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opinion

The bond market is flashing code red on our economy.

It’s a vivid warning of what’s likely to come, and what will likely cut the borrowing costs for millions of Canadians by the end of next year.

What we’re talking about here is the yield curve, which has a compelling track record of predicting recession – and falling mortgage rates.

What’s a yield curve, you say?

Think of it as a graph – one that shows how interest rates, or yields, change based on how long you lend to the government. People looking at the curve often focus on the difference, or “spread,” between yields on 10-year bonds and two-year bonds.

Normally, long-term yields are higher than short-term yields (reflecting the higher risk in lending for a longer period). Not today.

As we speak, the 10-year yield is almost 100 basis points below the two-year. That’s extraordinary. (A basis point is one-hundredth of a percentage point.) In fact, it hasn’t happened in more than three decades – and the last time it did, in the early 1990s, we had the longest recession since the Great Depression.

The inversion of 10-year and two-year yields is not an infallible signal but deep inversions – the type we’re seeing today – are highly reliable. It’s basically the market screaming that Canada is on a crash course with recession, likely in 2023.

What it means to mortgagors

By this time next year, odds are good we’ll have seen two-plus quarters of negative GDP and a significant jump in unemployment. The Bank of Canada’s answer to recessions is virtually always the same: Cut rates. The only thing we can’t be confident of this time is when that will happen.

The market is betting it’ll happen next December, but inflation has been a runaway train. If core inflation doesn’t drop fast enough, rate cuts could be a 2024 story instead.

Either way, the bond market implies that this is no time to lock into a long-term fixed mortgage. Indeed, for well-qualified borrowers who can handle rate risk, a short-term fixed is the way to play this point in the rate cycle.

Unfortunately, like Canada’s yield curve, our mortgage rate curve is also inverted. The lowest uninsured one-year fixed is now a lofty 5.89 per cent. That’s 60 bps above the lowest five-year fixed.

Interestingly, however, if you plug all that into a rate simulator and assume the bond market is correctly forecasting another 50 basis points-plus of further rate hikes and then falling rates in late 2023, today’s inflated one-year fixed still make sense. That is, it would still lead to the lowest hypothetical borrowing costs over five years, versus all other terms.

That, once again, is due to the expectation you’ll be able to renew lower by the end of next year.

Going with a one-year fixed may look good on paper but here’s the risk. If the Bank of Canada’s rate hikes don’t zap inflation quickly enough (I think they will), this particular go-short-and-reset-lower strategy will flop.

That’s why a two-year fixed is the more conservative play. It doesn’t let you reset your rate as quickly, but it does costs 35 basis points less than today’s lowest one-year. (That’s based on HSBC’s uninsured 5.54 per cent offer, which leads all national lenders.)

Rates edged lower this week

Optimism over falling inflation is pulling down bond yields. That’s led to falling fixed mortgage rates in all terms except the one-year fixed.

Amid higher demand for one-year terms and expectations for a rising overnight rate, the lowest nationally advertised one-year fixed actually climbed this week, by 20 bps. How convenient, given it’s the most logical theoretical term for risk-tolerant borrowers at this point in the rate cycle.

For default insured fixed mortgages, the picture looks better: 4.99 per cent or less for one to five year terms. As always, check the rate sites online for better regional offers.

Lowest nationally available mortgage rates

TERMUNINSUREDPROVIDERINSUREDPROVIDER
1-year fixed5.89%Alterna Bank4.99%Quest Mortgage
2-year fixed5.54%HSBC4.99%Quest Mortgage
3-year fixed5.44%HSBC4.92%Nesto
4-year fixed5.54%First National4.99%Quest Mortgage
5-year fixed5.29%HSBC4.84%CanWise Financial
10-year fixed5.94%HSBC5.59%Nesto
Variable5.45%Merix Financial4.75%Nesto
5-year hybrid5.42%HSBC5.56%Scotia eHOME
HELOC5.95%HSBCN/AN/A

As of Nov. 24

Rates in the accompanying table are as Thursday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.

Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.