Anticipation isn’t just a Carly Simon song. It’s a key characteristic of bond traders.
That characteristic drives interest rates day in and day out.
People often wonder how fixed mortgage rates could increase when the economy is so tentative and the Bank of Canada (BoC) is on hold. Bond traders possess the answer.
Fixed rates are guided by the bond market (which sets the rates lenders pay for fixed-rate mortgage money). It’s a market that is incredibly anticipatory. In other words, bond traders take positions well in advance of significant economic trends. Usually, by the time the central bank says, “OK", It’s time to raise rates,” the bond market has already factored in the hikes.
This chart below displays the last four U.S. FOMC rate cycles. It shows how bonds often sell off months before monetary policy rate increases–which are indicated by the red arrows. (The same principle applies to Bank of Canada rate increases but we didn’t have a BoC chart handy.)
As bond prices drop, rates move higher (bond rates and fixed mortgage rates).
The odds are decent that the same pattern will repeat itself this time around. If so, fixed mortgage rates will likely rise ahead of the first Bank of Canada rate increase.
Chart: Courtesy of Action Economics
Last modified: April 28, 2014
There have been a lot of posts recently on this page regarding the direction of interest rates. I am not sure what the point of all of this is. Is it to help people anticipate the direction of short and long tertm rates? To be used as an advice piece to our clients?
Having been in this business for 15 years, I have learned that the moment you think you know where interest rates are going, the exact opposite happens – just as we have seen in the past few weeks. If you start playing this game, you will get burned.
As mortgage planners and advisor, once you go down the road of giving your clients an interest rate ‘call’, it is the beginning of the end of that relationship because you will be wrong at some point in time. You will look like an idiot.
It would be nice to see more posts around how to provide decent financial planning advice as it relates to managing your mortgage – establishing goals, identifying risk tolerance and providing options/solutions.
Just a thought..
Hi IRS,
Appreciate the feedback.
First off, I agree totally with the essence of your message.
That said, you’ll find stories here about all aspects of the mortgage market and the mortgage process. If you go back in the archives you’ll see several articles on mortgage planning, and new ones come out regularly.
The interest rate stories of late are newsworthy given the environment we’re in. They are intended for general interest only. People like to know how the the market “works,” and what is behind rate movements.
Of course, knowing what drives rates doesn’t really help you predict rates. That’s why you’ll see CMT’s stories commonly advising folks not to play the rate prediction game.
Cheers,
Rob
15 years is a long time in the business. I’m kind of curious. When is the last time you saw bond rates rise this much and then fixed rates do the opposite and fall?
It seems to me that what happened in the past few weeks is really unusual.
Karen
I’m wondering if this isn’t somehow related to the “five year funnel” being created by the new mortgage rules. There are economies of scale in many things.
Perhaps recently increased demand for 5-year money makes it possible to make profitable loans with a lower spread?
Maybe I’m wrong but if demand for 5 year money goes up, wouldn’t supply go down?
Wouldn’t the cost of 5 year money then go up and reduce bank profits even more?
With the BofC overnight rate at 0.25% the is virtually an unlimited supply of money to be lent at 5%
Well, what I was getting at was the idea that the recent qualification changes will cause people to move from variable or three year terms into five.
So in my mind it was just about moving “money available to fund mortgages” from one place to another, although I guess the supply of one type of funding might be more elastic than I expect.
For some reason I have the impression that variable rate mortgages (or even 10 year fixed ones) are often funded out of 5 year bonds anyway.
Who is lending money at 5%? What term are you talking about?
5 year fixed mortgages are not funded with 0.25% money.
ForWhom says: For some reason I have the impression that variable rate mortgages (or even 10 year fixed ones) are often funded out of 5 year bonds anyway.
That makes no sense! Its clear that you have no clue how the mortgage funding market works and all the less reason to comment about it.
Thank you for your well reasoned comment. I think we all benefited from your helpful elucidations of the mortgage funding processes. Your user name is well chosen.
Anyway, banks often have duration mismatch problems when they fund long term loans with short term money. There is no reason in principle they can’t fund any sort of loan they want from any source, though I’m sure they don’t for many reasons.
Now, if you want to be helpful, you could condescend to tell us mortals why the five year fixed rates are dropping while bond yields rise.
If our gracious hosts weren’t so focused on raising the intellectual bar around here, I could have a lot of fun winding you up.
“condescend to tell us mortals”
LOL.