The 5-year government yield is doing the limbo, and the bar keeps being lowered.
It closed Friday at 1.35%. How low it goes depends on how bad things get economically—and how bad investors think things will get.
It’s interesting to contrast Canada to other countries because our yields are still notably higher than many. That’s despite a relatively stable fiscal and economic outlook.
Here’s a sampling of 5-year yields from around the globe, including each country’s debt-to-GDP and unemployment rates (UR):
- Canada: 1.35% (Debt/GDP: 36%; UR: 7.3%)
- U.K.: 1.32% (Debt/GDP: 86%; UR: 7.8%)
- Germany: 0.91% (Debt/GDP: 44%; UR: 6.1%)
- U.S.: 0.87% (Debt/GDP: 61%; UR: 9.1%)
- Switzerland: 0.38% (Debt/GDP: 20%; UR: 3.9%)
- Japan: 0.35% (Debt/GDP: 183%; UR: 4.7%)
Economically, these other countries don’t compare cleanly to Canada, but they do have a few things in common:
- Each is being impacted by the same worldwide trends (including a global slowdown and flight-to-safety).
- There are plenty of investors willing to settle for ultra-low yields (temporarily at least) on the debt of countries that are arguably less fiscally and/or economically stable.
It’s therefore not inconceivable that Canada’s 5-year yield could inch closer to 1.00%. If it does, and financial crises don’t further inflate liquidity/risk spreads, fixed mortgage rates could potentially keep falling.
Europe is a huge wildcard, though. Rising risk of default by one of the PIIGS could boost liquidity/risk premiums in the mortgage market and offset falling yields. That could actually drive fixed mortgage rates higher unexpectedly (we all remember spreads in 2008).
Looking out longer-term, one has to wonder when:
- Investors will tire of negative real returns on bonds (after factoring in inflation)
- Economic growth will return to some semblance of “normal” (both globally and in North America)
- The spectre of insolvencies will diminish in the Eurozone
- Core inflation will start a steady march above the BoC’s 2% target
- The U.S. will stop coaxing yields lower (using its ever-creative monetary policy toolbox)
It seems the market is betting these collective changes might take anywhere from 9-24 months or more.
When global prospects finally do turn around, it could spark a stampede out of bonds—and a rapid rebound in yields. “A lot of capital just has nowhere to go right now,” says analyst Colin Cieszynski, “and when you have people piling into one thing, it can be disruptive when they come out.”
In the meantime, we’ll keep an eye on indicators like the TED spread (a gauge of credit market risk), government yields and the “posted–5-year GoC” spread for hints about where fixed mortgage rates are headed.
Source for debt-to-GDP and unemployment rates: OECD
Rob McLister, CMT
Last modified: April 29, 2014
Does it even matter any more how low they go? We have seen in the last 2 mos that lenders have a lower limit on discounted fixed.
Hi Dave,
It does matter because, as we’ve also seen, that lower limit has slowly fallen. All it takes is one or two lenders to break ranks and it falls a bit more. There are always lenders at the margin that are less afraid of being competitive.
Barring the unforeseen and holding liquidity/risk spreads constant (a key qualification), it’s unlikely that yields could keep falling with no effect on deep discounted fixed rates.
Cheers…
Rob this coming week will be anther turbulent stock market, we could see short term yields go lower still.
Hi Cameron,
That’s certainly possible, and if yields drop more we’ll have to see if it’s offset by wider funding spreads. The mortgage securitization market is tightening up a little bit because of all the uncertainty. You can see it in this week’s Canada Mortgage Bond issuance, which saw decreased liquidity (more expensive funding costs and smaller allocations to lenders).
Good post Rob. I would, however, point out that when provincial and federal debt is aggregated, we have 110% debt-to-GDP compared to 120% combined federal/state debt in US. Yes, we have more combined provincial debt than federal debt.
I’m also not sure where you found the federal debt-to-GDP figure of 36%. I’ve calculated it at 50% using CANSIM tables directly from Stats Canada. Here’s a visual:
http://theeconomicanalyst.com/content/canadas-economic-prospects-sour-imf-bmo-bank-canada
Cheers
Hi Ben,
Thanks for the note. Trust things have been going great at the Economic Analyst.
This particular article compares sovereign 5-year yields. For that reason the relevant debt is that guaranteed by the federal government—so provincial debt is excluded.
The data presented is the latest available from the OECD. It normalizes a lot of its data which makes international comparisons a bit easier.
If you click the OECD link above and type: “central government debt” in the search box, you’ll find the respective data series named “Central Government Debt”.
I’m not sure of the definition or composition of the federal debt figures you noted, but the OECD’s data is primarily based on “the Debt Management Report, published by the Department of Finance and the Summary of Government of Canada Direct Securities and Loans, published by the Bank of Canada.” The reported data corresponds to “outstanding amounts of debt issued by the federal government and does not include off-balance-sheet derivatives (e.g., swaps) and non-market debt (i.e., debt not issued to the general public). Non-market debt is, however, a component of the Government of Canada’s net liability position and is reported in Canada’s Public Accounts.”
More details available at: http://stats.oecd.org
All the best…
Thanks Rob!
Good article! Thanks Rob.
Just deciding on a mortgage. What would you guys recommend, fixed or variable?
thanks