The cost of funding fixed-rate mortgages surged this week as bond yields escalated.

The 5-year yield is up over 30 basis points in 10 days, and 45 bps since the end of January.

That means lenders could start pulling some fixed-rate specials and/or increasing rates in general, as early as next week.

Some have already lifted rates in the last 48 hours and we hear at least one major bank will be cancelling its 2.99% 4-year offer on Tuesday.

As for the industry’s headline 2.99% 5-year promotion from BMO, a spokesperson there told us: “The offer remains available until March 28.”

Despite rising funding costs industry-wide, BMO says: “We have structured our offering based on maintaining margin.”

More on BMO’s Strategy

Our sense is that reports of BMO “amassing a stockpile of cheap funding in the bond market (for months in advance of its big promotions),” might be misleading if taken in a literal sense.

That said, it does seem apparent that BMO strategized so it could afford to keep its 2.99% offer on the market while other lenders raise their rates.

A capital markets source tells us: “One way to lock in margin is through hedging. (For example,) you could put on a ‘pay fixed’ swap to lock in (the equivalent of a specified) bond yield.”

By “swap,” he’s referring to interest rate swaps, which are instruments that banks regularly use to hedge the rate risk on their fixed rate mortgages. (Remember also that bond yields serve as a rough proxy for the base funding cost of a fixed mortgage.)

The 5-year swap spread (i.e., the swap rate minus the 5-year government bond yield) is currently reflecting significant demand by lenders to hedge fixed-rate mortgage activity.

In fact, the swap spread has almost doubled in the last month, to an uncommonly high 30 bps. That happens when there’s a lot of mortgage fixing going on, or a lot expected.

“Hell, the BMO Treasury guys can help move the markets with the sizes they need to undertake,” another dealer told us.

That dealer adds that hedging of this sort is not unheard of, and is “hardly a market bet, though it could be construed as such. It’s more like common sense.”

“Based on where we were/are in yield levels, (and) when you assess all the market conditions and the thinking of the Bank of Canada, (you have to ask yourself): How much lower do you think they’re going to go?”

“Add in the huge spring…mortgage season, (potentially large) renewal volumes, the fact that floating and fixed rates are on top of each other, and the fact that fixed rates are (on) special.”

Taking all of this together, it would not be surprising if BMO hedged much of its exposure in the financial markets before this promotion.

Rob McLister, CMT

Last modified: April 29, 2014