Dramatic Sentiment Shift

The air of concern about a North American economic slowdown has grown thick enough to slice. Nowhere is that more evident than in the U.S. treasury market, where 2-year yields have collapsed to an all-time low of 0.4892%.

What a stark contrast to just four short months ago, when Canadian headlines cheered the great economic rebound of 2010.

Now the bond market is acting like the U.S. and China are shutting down their economies.

Of course, when yields plunge there is an upside:  lower mortgage rates.

Highly discounted 5-year fixed rates are now in the 3.89% range, less than 1/2 point from the lowest we can remember. They’ll probably go even lower in the short term.

Fixed-Variable-Mortgage-Spread Moreover, the percentage spread between discounted 5-year fixed and variable rates has tumbled over 110 basis points in the last few months. That’s reduced the variable-rate advantage markedly.

In fact, our models show that fixed and variable rates are once again neck and neck in terms of 5-year hypothetical interest cost. That’s assuming you buy into the rate increase projections of major economists (i.e., up 2.00-2.50% in the next 18-24 months).

That said, the 5-year fixed isn’t the only term benefiting from the recent plunge in yields.  There’s tremendous value in 1- and 3-year terms as well.  Have your mortgage planner run some amortization simulations to see which term might work best for you.

  1. Can someone comment on the correlation of future bond yields and variable rates.
    I would have thought that yields would reflect a prediction on where the BOC rate was heading. i.e. variable rates won’t keep going up if the future yield remains low.
    Why would you take on a bond with a yield that was less then what you would get in a money market type situation?
    What am I not understanding?

  2. The Bank of Canada overnight rate, which variable mortgage rates are directly tied to, generally only influences short-term fixed rates (up to 2 years). Beyond that, the longer-term fixed rates are influenced by a variety of other factors:
    – US bond yields
    – inflation expectations
    – economic growth expectations

  3. Money market rates are not as high as bond yields. Not right now anyway. Short and long-term rates do move the same direction over longer time periods but they have huge deviations in the short term.
    Bond rates always reflect BOC policy. Right now the bond market appears to think the BOC will not have to tighten significantly and rates will stay low.

  4. IMHO, the economic reports that called for a 200-250 point increase in rates are somewhat outdated now. They were forecasting rate increases in at a time where the general consensus was that the worst of the economic news was behind us. Now the concern is that we are susceptible to a double dip. Add to that the BoC’s and Feds recent guidance, I think it is prudent to assume that rates will not increase as much or as quickly as forecasted a few months ago. If you believe that to be true, VRMs are still the way to go.

  5. Hi AC,
    Thanks for the comment. I know what you’re saying and there’s no doubt that rate projections have leveled off a bit.
    Economists’ 200-250 bps estimates are still current however. It seems that most of them don’t want to revise down their projections much more–at least not yet. There’s just too much uncertainty at this point and two years is a long time. A lot can improve in that timeframe. Heck, a lot can change in a few months, as the last few months have shown.
    It’s all speculation as always. However, you might want to consider a 3-year fixed term as well. 2.90% locked in for three years is extremely compelling in almost any environment.
    Cheers for now,

  6. another plight to produce more converts from VRM to fixed. Japan had near zero rates for the better part of a decade, isn’t this a possible scenario here? If we see short term 2-3% rate hikes then the little guy that’s leveraged to the max will feel the greatest impact and we’ll see alot of negative activity in RE at the entry level.

  7. Anything is possible but Canada and Japan have so many differences.
    Japan suffered from deflation. We are not.
    Japan was not resource rich. We are.
    Japan’s debt is 170% of GDP. Canada is 62%.
    Japan’s equity market went meteoric and then collapsed. Not in Canada.
    Japan had to bail out and nationalize its banks. No such problem in Canada.
    Japan’s recession was much deeper and the Bank of Japan cut rates slower. Not in Canada.
    The differences go on and on. My point is, don’t bet on Canada going down the same road. Likewise, thinking that rates will not normalize here in Canada would be a mistake.

  8. An accurate analysis but all I’m really saying is that the low man on the totem pole needs a break, why can’t existing home owners get a chance to “owe” a little less?
    LOW RATES could impart a different scenario compared to the effects of Japan’s lost decade and here’s how…
    The homeowners of Main Street can stimulate GDP if they could save some points on their mortgage and inject that cash into other parts of the economy. This would be a more effective solution compared to some of the QE efforts from the BOC.
    AND let’s try to filter out Joe Speculator by returning to 25 yr ams and other tougher lending rules as the RE market becomes “balanced”. Sure, we’re at a major resistence level now but it would only take a small drop in prices to find support from those envious “renters” that are currently sitting on the sidelines.
    ‘Give’ to the people at the bottom of the pyramid and you will rebuild a strong economic foundation, otherwise we’ll lose our good jobs and find ourselves flipping burgers or fetching you coffee.

  9. Paul,
    You missed another important comparison…
    Japan’s financial system mainly benefitted Large Business and favored heavily secured, high value transactions. Japan’s banks didn’t have the wherewithal to deal with SME’s or the average consumer. Not the same in Canada.
    This is pivitol because when the meltdown kicked in there were no tools to jump start the economy. There was a heavy reliance on big business to step in and recapitalize but many of these guys were only interested in hoarding liquid assests instead.

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