Bond yields ended the week sharply higher, flirting with a key technical level of 4% following the release of overall strong employment data in both Canada and the U.S.
In response to Canada’s better-than-expected job gains in June, the Government of Canada 5-year bond yield hit a key technical level of 4%, though later retreated slightly.
Bond yields, which lead fixed mortgage rates, have been rising steadily over the past several months and have jumped nearly 30 basis points this week alone.
As a result, mortgage providers have been hiking their rates on a near weekly basis, with 5-year fixed rates now in the 5-6% range.
Shorter-term fixed rates have also been climbing, with the majority of providers now offering 1- and 2-year fixed terms in the 6-7% range. Popular 3-year fixed terms, meanwhile, are seeing rates in the 5% range disappear as they move into 6% territory.
That means those in the market for a new mortgage are now having to qualify based on a stress test rate of 8% and even 9%. That’s because borrowers with either a default-insured or uninsured mortgage must currently qualify at a rate 200 basis points (two percentage points) higher than their contract rate.
What happens if bond yields rise above 4%?
As the American and Canadian economies have so far proven more resilient than expected to the sharp rate hikes delivered over the past year, and with inflation still at elevated levels, the prospect of future rate hikes and/or higher-for-longer interest rates is driving bond yields higher.
Rate-watcher Ryan Sims, a TMG The Mortgage Group broker and former investment banker, says the 5-year GoC bond yield has taken several runs at the 4% threshold, but “cannot quite seem to break through.”
If it does, however, Sims said that could translate “basis point for basis point” to higher fixed rates in the coming weeks.
“My concern is that if we close and sustain 4% on the 5-year bond yield, the next resistance level is around 4.40%-ish,” he told CMT. “If we clear 4%, there is really nothing stopping us from going up 40 bps quickly. Lenders would be leap-frogging each other to raise rates on an almost daily basis at that point.”
He noted that the current spread between bond yields and fixed rates offered by the big banks is now around 250 bps, which he called “huge.” While lenders have already added in a risk premium to their rates, Sims said he suspects the spread is at a sufficient level where any future increases will take their lead directly from changes in the bond yields.
The fixed vs. variable question
With the prospect of at least one additional Bank of Canada rate hike, which will take existing variable mortgage rates higher, and ongoing fixed rate increases, borrowers are left wondering: should they go fixed or variable?
It’s a question mortgage broker Dave Larock explored in a recent blog post, where he ran several simulations comparing a borrower who took a 3-year fixed term to one that opted for a 5-year variable.
The outcome? Well, that depends largely on future Bank of Canada rate expectations. Should the Bank get inflation under control and be in a position to start cutting rates by early 2024, a variable rate would come out ahead, Larock calculates.
However, should inflation prove sticky, thereby taking peak rates higher and postponing rate cuts until the end of 2024, a 3-year fixed mortgage would win on interest cost.
“Each reader will have to decide for themselves which simulation seems to best fit their expectations,” Larock wrote.
“For my part, I think the BoC will still prefer to err on the side of over-tightening, all else being equal, and I still subscribe to the higher-for-relatively-longer view,” he added.
“Because of that, I continue to believe that the safest pick for anyone who is currently in the market for a mortgage, and who wants to aim for the middle of the fairway, is a 3-year fixed rate.”