Bond Yields

How Government Bond Yields Relate to Mortgage Rates

Fixed mortgage rates and bond yields are closely related. But it might become challenging to comprehend the bond market. Here is a quick guide to understanding bond yields so you can predict the future of fixed rates.

Fixed Mortgage Rates Follow Bond Yields Up Or Down

You can get a fair sense of where fixed mortgage rates are headed by monitoring changes in Canadian government bond yields:

  • Keep an eye on the daily changing 5-year bond yields. Do they increase? Banks are likely to increase their 5-year fixed mortgage rates as a result of consistent increases over days.
  • Are yields on 5-year bonds decreasing? Banks will eventually lower their rates if there are consistent drops over days, which indicates that they are considering doing so.
  • Large swings in either direction over a brief period don’t always mean banks are compelled to move more quickly; instead, they may choose to wait to see if the trend slows down or reverses.
  • The highest and lowest yields over the previous 52 weeks are displayed, which can help put the current bond yield situation into perspective.

In connection to changes in bond yields, banks boost their fixed mortgage rates more quickly and drop them more slowly. They do this because they want to guarantee that their expenses are covered when the market changes.

Therefore, keeping an eye on the yield on the 5-year bond is not a reliable indicator of when fixed rate adjustments will occur or how much banks will really change rates.

However, being aware of the trends might give you a useful head start when choosing your mortgage rate. You’ll be in a better position to choose between getting pre-approved right away to lock in your rate and speaking with one of our knowledgeable brokers about a fixed vs. variable rate plan for the greatest mortgage savings.

Why Do Bond Yields Affect Fixed Mortgage Rates?

Bonds are a low-maintenance source of fixed-interest revenue that banks purchase. On the other hand, the fixed mortgage rates they provide clients with require additional upkeep (it costs more to operate mortgage loans).

However, fixed mortgage rates compete with bonds on comparable terms to draw money (e.g., 2-year, 5-year, etc.), so they consider the yield of those less-expensive bonds to assist determine how high or low to set rates of more-expensive mortgages.

What Exactly is a Bond Yield?

The actual “rate of return” throughout the course of the bond’s term is indicated as a bond yield, expressed as a percentage. Bond yield is equal to the bond price divided by the annual coupon payment (initial interest).

Banks purchase government bonds at a fixed price for a fixed duration (for example, five years) at a fixed interest rate.

But interest rates always alter after a bond is bought. Bonds are traded on a public market at a higher or lower price than their original face value in order to “equalize” their interest rate returns. This ensures that a bond is never worthless because of its original interest rate (why would a bank want a lower-interest rate bond if a higher one is available?).

The present “yield” of bonds, broken down by term length, is the result of that ongoing trading on the bond market.

Why are Fixed Rates Set Higher than Bond Yields?

Because fixed-rate mortgages are riskier and more expensive to maintain, their yields are set higher than those of less expensive bonds, which establishes their “spread relationship.”

The difference between higher fixed mortgage rates and lower bond yields isn’t always constant; depending on a number of economic factors, such as the banks’ assessment of future risk, it may broaden or contract (loan arrears and defaults).

The gap varies among lenders since they are all competing for your mortgage funds, and each is deciding whether they can further reduce rates based on their own bottom line. Big banks, which provide a wide range of investment products, frequently have less flexibility to reduce your rates.

How Much Higher are Fixed Rates Over Bond Yields?

The typical spread, or markup, of fixed mortgage rates above secured government bond yields in a normal market ranges from 100 to 200 basis points, or 1% to 2%. (there are 100 basis points in a percentage point).

How come not higher? Returning to the word “competition,” Banks must compete with other banks for investment while still needing capital to function. Rates and prices are regulated by the nature of competition using supply and demand. Consequently, the level of higher fixed rates is constrained by competition.

What Can Impact the Spread Relationship?

The disparity between the yield on 5-year bonds and the 5-year fixed rate can experience “mood swings” during uncertain financial times. For instance, in 2020, as the COVID-19 pandemic rattled Canadian markets, some banks temporarily increased their fixed mortgage rates despite dropping bond yields (widening the spread) because they worried a pandemic-driven recession and the ensuing defaults.

Alternatively, bond dealers may react to unexpectedly high inflation data by sharply increasing the yields on 5-year bonds. For instance, when alarming inflation figures were released in June of last year, bond yields spiked on the expectation of future interest rate increases, compressing the spread until the corresponding increases in fixed rates restored the normal spread relationship.

The Bottom Line

Bonds can fluctuate at any time because they are traded continuously (during exchange hours).

While banks don’t always change rates in lockstep with changes in bond yields, keeping an eye on the spread connection can help you predict where fixed rates may be headed and perhaps give you a little thrill when you do.


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