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Hank Cunningham on the Credit and Mortgage Markets

Hank_Cunningham Many folks are aware that mortgage rates are influenced by the bond market, but not everyone can explain how that relationship actually works. 

To break it down, we took an opportunity to speak with Hank Cunningham.  Hank is one of Canada’s true credit market experts.  Hank is widely quoted in the media, is a frequent guest on BNN, and is author of “In Your Best Interest,” a guide to the Canadian bond market. Hank also hosts of the popular fixed income website

CMT:  Hank, thanks so much for joining us. We’d like to start by talking about bonds and fixed mortgage rates.  A lot of people know that the 5-year bond influences fixed mortgage rates, but what actually causes them to be related?

Hank:  Canada’s mortgage market is dominated by long-term mortgages whose rates are reset every 5 years. The lending institutions are therefore constantly monitoring the yield on five-year Canadian bonds to know the base risk-free rate (and help them price their mortgages).

Lenders may also use 5-year bonds to hedge. For example, they’ll sometimes use the 5-year Canada to lock in a certain spread based on their forward commitments and their own rate views. If they didn’t do this, and rates were to rise before their mortgage commitments were funded, financial institutions would see their spreads (profit) narrow or disappear.

CMT:  Ok. What about variable mortgage rates? While fixed rates are influenced by bond yields, variables are affected by bankers’ acceptance yields. How does that relationship work?

Hank:  Bankers’ Acceptances (BAs) fluctuate with Treasury Bill yields and are a valuable reference point for pricing floating rate mortgages.  They may also be used (by lenders) for hedging variable-rate mortgage commitments.

CMT:  Where can people monitor bankers’ acceptance yields?

Hank:  One can find BAs in the Financial Post–in the Bond Yields and Rates section–and from one’s advisor. You can also visit my website and find BA rates in the Daily Fixed Income snapshot in the learning centre.  Live Treasury Bill yields are available at

CMT:  OK, on a slightly different note, I’ve heard you mention that the 2-year bond can be a useful indicator.  Is it possible to use the 2-year bond to help predict, for example, whether the Bank of Canada (BoC) will raise or lower rates?

Hank:  Yes. The two-year is, in my opinion, the most useful gauge. The Bank of Canada has little influence beyond the 3-month term. The market uses the 2-year for a variety of reasons, one of which is to gauge which way the Bank of Canada is going with rates. As you will see, the two-year yield moves below the Bank Rate before the bank eases and stays below while the period of monetary ease lasts, but begins to turn up and moves through the bank rate when the market perceives tightening. It is very reliable.


                     Chart courtesy of (click to enlarge)

CMT:  What about Bankers’ Acceptance (BAX) futures? How are they used to gauge Bank of Canada rate expectations?

Hank:  Market participants move the yields on the BAX futures to levels reflecting where they think the Bank rate will be at different maturity points.

CMT:  Are BA futures any more or less worthwhile as a BoC indicator than the 2-year bond?

Hank:  In my opinion, they are less worthwhile as they tend to get jerked around more by short-term sentiment, while the two year is out of the immediate range of the Bank of Canada. So while BAX futures represent the market consensus, in my view, the two year is a much more reliable indicator.

CMT:  The press sometimes quotes the “probability” of a BoC rate hike/cut, based on BA futures yields.  Here is a recent example:  “BAX contracts suggest a 68% probability the central bank will lower rates by a quarter-point at the Sept. 3 meeting.”  How can BA futures be used to calculate this probability?

Hank:  If the Bank Rate is 2.00%, spot BAs are 2.25%, and 3-month BAX futures are 2.40%, that would imply that the market believes that there is a 60% chance of a Bank Rate hike. 

If the market was 100% convinced that the bank rate was going up 25 basis points, the BAX futures would be at 2.5%.

CMT:  Do you think mortgage professionals have any chance of accurately and consistently predicting mortgage rates 6-months or 1-year out?  Or is the market simply too random as most academics suggest.

Hank:  No more than any other market participants. No one has ever consistently forecasted interest rate movements. However, the yield curve is a great predictor and market professionals cannot only have a good idea where 6 month and one year yields are going, but they can also hedge their (future) commitments.

CMT:  For those unfamiliar with yield curves, how are they used?

Hank:  The yield curve basically tells you where rates will be. In other words, current forward rates provide the best forecast of future spot interest rates.  (Editor Note:  Here’s a good overview of yield curves from the Globe & Mail.)

CMT:  Lastly, a quick question about Canadian Mortgage Bonds.  CMBs are fully backed by the government, yet always entail a premium over regular government bonds.  Is there any reason someone would be better off in a vanilla government bond than a Canadian Mortgage Bond?

Hank:  The current mortgage rate environment is dominated by the credit crunch situation. Despite monetary ease by the Fed and the Bank of Canada, mortgage rates have remained stubbornly high and will continue to do so for some time as there is scant evidence of any improvement in lenders’ confidence.

The CMBs are a screaming bargain. Even at their normal 15 basis points over Canada’s they are good value but when the credit crunch hit, ALL credits were affected. CMBs blew out to 65 over and are now in the mid 40’s (basis points above Canadian government bonds), still a great deal for anyone.

One day the Government will raise the money directly and give the proceeds to Canada Housing. This would save us taxpayers a lot of money. Also provincial yields have blown out too and are very attractive.


More About Hank

Hank Cunningh
am has been a fixture on Bay Street for over 40 years.  In that time, he’s seen the credit markets from the perspective of a global bond trader at CIBC, a portfolio manager at Investors Group, and Head of Fixed Income at Blackmont Capital–with stops in between.  Hank is currently working on the second edition of his book In Your Best Interest, due to hit stores in early 2009. This next iteration will greatly expand on the current book and offer various bond market strategies accessible to the average investor.