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The bond market is signaling that interest rate cuts are imminent
Published on December 7th, 2023 • Last updated 1 day ago • 3 minutes reading time
The mortgage industry is expecting interest rate relief. Photo by Jim Wells/Postmedia
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Twenty months after the Bank of Canada embarked on one of the most intense rate hike cycles ever, the bond market is signaling that rate cuts are on the way.
Yields on Canadian government benchmark five-year bonds fell below 3.5 percent to 3.44 percent on Dec. 5 and fell below 3.4 percent a day later, according to data on the central bank’s website.
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As a result, five-year bond yields fell more than 100 basis points from their peak of 4.42 percent on October 3.
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The decline accelerated even though the Bank of Canada kept its key overnight interest rate at 5 percent on Wednesday but left the door open for another rate hike.
Falling bond yields are leaving the Bank of Canada with the daunting task of adjusting its interest rate policy to reflect current economic conditions, according to James Orlando, a senior economist at TD Economics.
“The next few months will be challenging as we expect the unemployment rate to continue to rise, which will impact consumer spending and therefore also reduce inflation. No wonder 2-year and 10-year Canadian government bond yields have fallen about 90 basis points over the past two months,” Orlando said in a note following the bank’s decision in December.
“The markets do not believe that the bank can make itself too comfortable. The next step is clearly a cut, and the odds suggest the first step will come in April,” Orlando said.
The mortgage industry expects interest rate relief because interest rates on fixed-rate mortgages typically adjust in response to changes in bond yields.
Mortgage strategist Robert McLister said investors are recognizing the signals of a weakening economy and anticipating the inevitable.
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“Investors see the economy collapsing and know what’s next: interest rate cuts,” McLister said. “Falling yields are causing fixed mortgage rates to fall back below six percent for uninsured mortgages and below five percent for insured mortgages. If inflation behaves, we could see interest rates in the low four percent range by spring.”
However, McLister cautioned against expecting interest rates to accurately reflect the decline in yields.
“Rate cut expectations could impact property prices this spring as prices are already showing signs of bottoming out. Unfortunately, a resurgent real estate market could also be inflationary and limit the extent of any fall in interest rates,” he said.
For now, he advises borrowers to remain cautiously optimistic: They should hope for interest rate cuts next spring or summer, while at the same time be prepared for a low probability that there might be no easing until 2025.
Alex Leduc, managing director of Perch, a Toronto-based digital mortgage advisory firm, said the mortgage cliff, which will cause a surge in renewals over the next few years, is a good reason the former option is more likely.
“A huge number of scheduled mortgage delinquencies are expected over the next two to three years, which has caught the attention of the federal government,” Leduc said. “As a result, the bond market now expects interest rates to fall over the next few years. This is great news for all borrowers as these falling rates will mitigate the expected payment increase and also restore the calm that has been missing in the property market over the last 18+ months.”
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Ron Butler of Butler Mortgage said he expects loan rates to lag behind the rapid decline in bond yields, reflecting a “seasonality” inherent in how interest rates work.
“Banks tend to offer competitive interest rates in February and March as they compete to attract first-time buyers for the spring housing market,” Butler said. “This means they don’t typically offer the best rates in the colder months of December and January. They like to make a little more profit before they have to fight for the spring market.”
McLister pointed to a mortgage trend that could reverse more quickly. “It’s probably safe to go back into the variable rate water,” he said.
The Bank of Canada’s next interest rate announcement is scheduled for January 24, 2024.
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