Yields Plunge. Spreads Explode

The bond market continues to defy economists’ expectations (no news there). What is news, is that the 5-year yield has fallen to 2.30%, well below technical support at 2.40%.

Disappointing Canadian GDP, weaker growth in China, and rallying U.S treasuries are just the latest catalysts pushing down yields. The 5-year GoC is now back to its yield levels from May 2009.

More importantly, the spread between discounted 5-year fixed rates and the bond is now 2.09%—a 15-month high. (The 10-year average is 1.25)

Fixed-Bond-Spread(Click chart to enlarge)

Fat spreads mean fat profits for lenders. It also means that fixed rates are way higher than they should be, based on the cost of funds.  The last time the 5-year yield was at 2.30%, discounted five-year fixed rates were 3.75%. (The banks’ “special offer” discounted rates are 4.49% today.)

It wouldn’t be a stretch to expect more cuts to fixed rates soon…

  1. Banks and credit unions have 607 billion in mortgages on their books at May 2010. Another 300 billion is in CMHC mortgage backed securitization.
    That’s 1 trillion of mortgages. Despite the interest rate spreads, where will the banks scrounge up more money to lend?
    Greece has high interest rates too!

  2. We live in interesting times indeed.
    1 month ago bond rates were going up and now they are going down.
    As someone who has to borrow for large commercial and multifamily buildings it is definately interesting! One month GOC bonds rates are up and consequently CMBs (Canada Mortgage Bonds), the next they are down.
    The past ~2 years of cheap short term (1-2 year term rates) money is hard to beat because bond yields would have to rise A LOT in years 4&5 of a 5 year term for me to be looser. (provided your building has cash flow to absorb any hikes in rates.)
    Is everyone going 5 year terms or are there other contrarians out there who like the 1-2 year term cheap-cheap money?

  3. discounted variable rate still handedly beats all fixed term rates at this time.
    A smart and sound pay down strategy is to make higher payments equal to a 5 or 6% fixed mortgage and slash the principle owing. Just my opinion.

  4. “It wouldn’t be a stretch to expect more cuts to fixed rates soon…”
    Characteristically cautious words from CMT! Perhaps afraid to step on any toes?
    I think it’s imperative that fixed rates should be cut immediately … and not afraid to say it like it is ;-)
    Just like that chart posted shows, profit spreads are over 200 bps, compared to under 100 bps in March … that’s gotta come in. Hopefully competition drives it down sooner rather than later. This should also keep the housing market alive a bit longer.

  5. “Fat spreads means fat profits for lenders.”
    “It wouldn’t be a stretch to expect more cuts to fixed rates soon…”
    Fat chance! The fat cats (banks/lenders) are running this game for the profits. Gluttony and greed are considered “capital vices” 2 of the 7 deadly sins.

  6. Why do banks remind me of gas stations? Oh right, that’s because they’re so fast to raise rates but extremely slow to lower them.

  7. Now it’s a holiday here so they will probably try to hold off cutting rates until next week, and hope that bond yields are back up by then.
    By the way why do the other banks always have to wait for RBC to act first?

  8. A week, a trend does not make. Agreed there is fat to trim in the spread but to expect Banks to trim the spread back to 80-90bps like it was in March 2010 is totally unrealistic. After arrears, securitization, broker commissions, fraud, and other operating costs, no FI stands to make money on such a business model and FI’s like most businesses are not in business to lose money.

  9. If bond yields stay low discounted rates will drop.
    On a slight side-note, It seems that the government has made it quite profitable for banks to keep posted rates high. Not only do high posted rates do the obvious (give certain customers the feeling that they are getting a good deal / special treatment, make desperate customers renew with unfavorable terms, stop many customers from qualifying for less profitable variable rate mortgages). They also impact commercial lending quite a bit.
    The Canada Small Business Financing Act says that For a variable rate loans, the maximum chargeable is the lender’s prime lending rate plus 3%. For a fixed rate loans, the maximum chargeable is the lenders’ single family residential mortgage rate plus 3%.
    If the big banks lower their posted residential rates or their prime rate, it restricts the maximum amount they can charge on Government Insured Commercial Loans. By contrast, offering discounts to some or most customers seems to have no impact on commercial lending…

  10. This is no better than pure Robbery.
    There is no way that fixed rates should be where they are currently with the bond yields where there are at. 5 year and 10 year yields are back down to the lows seen during the ‘panic’ in 2008/early 2009. Fixed rates should be at record lows just now. They are not even close. The only reason can be that the banks dont think the economy is ‘that bad’ and that leading indicators may turn around again to the upside. Dont bet on it. The US is in freefall again and with Europe also struggling, dont expect Canada to hold up all by itself. As seen by the very disappointing GDP numbers in April in Canada, WAY below expectations, our economy is starting to tank as well. Rates will HAVE to come down. The banks are just holding on as long as they can right now.

  11. Hi Banker,
    You’re right that 3.75% isn’t realistic for a full-featured 5-year bank mortgage at this time. That kind of cut should not be inferred from this article. But some degree of rate improvement is definitely overdue, and it should be more than a token 5-10 basis points.

  12. Hi Dan,
    When it comes to rate predictions you can always throw caution to the wind and hope you’ll be right. But the market is proficient at taking people who are too confident and making them look like chumps.
    That said, as the article suggests, fixed rates should be cut, and they likely will be soon.

  13. Hi Dan,
    Every bank has been waiting for someone else to act. They’ve been milking these spreads for all they’re worth.
    The first to change rates is often RBC, but other banks also occassionally lead the pack (e.g. TD, BMO, etc.).

  14. Sorry banker, but you sound like you don’t know enough to make that statement. If you have some real numbers maybe you have a case.

  15. Agreed, markets are too volitile to be making changes w/out an established trend. Banks change today and yield explode next week. Traders have been whipsawing this market around via cheap paper/margin since Sept 2009. The current bond rally will begin to unwind. Yields are so low there’s not much more to squeeze out of them. Keep the rates where they are at… I’d much rather slow growth than a continuation of senseless rising house prices in Vancity. 620K to get into a single detached home.. in the suburbs. I mean c’mon!

  16. folks, I have a 3.75% for 5 years locked in till the end of July; or I can go with a prime-0.6 on a $400,000 mortgage. What should I do? I have been considering a hybrid of 50% fixed and 50% variable.

  17. I have the same dilema. Right now I am on variable,prime -0.75% for 180,000 mortgage.Should I go hybrid? Thank you.

  18. You can’t pick a mortgage by only comparing the interest rates. Consult a mortgage specialist for proper advice.

  19. Fat spreads also means there is a higher probability of a falling Canadian house market. Considering high spreads started in 2007 and later abated in early 2009, and high spreads are now coming back, this has mirrored what has happened in the housing market. Drop, bounce, and now down again. I am seeing sales to new listings ratios below 50% in Calgary which is indicative of a declining house market and inventory levels are now near record levels (again).

  20. I’ve considered this, plus having extra cash on hand allows for more flexibility if looking for purchasing opportunities.

  21. Yields crept back up today … ahhh well … there go the dreams of seeing record-low fixed rates again. The banks dithered and now the pressure is off.
    We’re now about 12-13 bps above last week’s lows on the 5-yr.

  22. There is no reason for yields to be this low. The banks know that so don’t expect them to reduce rates much further.

  23. Sorry Brian, seems your dead wrong in your blank assessment. I should know enough about banking product margins and real numbers since my signature and credibility goes on the front of our FI’s glossy annual report every year.

  24. Well the banks sat tight while yields were uncomfortably low … and now they’ve been rewarded, we hit 2.50% again today, back to a normal ballpark.
    We all know where that big sigh of relief is coming from …

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