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A Historic Day for Yields

This has been one spectacular swan dive in the 5-year Canadian bond yield. We ended Thursday at 1.01%, an all-time low and just a “beep” above the psychological threshold of one percent.

If you’ve been watching this waterfall in yields over the past two months, you may well be wondering, “If bonds lead fixed mortgage rates, when will we finally see some rate love from lenders?”

In the past, when long-term yields have moved 15-20 basis points, lenders have adjusted fixed rates accordingly. But today is a different world. The banks, which control over three-quarters of the mortgage market, will be “ruthless” at protecting earnings, analyst Peter Routledge told the Financial Post.

Banks will do (and have been doing) whatever they can to maintain margins. It’s a testament to their power that they’ve kept 5-year rates near 3% for this long. And fortunately for them, very few large lenders are stepping out of line. That’s despite the fact that fixed-rate funding costs (as approximated by the 5-year swap) have dropped 40 bps in the last month and over 60 bps since September.

In fact fixed rates have been rather flat since last summer, with 5-year rates dropping just 10 basis points or so to roughly 2.84-2.89% on average. Compare that to “fair value,” which is roughly the five-year yield plus 150 basis points, or somewhere near 2.50% today.

Given enough time we’ll see those 2.50% five-year fixed offers, and better. But don’t expect mortgage rates to fall beep for beep with bond yields. Government initiatives to bolster financial stability (e.g., securitization limits, greater capital requirements, regulatory compliance, lending restrictions, etc.) have been costly for the banks. Moreover, their base funding costs haven’t improved as much as bond yields have (as swap spreads indicate).

The end result is that mortgage rate premiums (over bond yields) may continue to remain disappointingly high relative to recent years. That is unless one of the Big 6 breaks ranks and starts pricing assertively.

On that note, spring is just around the corner and we haven’t seen a conspicuous BMO mortgage sale in months. A headline-grabbing 2.79% to 2.89% promo could get the market’s juices flowing once again.

For now, given the high volatility, most lenders may just wait for yields to settle before adjusting rates. That could take a few days, a week or more. (Some of the banks did cut fixed rates this week, but only by a measly 5-10 basis points.)

There has been one signal of competitiveness, however. On Wednesday RBC slashed its 10-year fixed rate to 3.99%. That’s the lowest nationally available 10-year in over 12 months. But with financial markets pricing in a 65% chance of a rate cut (yes, cut) by October, no one is going to be lining up for 10-year money.*

On the variable-rate front, things couldn’t be better. Oil’s collapse is alleviating inflation worries, variable discounts are improving and our dismal scientist friends are once again postponing their rate hike forecasts—this time until 2016 and even 2017. Speaking of economists and rate predictions, it’s about time those guys just give up. Really.

* Implied probability based on overnight index swap (OIS) prices.

Chart source: BigCharts