Lower mortgage rates expected by spring as bond yields plummet

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Twenty months after the Bank of Canada launched one of the most intense interest-rate hiking cycles on record, the bond market is indicating that cuts are on the way.

Government of Canada benchmark five-year bond yields dipped below 3.5 per cent on Dec. 5 to 3.44 per cent, according to data on the central bank’s website, then fell below 3.4 per cent a day later.

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That put five-year yields down more than 100 basis points from their peak of 4.42 per cent on Oct. 3.

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The decline accelerated even as the Bank of Canada kept its key overnight rate at five per cent on Wednesday, while leaving the door open for another rate hike.

According to James Orlando, a senior economist at TD Economics, falling bond yields leaves the Bank of Canada with the formidable task of aligning its interest-rate policy to address current economic conditions.

“The next few months are going to be challenging given our expectation that the unemployment rate will continue to rise, which will hit consumer spending and bring inflation down along with it. No wonder the Canada 2- and 10-year yields have fallen approximately 90 basis points over the last two months,” Orlando said in note after the Bank’s December decision.

“Markets don’t think the bank will be able to get too comfortable. The next move is clearly a cut, with odds pointing to the first move in April,” Orlando said.

The mortgage industry is anticipating that relief on interest rates is coming, as fixed mortgage rates usually adjust in response to changes in bond yields.

Mortgage strategist Robert McLister said investors are reading the signals of a weakening economy and anticipating the inevitable.

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“Investors see the economy crumbling and know what happens next: rate cuts,” McLister said. ”Plunging yields are taking fixed mortgage rates back below six per cent for uninsured mortgages and below five per cent on insured rates. If inflation behaves, we could see rates in the low four per cent range by spring.”

However, McLister cautioned against expecting interest rates to precisely mirror the decline in yields.

“Rate cut expectations may be jet fuel for home prices this spring, given prices are already showing hints of a bottom. Unfortunately, a resurgent real estate market could also be inflationary and limit how far rates might fall,“ he said.

For now, he advises borrowers to remain cautiously optimistic: hope for rate cuts in the upcoming spring or summer, while preparing for a low probability that there could be no easing until 2025.

Alex Leduc, chief executive of Perch, a Toronto-based digital mortgage advisory, said the mortgage cliff that will see renewals spike in the next few years is a good reason why the former option is more likely.

“A massive amount of scheduled mortgage maturities are expected within the next 2-3 years which has gotten the attention of the Federal Government,” Leduc said. “As a result, the bond market now expects rates to decline over the next few years. This is great news for all borrowers as these declining rates will mitigate how much of a payment increase they can expect, and will also restore the calm that has been missing in the real estate market over the last 18+ months.”

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Ron Butler of Butler Mortgage said he expects lending rates to lag the rapid decline in bond yields due to an element of “seasonality” inherent in the functioning of interest rates.

“Banks tend to offer competitive rates in February and March, as they compete to attract first-time homebuyers for the spring real estate market,” Butler said. “This means they don’t usually provide their best rates in the colder months of December and January. They like to make a little more profit before they have to start fighting for the spring market.”

McLister pointed to one mortgage trend that might reverse itself more quickly. “It’s likely safe to get back in the variable-rate water again,” he said.

The next Bank of Canada interest rate announcement is scheduled for Jan. 24, 2024.

• Email: shcampbell@postmedia.com

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