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A New Record Low for the GoC

The 5-year Government of Canada bond yield fell today to a never-before-seen 1.28%.

Its 13 bps drop came on the heels of August job losses, a stock market selloff and more eurozone anxiety.

The spread between posted fixed rates and the 5-year yield (a very rough proxy for a lender’s base funding costs) is acting like there’s a credit crisis. But there’s not…at least not yet.

(Click to enlarge)

Banks are keeping posted rates elevated, in part, to pad profits. They’re also building a buffer to ride out potential turbulence in funding costs (due to credit market volatility). There’s also speculation that they’re doing so to keep qualification rates high—so people can’t get into “riskier” variable-rate mortgages so easily.

In the 10 years prior to the credit crisis (pre-2008), the 5-year posted-bond spread averaged 237 basis points. If you applied that “normal” spread today, 5-year posted mortgage rates would be closer to 3.66%, instead of their current 5.39%.

On the bright side, inflated posted rates are keeping IRD penalties lower than they otherwise would be. That’s certainly a help to people breaking fixed-rate mortgages.

Posted rates aside, it is inflated discounted rates that are the real irritant. Today’s “discounted” fixed rates are in no way commensurate with banks’ astoundingly low funding costs. If you applied a typical 135 bps spread above today’s 5-year yield, you’d have a 2.64% five-year fixed mortgage. Instead, borrowers are being fed rates as high as 3.59%+!

Granted, there are slight liquidity premiums and IFRS premiums built into today’s rates (compared to pre-2008), but those in no way justify the mortgage spreads we’re seeing.

Banks are obviously not feeling enough public pressure yet to reduce their astonishingly high fixed mortgage margins. We’ll see if they feel any more generous next week…

Rob McLister, CMT