Yields Ascend To A 5-Month High

Everyone’s seen the housing bubble headlines this year. But some say there is a real bubble that’s been overlooked, and it’s been losing air fast.

The reference is to the bond market. Bonds have collapsed and yields (which lead fixed mortgage rates) have catapulted 70 basis points higher since October 19.

On Friday, 5-year government yields made a 22-week high, closing at 2.56%. The Wall Street Journal proclaimed, in reference to US yields, this could be “the end of the bond mania.” (US and Canadian yields are tightly correlated.)

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If yields move much higher, lenders will certainly lift longer-term fixed rates. A few already have. Keep that in mind if you’re planning to get a fixed rate hold soon.

Fortunately, there are still excellent fixed rates to be had. Based on historical spreads, discounted 5-year fixed rates should be roughly 3.76% based on today’s yields. However, you can still get them for the bargain of 3.54% as of Friday (or less if you can tolerate mortgage restrictions).

Whether yields continue higher from here is anyone’s guess. Traders say there is a bias in the market to keep selling bonds near-term, but there is also a high probability of up-and-down volatility until economic growth is more consistent.

Some of the many variables currently affecting yields (and mortgage rates) include:

Whatever the case, yields were unable to sustain the panic-lows they saw in October. Hence, the days of 3.19% five-year fixed rates are probably history.

On the upside, few analysts expect yields to soar and not look back. BMO stated on Friday that Canada could be “in a period of sustained exceptionally low long-term interest rates.”

Nonetheless, if North American economic growth trends higher, 5-year yields could easily pierce 3% in the next few quarters. That would bring 5-year fixed mortgages back to 4.20% or above.


Rob McLister, CMT

  1. Not to be difficult, but the BMO phrasing:
    “If yields struggle to rise against that backdrop, it truly appears that we are in a period of sustained exceptionally low long-term interest rates.”
    is pure analyst weasel-wording, e.g. if x then it “truly appears” that y. They continue:
    “one development that could throw long-run return estimates off base would be a significant reversal in bond yields, which we got a taste of this week.”
    Well yes, if rates go up, then that would contradict the assumption that rates will not go up.
    Since these statements make no truth-claims, one should not attach any significance to them in my view. Fact is, Can bond yields are fundamentally determined by US treasury yields, and these will inevitably go up–the only question is how soon and how fast.
    My opinion: soon and fast.

  2. Hi David,
    Many thanks for the post. Definitely agree with you about BMO hedging their call. Economists have a habit of doing that, as we all know.
    The significance of BMO’s forecast is its underlying belief–that rates will stay reasonably low long-term. Many analysts share this view, which is based on the premise of low-growth (due to our mature economy) and low-inflation (due to the Bank of Canada’s monetary supervision).
    The fact that BMO doesn’t want to be wrong and is covering their butts is secondary. Naturally, any number of unpredictable events could derail this outcome, and a long-term view doesn’t mean rates won’t spike up in the short-to-medium-term. Yet, it’s important for people to know that significantly higher long-term rates are not the most probable scenario.
    Cheers,
    Rob

  3. > mature economy
    Hold on – What were rates back in 2005-2007?
    The only difference between now and then are the emergency interest rates.
    God help us if that’s the new normal because it means we’re circling the toilet bowl Japan style.

  4. No offense but you have a short memory wjk. In 2005-2007 we weren’t coming out of a recession and U.S. home prices were 35% higher. That is a big difference.
    I also believe that each year that goes by North America will lose jobs to overseas. IMO that could be a major drag on our economy over time.

  5. Hi Rob,
    Again, with all due respect, aren’t you just repeating BMO’s tautological forecast? E.g.
    “The significance of BMO’s forecast is its underlying belief–that rates will stay reasonably low long-term. Many analysts share this view, which is based on the premise of low-growth (due to our mature economy) and low-inflation (due to the Bank of Canada’s monetary supervision).”
    So the significance of the forecast that Can rates will stay down is the underlying belief that rates will stay down.
    As a former bond trader, I’d have to say that these arguments are empty. If US treasuries continue to tank, as they are doing as I write, and as they will almost certainly continue to do for the next decade, Can rates will continue to rise. All this stuff about internal Canadian metrics is essentially irrelevant to this process.

  6. Hi David,
    No problem at all. Happy to clarify further.
    The fact that someone qualifies their forecast doesn’t change the point that they lean towards one side. It is BMO’s leaning that is of interest. The fact that it matches market expectations is also of interest. Now, if you want to talk about the accuracy of economists’ forecasts, well, that’s a whole different discussion. :)
    For illustration I’ll note that your forecast has an “if” in it as well, namely “If US treasuries continue to tank.” You’ve also added a prediction on what yields will do for the next decade. Yours and BMO’s are both predictions that are qualified with contingencies. That’s fine. Everyone has their own opinions and that’s what makes a market.
    Cheers,
    Rob

  7. You are quite right, Rob: both BMO’s and my statements contained an antecedent assumption.
    But there is a difference: my antecedent assumption related to the US treasury market, theirs was based on assumptions about the Can. economy.
    I think that Carney’s remarks in the meantime, the continuing selloff in US treasuries, and the fact that–with 30yr treasuries at historic lows–the likelihood of higher and lower rates is asymmetrical, show that my antecedent premise is satisfied, whereas theirs is not.
    Anyhow, as you noted yourself, rates have indeed been raised in the meantime. Meanwhile, treasuries continue to sell off.
    What I’m actually curious about is why BMO says these things, i.e. what is motivating them. (I take it as a rule that house economists are always talking their employers’ book. ;-)

  8. “Based on historical spreads, discounted 5-year fixed rates should be roughly 3.76% based on today’s yields.”
    During the last 10 years, what’s the average historical mortgage spread? 3.76% – 2.56% = 1.2% discounted spread?

  9. Hi Brian, For average discounted 5yr rates it’s roughly 130-140 bps over bonds. That is an estimate. For deep discounted 5yrs it’s approximately 120 or less. The most relevant lookback period is the last two years because banks got very aggressive starting in early 2009. We’ve also factored out the abnormal credit crisis spreads which were not indicative of long-term pricing.

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