Following our October 27 story, a few readers questioned how low Canadian bond yields (and hence, fixed mortgage rates) can really go. Despite that story’s curt title “The Bottom is Zero,” the bottom in bond yields is actually (theoretically) below zero.
Negative bond rates have numerous precedents. Government yields from countries like Japan, Switzerland, Germany, Sweden and even the U.S. have all been sub-zero. When yields dip below zero, it means giant fixed-income investors are paying for a safe place to park their billions.
As just one example, observe this chart of the Swiss 2-year government bond. It’s been underwater (with a yield below zero) for several quarters.
Some wonder if this could ever happen in Canada. Many feel it’s so unlikely as to not bother entertaining the thought, especially for longer duration bonds like the 5-year.
To hammer Canadian yields down to zero (or below) would take persistently feeble growth and inflation, coupled with aggressive bond buying — including considerable safe harbour buying and/or quantitative easing. If it ever did happen, 5-year mortgage rates could dive to astonishingly low levels, perhaps as low as 150-175 basis points above a 0% five-year government bond.
Mind you, while a 1.50% 5-year fixed rate may sound enticing at first blush, we best hope that Canada never sees those rates. They’d likely be accompanied by dire economic and employment ramifications.
In any case, the fact that negative yields are possible in Canada doesn’t make them probable, at least not in the near term. Moreover, this theoretical discussion does little to help someone pick the right mortgage, other than to quash thinking that rates can’t fall much lower. But even that is a worthy endeavour, to the extent it reminds people that locking in is not the only rational mortgage strategy.
Rob McLister, CMT
Last modified: April 26, 2017
Rob, when I came to Vancouver in 1997 the outstanding Residential Mortgages in Canada were close to 600 billion. Now according to Stats Canada (http://bit.ly/Trillion-1) it is 1.2 Trillion (doubled in a bit more than 15 years), so it has become a big rock to move. Let’s do the Math… if residential mortgage rates increase 2%, that would mean canadians would pay $24 billion a year more in interest. Given the current Government worry of too much debt, negative savings… etc…. Would this be possible?
Hi Camilo, Do you mean, would it be possible for mortgage rates to drop another percentage point, given the housing imbalances in Canada’s major cities?
There is a flip side too….negative or low bond yield will not automatically accompany low mortgage rates. if the macro economic factors are negative (high un employment, property market crash, fiscal burden on the Government etc), the credit riskspread will increase and mortgage rates may become higher.
the best thing to hope is growing economy and afforadble mortgage rates (affordable is a relative term!)
You’re absolutely right about spreads Sunny. While we’ve seen mortgage rates follow plunging yields in countries like Germany, it’s not a given. Thanks for the post.
Robert, my point is that residential debt in Canada is so high and the probability of rates going lower are low AND also the probability of rates going too high is also low in my opinion since it would cause a big negative impact… so my question is are we going to stay at this level long term?
Hi Camilo, Mortgage rates ultimately follow bond market and money market rates, which are primarily governed by supply/demand factors unrelated to Canada’s housing market. Despite the BoC’s well-warranted housing concerns, it’s highly unlikely the BoC would let those concerns overshadow inflation risks when setting Canadian interest rate policy. Moreover, the BoC cannot control the infinite international factors that also play on Canadian rates. Long story short, Canada’s real estate challenges will not dictate mortgage rates over the long run unless they threaten to push inflation beyond acceptable bounds.