25 July 2019
Today’s market trends are mostly caused by the changes at the bond market, where investors receive higher profits from short-term than from longer-term debt.
A bond is an investment, representing a loan provided by an investor to a company or government for a certain term. As a rule, the longer period gives higher profits. Nevertheless, the returns on longer-term bonds can go down in case investors expect the economy to slow (or face the recession) and the rates to fall. This leads to an inverted yield curve.
The U.S. have been facing this situation until lately, as traders worried about the economic slowdown. But the yield curve there has increased as the Federal Reserve is expected to reduce interest rates on July 31, supporting the national economy.
Meanwhile, the yield curve remains inverted in Canada. And it doesn’t mean something bad is coming. It’s a mix of domestic and external influences.
Lower returns on long-term debt in the U.S. push the Canadian longer-term bonds down.
“Year-to-date, Canada has accounted for about 70% of moves in global markets,” – noted Ian Pollick from CIBC Global Markets.
However, the Bank of Canada hasn’t hinted at plans to cut the rates, as the economy performs well.
Although an inverted yield curve has often been followed by weaker economic growth, it’s a much less reliable indicator of the future recessions in Canada than in the U.S., says Doug Porter, chief economist at BMO Financial Group.
The BoC governor Stephen Poloz believes Canada’s current yield-curve inversion is not dangerous and it doesn’t predict any recession.
How does it affect the mortgage market?
The yield on the five-year Government of Canada bond is the main factor determining a five-year fixed-rate mortgage. When the return on the five-year government bonds fell, the rates followed the example.
At the same time, the main influence on variable rate mortgages is the central bank’s key lending rate, affecting short-term rates. It hasn’t changed since October 2018.
But Pollick says it won’t last forever. In his opinion, the Bank will cut the rate in spring, as lower rates in the U.S. lead to higher Canadian dollar and it slows the economic growth.
As a rule, bond markets adjust to the first expected rate cut about six months before the decline. In means if the Bank cuts the rate in March or April, the yield curve will start growing in October, Pollick said.
However, Porter thinks the rates will remain unchanged throughout 2020.
What does it mean for Canadian mortgage holders?
In case you’re planning to get a new mortgage, it will by very hard to say no to a five-year fixed-rate mortgage at 2.69%.
If you already have a variable-rate mortgage, it’s possible to think about switching to a lower fixed one. In case you decide to do so, please, negotiate through you mortgage broker or bank. It’s important to remember that your bank may want you to sign up for a term which is longer than the remaining term on your existing loan. Moreover, breaking your mortgage will cost you more in case of a fixed-rate mortgage.
When choosing a new variable-rate mortgage, be careful if you prefer it only because you hope for a rate drop next year. Even if the BoC cuts its rate, it doesn’t mean your bank will pass the entire cut on your mortgage.