Waiting for Better Fixed Rates

The Bank of Canada’s next interest rate announcement is just two weeks away, and many mortgage shoppers are fixated on it.

We’ve probably spoken to a dozen people in the last week who want a fixed-rate mortgage but don’t want to apply until the Bank of Canada meets March 3.  The thinking is that the BoC announcement will cause fixed rates to fall.

We’re used to seeing this psychology with variable-rate shoppers but not with fixed rates.  As such, it’s worth examining further the linkage between the Bank of Canada and fixed mortgage rates.

As many know, the BoC sets Canada’s overnight target rate.  This in turn influences prime rate, which directly affects variable rates.

Fixed rates are a different story.  Fixed rates are driven by bond yields (usually, that is—the last few quarters have been atypical).  The Bank of Canada has no direct control over bond yields, although it can influence them in certain ways.

The fact that bonds are independent from the Bank of Canada is something many don’t grasp.  For example, the entire country might expect the Bank of Canada to cut rates 1/4% on March 3, but if stronger-than-expected economic reports precede the BoC announcement, bond yields could jump.  In that case, fixed mortgage rates could increase while variable rates fall.  (We’re not saying that will happen this time. It’s just an example.)

So how much do fixed rates really follow the Bank of Canada’s lead?  According to TD, “for every percentage point of central bank easing (for example), the 5-year yield should decline by 70 bps.” 

We ran our own tests and found the correlation between prime rate and 5-year bond yields to be 69.5% over the last 10 years.  So, a fair amount of time, bond yields will deviate from prime rate. 

That makes sense because 5-year yields are driven by demand for long-term funds while prime rate is linked to demand for short-term funds.

The chart below illustrates how the direction of 5-year yields and prime can differ drastically over 3-6 month timeframes.

In sum, bond yields and prime rate (and fixed and variable rates) do move together long-term.  But short term, anything can happen.

So.  Should fixed-rate mortgage shoppers wait until the Bank of Canada’s rate announcement before locking in? 

In our view, no.  It’s just a gamble.

There isn’t much foreseeable to gain by doing this unless one feels strongly that the Bank of Canada will scare the market with a dire economic forecast…and drive down bond yields.

Most folks in this boat are simply trying to outguess the market, which no one can do consistently.  Moreover, they’re disregarding the fact that fixed rates are already at historic lows. 

Why bother with greed-driven chance taking when you can lock in now, get assurance that your rate won’t go up, and have the ability to request a downward rate adjustment should your lender drop rates in the next few weeks?

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Here’s a 2nd opinion from Canadian Business Magazine (old but still good). Link