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Yields Boomerang From Lows


As noted Monday, it would take a strong rebound in bond yields to derail further reductions in fixed mortgage rates…and that’s exactly what we got.

The 5-year government yield has catapulted 30 basis points from Monday’s psychological 2% level. On a closing basis, that’s the largest 2-day advance since October 2009.

At the moment, we’re 6 basis points above the 5-year yield on June 3. That’s the day when banks last cut advertised fixed rates. If yields continue much higher, current bargain basement five-year fixed rates (like 3.59%) could disappear posthaste.

Among other things, this whipsaw in yields is being driven by:

  • Today’s stunning surprise with May inflation (At 3.7%, headline inflation is on its fastest pace since 2003. Although, some analysts see this as temporary given recent easing in commodity prices. Core inflation [which is more relevant for interest rate policy] also exceeded forecasts at 1.8%, just under the BoC’s 2% target.)
  • Improving odds of a Greek debt restructuring
  • Technical factors (Bond traders are taking money off the table after almost three months of aggressive buying.)
  • Rebounding equities (and asset allocation out of bonds)

As of yesterday, financial markets weren’t fully expecting a rate hike until spring 2012. Today’s news has brought those expectations closer. Overnight index swap traders are now pricing in a 60% chance of a December increase (up from 30% on Monday). We may also start hearing more economists become vocal in support of a fall rate move.

Be that as it may, CIBC economist Avery Shenfeld suggested today on BNN that the BoC will still need to see real sustained “demand” before lifting rates. A big spike in headline inflation, on its own, doesn’t justify removing liquidity from the system.

Rob McLister, CMT