When it comes to understanding fixed mortgage rates, bond yields are a key factor. In this guide, we’ll explain what bond yields are, how they work, and their direct connection to the pricing of Canadian fixed mortgage rates.
Whether you’re a homebuyer, investor, or mortgage professional, this information will help you understand the financial dynamics that influence mortgage rates.
What are bond yields?
Bond yields represent the return an investor can expect to earn from holding a bond. In simple terms, they indicate how much income (interest) an investor will earn relative to the bond’s current market price or its face value. Bond yields are typically expressed as an annual percentage and are influenced by factors such as interest rates, inflation, and the perceived risk associated with the bond issuer.
There are several types of bond yields:
- Coupon yield: The bond’s fixed interest rate, calculated as the bond’s annual coupon payment divided by its face value.
- Current yield: The bond’s annual coupon payment divided by its current market price.
- Yield to maturity (YTM): The total return an investor can expect if the bond is held until it matures, accounting for both interest payments and any capital gain or loss.
- Yield to call (YTC): The yield an investor would receive if the bond is redeemed by the issuer before its maturity date.
The link between bond yields and fixed mortgage rates
Bond yields, particularly those on government bonds like the Canadian Government 5-year bond, are directly tied to the pricing of fixed mortgage rates in Canada. Here’s how:
- Investor behaviour: When investors purchase bonds, they look for a return based on prevailing interest rates. If bond yields rise, it often means that interest rates have increased, which in turn impacts fixed mortgage rates. Mortgage lenders tend to price their fixed mortgage rates similarly to government bond yields to remain competitive and offer attractive returns to investors who purchase their mortgage-backed securities.
- 5-year government bond yield: In Canada, the 5-year Government of Canada bond yield is one of the most closely watched indicators for setting fixed mortgage rates. Lenders typically use the 5-year bond yield as a benchmark because it closely mirrors the rate of return that lenders expect to pay to bondholders who fund mortgage loans. When the 5-year bond yield rises or falls, lenders adjust their fixed mortgage rates accordingly to maintain profitability.
- Economic conditions: Bond yields are also a reflection of economic conditions. When the economy is strong and inflation is rising, bond yields tend to increase, leading to higher fixed mortgage rates. On the other hand, when the economy is weak or inflation is low, bond yields typically decrease, which can cause mortgage rates to drop.
- Inflation and central bank policies: Bond yields and mortgage rates are both affected by inflation expectations and central bank policies. When inflation is expected to rise, bond yields tend to increase as investors demand higher returns to compensate for the potential loss of purchasing power. As a result, fixed mortgage rates generally rise as well. Similarly, when central banks raise interest rates to combat inflation, bond yields and mortgage rates both tend to increase.
How bond yields affect Canadian fixed mortgage rates
Fixed mortgage rates in Canada are generally aligned with bond market movements, meaning that when bond yields rise or fall, mortgage rates will follow suit. Here’s how bond yields can impact your mortgage:
- Rising bond yields: When bond yields increase, fixed mortgage rates tend to rise. This is because investors are demanding higher returns on their investments, and mortgage lenders must offer higher rates to attract those investors.
- Falling bond yields: Conversely, when bond yields fall, mortgage lenders typically lower their fixed mortgage rates to stay competitive in the market.
For example, if the 5-year Government of Canada bond yield rises due to higher inflation or interest rate hikes by the Bank of Canada, you can expect fixed mortgage rates to increase. This will make borrowing more expensive for consumers, particularly for those looking for a 5-year fixed mortgage.
Why bond yields matter for mortgage borrowers
Understanding bond yields can help mortgage borrowers make informed decisions about when to lock in a rate or consider a variable mortgage. If you’re shopping for a fixed-rate mortgage, paying attention to bond yields and broader economic trends can give you an idea of whether rates are likely to rise or fall in the near future.
- Locking in a fixed rate: If you anticipate that bond yields will rise, locking in a fixed-rate mortgage might be a good choice to protect yourself from future rate increases. On the other hand, if you think bond yields will decrease, it may be worth considering a variable-rate mortgage.
- Timing the market: Bond yields are influenced by various economic factors, including inflation, employment data, and central bank policies. By staying informed about these factors, you can get a better sense of when fixed mortgage rates may rise or fall.
The bottom line
Bond yields play a significant role in determining the price of Canadian fixed mortgage rates. Understanding the relationship between bond yields, interest rates, and mortgage rates can help borrowers make smarter financial decisions.
As the economy fluctuates, bond yields and mortgage rates will continue to move in tandem. Keeping an eye on bond market trends and economic conditions can give you valuable insights into the direction of fixed mortgage rates and help you choose the best mortgage option for your needs.
Last modified: November 21, 2024