Rate Correlations - A Quick Primer

Ever wonder why fixed and variable mortgage rates don't always move together?

Essentially it's because fixed rates are based on bond prices and variable rates hinge off of prime rate. 

Contrary to intuition, prime rate and 5-year bond yields are not closely correlated.  The correlation between the two is only 72% (OK but not great for financial time series).  That's because these two rates come from different markets: the market for 5-year funds and the market for short term bonds.

Compare that to the correlation between 5-year bond yields and fixed mortgage rates.  That correlation is 95% (very high).  The reason is, financial institutions use the 5-year bond as a benchmark for determining cost of funds for 5-year mortgages.

(Contact us for citations of the statistics sources.)

Comments

[Dom]

Great info! How about correlation between Bank of Canada target rate and prime rate? And corr between US fed fund rate and BofC target rate? I am curious of the statistical probability that I will pay a lower mortgage rate with the recent 50 basis reduction of US fed funds.

[Canadian Mortgage]

Hi Dom, We don't have those stats on hand but I'll see if we can dig them up. Thanks for the note.

Robert, Co-Ed., CMT