Yields, Swap Rates & Fixed Rates — Higher Yet Again

steep-climbBond yields have been going vertical.

By early Thursday, the 5-year yield—which influences long-term fixed rates—was up as much as 20+ basis points in less than 48 hours. That’s an unusual move and it was driven by optimistic economic comments from the U.S. central bank.

This spike in yields has led dozens of lenders to announce fixed rate increases. The most notable today was RBC, which is boosting certain discounted fixed rates by 20 basis points on Monday.

But it’s not only bond yields that are flying. So is the 5-year swap spread, and that also has mortgage rate implications.

Swaps Basics

A “swap” (interest rate swap) is an agreement to exchange two different types of interest payments:  fixed-rate payments and floating-rate payments. Financial institutions buy swaps to hedge interest rate risk and lock in profits.

A simplified example of hedging: A bank with 5-year fixed mortgages receives fixed-rate payments from borrowers. That same bank also has short-term deposits. If short-term rates rise, the bank would have to pay higher rates to depositors, but be left with the same fixed rate payments from its mortgages. To solve that problem, the bank buys a swap that lets it receive floating-rate payments (at a higher rate than it has to pay out to depositors). In exchange, the bank must give its fixed-rate payments to the swap seller.

Why swaps matter

The difference between the 5-year swap rate and the 5-year government yield is called the “swap spread.”

When the swap spread gets wider, fixed mortgages can become more expensive to hedge, other things being equal. That often happens when bonds sell off and yields soar. Lenders then pass along that added cost to borrowers.

Here’s a chart of the swap spread from earlier Thursday. As you can see, it has been making new relative highs.


(Click to enlarge)

Swap spreads may continue to widen if Canadians rush to lock in low rates. In that scenario, banks would have even more fixed-rate mortgages to hedge in the swap market.

It’s hard to say how long rising yields and widening swap spreads will exert upward pressure on rates. So if you need a mortgage in the next 180 days, call your broker or banker soon for rate hold. Some protection is better than none, and you can always cancel a rate hold if needed.

Note: Variable rates are unaffected by this news. Image courtesy of flightzone / stockarch.com

Rob McLister, CMT

  1. It is good for the economy because people who have fixed rate mortgage would feel rich and they will spend more. Nice !!!!

  2. It is good for the economy because people who have fixed rate mortgage would feel rich and they will spend more. Nice !!!!

  3. It is good for the economy because people who have fixed rate mortgage would feel rich and they will spend more. Nice !!!!

  4. Interesting information about how swaps factor in to fixed rate pricing. Does this factor in to the margin lenders generally seek, meaning we are more likley to see spreads >1.5% over bonds if swap costs continue to rise?

  5. Get ready for another round soon. The five year getting hammered again today. This is escalating much faster than anyone thought…

  6. For those interested in the nitty gritty, here’s another factor inflating swap spreads (quoted today from a capital markets pro):
    “The September CMB is pricing today. That (also) has some implications for swap spreads. Participants will unwind existing hedges and put on hedges mandated by the CMB program. Market makers usually take advantage of that…”

  7. Hi guest, As of this minute, there are still a few 5yr fixed deals for well qualified borrowers in the 2.89%-2.99% area, depending on the features/restrictions you can live with. I’m not sure how applicable those lower rates still are. Cheers…

  8. Is the previous decline of swap spreads also what made the discount of variable mortgages shrink so much compared to 2011? If spreads rise like this, are we going to see more discounted variable rates again?

  9. A thank you to Rob for maintaining this site. We renewed our VRM(Prime-0.50) two months early on June 13, electing for 5 yr fixed at 2.99%. We had done well since purchasing our overvalued home in Aug 2008 by reducing mtg from 446K to 276K. (595K purchase, current tax appraisal 480K).
    I have spent the last 6 months or so checking every day or two to see the news/posts here on this site. Again, thanks for aiding and educating the consumer.
    BTW we stayed with CIBC (typical CDN bank customer). A big reason being the Mortgage Payment Disability insurance claim I have been on for the last 5 months.

  10. Unless there is another financial blowup somewhere I think we’ll see discounts improve on variable rates.
    If the Bank of Canada raises rates, I’d say it’s a given.

  11. CIBC, has not raised its five year fixed yet and mortgage advisors in BC have discretion as low as 2.84% still… not for long though.
    They can write mortgages in any province at those rates just that BC specialists have lower rates than other provinces because of the huge competition in Vancouver and Victoria.

  12. Rob another great article. Do you have any idea what % of borrowers take a split term mortgage I know several banks and credit unions offer this option but do any mono lines? Seems to me to be much like a GiC ladder strategy for hedging rate risks ?

  13. I think what ON Broker was saying that variable rates are going to start once again being the more desirable of the two, and I agree. The debate between variable and fixed is going to become heated once again. I also agree that this thing is happening much faster than anyone thought it would. Thanks for the breakdown of the swap spread, Rob!

  14. Be nice and pleasant to work with… lol
    Full disclosure: I work for CIBC but as a daily reader of this site make it a policy not to solicit clients from here… I want Rob and Melanie to prosper as much as possible from all their efforts in maintaining the best resource in Canada!
    Check with Rob and Melanie to see if they have options for you first…
    If you want to get a hold of me Rob has my email and can put us in touch.
    Island Advisor

  15. or maybe just a trick to lure people to lock on a fixed term and rate.
    time will show, but one thing is sure – Canada or US didn’t become richer in the last few months to justify this increases.
    I bet it’s mostly speculation.

  16. The U.S. seems to be on a calendar schedule now to march QE down to zero then start marching the interest rate up. Once that happens the market for Canadian and Australian bonds is going to be impacted.

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