After months of waiting, it finally happened on Monday. The mortgage market’s most closely watched indicator, the five-year Government of Canada bond yield, has reached levels not seen since before the pandemic was declared in early 2020.
The five-year yield at the end of the day was trading near 1.07%, down from 0.86% just a week ago. Bond yields have risen in recent days amidst hawkish moves by central banks, including suggestions from the US Federal Reserve that interest rate hikes could occur as early as next year.
Mortgage buyers need to be careful. For one thing, bond rates largely determine what you’ll pay for a new fixed rate mortgage. This is because lenders compare their rates to financial market returns.
Second, bond market rates, already at medium-term highs, signal an upcoming rate hike for fixed and floating rate borrowers.
In fact, financial markets are anticipating two rate hikes from the Bank of Canada in the next 12 months, compared to just one hike last month.
When will banks lift fixed mortgage rates?
Barring an unforeseen crisis, variable rates aren’t going anywhere until next year except – perhaps – for another cut of around five basis points. (There are 100 basis points in a percentage point.)
Fixed mortgage rates are a different animal. They activate the bond market, which is moving faster than the Bank of Canada. With an increasingly hawkish Federal Reserve pushing yields up, fixed rates could be vulnerable to take off by the time you eat Thanksgiving turkey, potentially much sooner.
One metric I like to look at is the spread between the lowest discounted five-year fixed rates of major banks and Canada’s five-year swap rate. The swap is an interest rate derivative that serves as a rough indicator of the fixed rate base funding costs of the big banks.
This âfive year swap spread,â as the types of traders call it, is only 44 basis points as of this writing. I’ve never seen it so low in my 14-year career. This means that lenders earn less than normal for every fixed rate mortgage they sell. It cannot last long.
Unless bond market rates decline, the lowest fixed rates are likely to rise by at least 5 to 15 basis points by early October.
Interestingly, however, two factors make this time a little different. Banks are currently overflowing with liquidity thanks to: a) government support during the pandemic, and b) record amounts of deposits.
In other words, they have a lot of money to lend. As a result, some banks may be a bit more patient before raising mortgage rates, sacrificing profit margin for market share.
Even so, now is not the time to play chicken with fixed rates. So far, there has been no significant increase in rates over the past week. Quite the contrary, in fact.
But if foreclosure is your best decision – given your five-year plan, your finances, your risk tolerance, etc. – then doing it today is reasonable. Banks still sell fixed five-year maturities at less than 2%, a rate that has rarely been lower.
Risk management, not crystal ball
You don’t have to be a fortune teller to use the past as a guide. Any rate observer knows that borrowing costs have historically increased in a context of above target inflation, rising inflation expectations, supply / demand imbalances, labor shortages and others. signs of economic recovery. This is where we are today.
Is it possible that the rates will fall again? Sure. But why play on it? Inflation is a threat enough to justify rate hikes next year – that’s what bond traders who bet billions daily on rate direction are saying.
All of this means that fixed mortgage rates could easily approach their highs of last year before too long. That could cause them to rise by at least 50 basis points (half a percentage point) by 2022, compared to today.
Half a point is not the end of the world and probably 90 percent of borrowers are stress tested by lenders at much higher rates. But half a point is still over $ 1,400 in additional interest per year – $ 7,000 over five years – on an average new mortgage of $ 300,000.
Is that risk enough to call your lender or broker and keep the rate on a fixed rate mortgage? It’s your call.