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Markets Reverse Engines. Bond Yields Soar. What Next?

Confused-Bond-Trader Up till yesterday, investors have been pouring into government securities as a safe haven from market turmoil.  Now, with the U.S. government rescuing financial institutions, investors are pouring back out of them.

As traders dumped bonds today, yields were flying.  The 5-year bond rate is up 0.21% today to 3.16%.  Just Monday, it was at 2.81%, after the biggest drop in almost 13 years.

What does this all mean if you’re looking for a mortgage?  We had an opportunity to speak with CIBC’s senior economist, Benjamin Tal.  His advice, and it’s good advice, is for people to “divorce themselves from the volatility.”  He says the move in yields “has nothing to do with the economy’s current fundamentals.”  Mortgage shoppers “cannot make educated decisions based on where yields are now because they may change tomorrow.”

From a lender’s point of view, the market has been absolutely wild.  Lending spreads were already wide going into this mess.  They got even wider this week. 

Spreads improved a bit today but there’s no telling when they’ll revert to normal.  Mr. Tal says, “To the extent the market is relieved by the U.S. government’s intervention, it might reflect the beginning of the end.  Will spreads soon go back to ‘normal,’ however?  I don’t think so.”

To relate this to mortgages, whereas homeowners were getting prime – .80% not that long ago on a variable mortgage, prime – .50 might be the new “normal” for the foreseeable future. 

Are variables still a good bet, however?  Mr. Tal believes that the likelihood of rates increasing in the short term are relatively low.  “Short term you can still go variable,” he says.  “The likelihood in the near term that rates are going up is low.”

Looking out through 2009, it might be a different picture.  “Although the current environment may be deflationary, when the global economy starts rebounding inflation will again be the issue.”  Mr. Tal points out that the latest round of central bank rate cuts were basically emergency cuts.  When the economy and commodity prices bounce back, bond yields will likely start creeping up, with mortgage rates following.