For years, investors worried about rising interest rates. Well, surprise: Rates are now falling farther and faster than anyone expected, and the drop has sweeping implications for the economy, the stock market and consumers.
Taking their cue from slowing growth and a more dovish tone from central banks, bond yields have taken a remarkable dive. The yield on the five-year Government of Canada bond, for instance, has plunged more than a full percentage point, to about 1.46 per cent from a recent peak of about 2.49 per cent in October.
Such a violent downward move is often associated with a sharp slowdown in the economy. The fact that portions of the yield curve are now “inverted” – the yield on 10-year government bonds is below the Bank of Canada’s overnight rate of 1.75 per cent as well as three-month Treasury bills – has only heightened those concerns.
“Clearly, a lot of people are worried about a recession,” said Jeff Herold, chief executive and lead fixed-income manager at J. Zechner Associates. “Not just Canada but the whole global economy is slowing down. You’ve seen weaker economic data here, there and everywhere.”
What does it mean for financial markets and consumers? Here’s a look at some of the losers and winners in the recent yield meltdown.
Low bond yields don’t cause slower growth – they’re a symptom. When investors expect growth to heat up, they demand higher yields to compensate for rising inflation. But when growth and inflation expectations cool, bond yields drop. In the United States, where protectionist trade policies are denting growth, the yield on 10-year bonds recently fell below the yield on three-month Treasury bills – a situation that has been associated with past recessions. But Mr. Herold said an outright contraction in Canada isn’t inevitable. Pointing to strong employment growth and recovering oil prices, he predicted that Canada will “stumble through with slow growth but not into a recession.”
If you haven’t checked guaranteed investment certificate rates recently, you’re in for a shock. After climbing for most of 2018, GIC yields have gone into reverse. A five-year GIC at Tangerine, for instance, now pays just 2.5 per cent annually, down from 3.1 per cent as recently as November. Government bonds are even less attractive. The five-year Canada bond now yields less than inflation – the Consumer Price Index rose 1.5 per cent in February – which means bond investors are earning a negative real return, said James Hymas of Hymas Investment Management. “And that’s before taxes,” he said.
The stock market
As bond yields have tumbled, stocks have surged – not surprising, given that low-interest rates cut companies’ borrowing costs and typically boost stock valuations. At some point, however, falling rates could start to bite if the economy goes into the tank. The good news, according to Brian Belski, chief investment strategist at BMO Capital Markets, is that we aren’t there yet. Based on past stock-market performance, the most important yields to watch are the two-year and 10-year U.S. Treasury notes. While those yields have flattened – which has historically been positive for stocks – they have not yet inverted. Moreover, in the four instances since 1980 when that happened, it took an average of 15 to 17 months for a stock-market correction or recession to happen. “Therefore, even if the yield curve inverts at some point in the near future, we do not believe investors should view this as an automatic trigger to sell stocks indiscriminately,” Mr. Belski said in a podcast on Tuesday.
For every saver cursing low GIC yields, there’s a home buyer cheering lower borrowing costs. With bond yields sinking and markets expecting the Bank of Canada to remain on hold or even cut its benchmark rate, mortgage costs have been falling. According to ratehub.ca, many financial institutions are offering five-year variable mortgages – and a few even have five-year fixed mortgages – for less than 3 per cent. Mortgage rates could fall further given that they usually lag government bond yields, Robert Kavcic, senior economist with Bank of Montreal, said in an e-mail. “Lower mortgage rates should help stabilize the market in Toronto as we go into the key spring selling season. It might help in Vancouver, too, but the correction there seems to be a bit more ingrained right now,” Mr. Kavcic said.