Home buyers and mortgage shoppers have new reason to celebrate. That is, if they care more about saving on interest than a vigorous economy.
With U.S. President Donald Trump taking another wrecking ball to international trade relations, government bond yields are continuing their decline. And bond yields are the No. 1 driver of fixed-mortgage rates.
At one point Wednesday, Canada’s benchmark five-year yield was down 23 basis points (0.23 percentage points) in just two trading days. Had it closed at those levels, it would have been the biggest two-day plunge since the oil shock of 2015.
The five-year government rate now stands at 1.22 per cent. In April, it was as high as 1.68 per cent. Where that yield goes, five-year mortgage rates eventually follow.
Speaking of oil, which is vital to Canada’s economy, it’s trading at a seven-week low. This too, could weigh on yields and push fixed mortgage rates lower.
It was just days ago that observers were debating whether the Bank of Canada would follow the U.S. Federal Reserve at all and start a new rate-cut cycle. Now it’s more likely the BoC could be forced to cut as early as January, like it or not.
And the market knows this. In fact, the market knows almost all there is to know about where rates are headed. That’s why 10-year bond yields are trading further below Canada’s overnight rate than at virtually any time this century. It’s also why “riskier” variable-mortgage rates are oddly 10-20 basis points higher than “safer” five-year fixed rates – a rarity in the mortgage world.
Fixed rates undercutting variable rates reflects a market warning of lower short-term rates to come. It’s just the BoC hasn’t had enough reason to move yet.
Despite five-decade lows in unemployment, resurgent household credit growth, a stabilizing housing market and strengthening wages, the BoC can’t afford to be too optimistic. Nor can it afford to be late with economic stimulus. Rate policy takes 12 to 24 months to have an effect. Cutting rates during a slowdown is far less effective than cutting rates ahead of one.
That’s why the market is now pricing in a BoC rate cut within six months.
How much lower rates go from here is uncertain, but it wouldn’t be out of the question to see Canada’s five-year bond yield below 1 per cent for the first time in two years, especially if Mr. Trump hikes tariffs on China again. Given that deep discounted five-year fixed mortgage sell for roughly 150 basis points above five-year government yields, that could make conventional, five-year fixed mortgages below 2.5 per cent widely available.
By year-end, things may not look so dire. Or perhaps they’ll look worse. It doesn’t matter because we can’t predict that far out.
What we do know, based on past cases of collapsing yields, is that it would now be nearly unprecedented for rates to reverse and make new long-term highs in the next few years. Moreover, BoC forecasts imply it could take four years for the economy to use up its excess capacity, Capital Economics reported on Wednesday.
Given the above, one could argue that short-term fixed rates and variable rates now pose less risk than they have in years.
Granted, however, five-year fixed rates near 2.7 per cent look incredibly tempting with most variable rates being closer to 2.9 per cent. But going fixed entails potential opportunity cost. In other words, being locked in will cost you if the economy can’t quickly recover from the psychological damage now being done.
It’s important to remember that while the BoC seemingly has little reason to lower rates, it has surprised everyone before.
“One day before the Bank’s first rate cut in 2015, markets were pricing in just a 5% chance of a cut,” Capital Economics’s Stephen Brown reported today.
If we get hit with a combination of one more round of damaging tariffs coupled, sub-$50 oil prices, another Fed rate cut and/or a five-year Canadian yield less than 1 per cent, that could be enough to compel a BoC rate cut sooner than economists now predict.
The timing is anyone’s guess but when long-term rates are plunging, well-qualified risk-tolerant borrowers usually do best in the lowest-cost, most flexible mortgage they can find. Right now, that’s any variable or short-term rate below 2.6 per cent, so long as the early breakage penalty is reasonable (a “fair penalty” gives you more options if life events require you to sell your home or refinance your mortgage early).
Just know there’s always a small danger that rate cuts exacerbate inflation once trade disputes are ironed out. If the labour market remains tight, that could eventually drive rates higher. If your budget, job stability, personal balance sheet and/or psychology can’t stomach that risk, a five-year fixed near 2.69 per cent (with a fair penalty) is a historical steal.
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