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With inflation potentially peaking and five-year bond rates coming down hard, mortgage shoppers have one question for banks: Where are the fixed-rate cuts?

After all, rates in the bond market have dived back to earth since their June 14 peak. And bank funding is largely linked to the bond market.

But so far, Big Bank uninsured fixed rates haven’t followed bond rates down.

Here’s why, say bankers …

With rates rocketing last quarter, banks’ funding and hedging costs soared even more, squeezing their profit margins. These “spreads,” as banks call them, only started improving materially in the past couple of months.

Big Five banks all have profit-margin forecasts. They’re now trying to make up lost margin to get closer to their targets. That’s especially true with markets pricing in recession, which should drive more credit losses.

So, in other words, banks are in no rush to pass through funding cost savings.

Indeed, Canada’s system is archaic, whereby less competition allows our top trendsetting banks to take their time when dropping rates. Some of our largest lenders also employ multiple specialists (for example, specialists in spread pricing, term funding and mortgage origination) who all must meet in committee to decide on rate cuts.

Contrast that to the United States, where lenders price in real time, sometimes updating their rates multiple times a day when there’s a big move in 10-year U.S. Treasury yields.

That speed is no coincidence given the U.S. has more than six times more banks per capita than in Canada. If you want fast rate drops, more competition helps.

What to watch …

Until recently, Canada’s most popular mortgage term has been the five-year fixed. But if you want one indicator of where five-year fixed rates are headed, you won’t find one.

The closest proxy is the four-year swap rate, which banks often use because it roughly matches the 3.8-year average duration of a five-year mortgage. Side note: Five-year mortgages only last 3.8 years, by the way, because borrowers break mortgages early.

Swaps are a better indicator of fixed-rate direction than the more commonly cited five-year bond yield for two reasons. For one, banks use swaps to hedge five-year fixed mortgages. For another, swap pricing incorporates bank credit risk, and the supply and demand for mortgage funding.

What is a swap?

It’s basically a swap of cash flows.

Without getting too far into the weeds, swaps let a bank convert its variable funding costs to fixed funding costs, to reduce risk.

Essentially, the bank makes a stream of fixed payments (which come from the fixed-rate mortgage borrower) to the swap counterparty and in return the swap counterparty pays the bank with floating payments at an agreed-upon rate.

The banks can then sell a five-year fixed mortgage at a higher rate, for example, and guarantee a fixed profit spread.

Banks use swaps in mortgage funding because so much of their mortgage funds come from the floating-rate market (for example, deposits, bankers’ acceptances, overnight loans, and so on). If banks didn’t use swaps, their floating rates liabilities could exceed their rates on fixed mortgages, and they could take a loss.

Where to find swap rates

The problem with swap rates is that they’re harder to find than the most common fixed-rate indicator, Canada’s five-year bond yield.

One place to look for four-year swap rates is RBC’s website:

Since 2015, competitive Big Bank five-year fixed rates have averaged roughly 130 basis points over the four-year swap rate. (A basis point represents one-hundredth of 1 per cent.)

Today they’re 190 basis points over. Part of that extra spread is justified because of higher credit risk and liquidity issues. But much of it is just banks milking their pricing power for all it’s worth.

The rate outlook in the near term

Barring an unexpected rebound in swap rates, banks will ultimately pass through some of their excess spread to mortgage shoppers, by way of lower fixed rates.

HSBC has already done so, slashing its nationally-leading five-year fixed rate by 30 basis points to 4.79 per cent (uninsured) this week. In the insured mortgage market, Nesto has dropped its leading five-year fixed to 4.34 per cent, the lowest in almost two months. Regional brokers will save you another five to 10 basis points, but most should avoid getting sucked into a mortgage with heavy restrictions just to save five to 10 basis points.

As for those Big banks, it’s likely they’ll finally lower their five-year fixed rates below 5 per cent soon. In the meantime, if you’re out there shopping for a five-year fixed mortgage, reward competitive lenders that try harder.

Lowest nationally available mortgage rates

1-year fixed4.59%Manulife4.39%True North
2-year fixed4.69%Alterna4.49%QuestMortgage
3-year fixed4.79%Alterna4.34%Nesto
4-year fixed4.79%Alterna4.49%Nesto
5-year fixed4.79%HSBC4.34%Nesto
10-year fixed5.54%HSBC5.54%HSBC
5-year hybrid4.49%HSBC4.74%Scotia eHOME

As of Aug. 10

Rates are as of Aug. 10 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 You can follow him on Twitter at @RobMcLister.