada’s otherwise slowing economy.
Despite expectations from bond traders, the Bank of Canada has been tight-lipped about the timetable for rate cuts, which Laird says has likely been intentional on the central bank’s part.
Monetary policymakers have routinely said lately that while rates might be high enough at 5.0 per cent, they could still rise further if there are signs the inflation fight has stalled.
Laird says the Bank of Canada’s decision-makers have likely “learned their lesson,” and won’t offer hints of rate cuts until they’re sure they won’t inadvertently stoke another fire in the economy.
“I expect their tone to stay more ‘higher for longer.’ That’ll stay there until the cuts are here,” he says.
But market expectations aside, Bartlett notes that the Bank of Canada has tried to keep upward pressure on bond yields in other ways.
The central bank, which will make its final rate decision of the year Dec.6, has been letting bonds mature and roll off, reducing the size of its balance sheet. That helps keep yields otherwise elevated, Bartlett says, providing some “mechanical tightening happening in the background.”