The Role of Bond Yields in Mortgage Rates

In Canada, the price of mortgage rates—particularly fixed-rate mortgages—is influenced by bond yields, particularly the Canadian 5-year bond. Bond yields are essentially the return that investors expect from bonds, and when yields go up, fixed mortgage rates tend to follow. The inverse is also true: when bond yields go down, mortgage rates usually decrease.

Recently, we’ve seen some interesting movements in the bond market. After the Bank of Canada began lowering interest rates earlier this year, there was optimism that mortgage rates would continue to decrease. Fixed rates dropped significantly from around 5% down to nearly 4% for five-year terms. This was a welcome development for many homeowners and buyers, especially after the rate hikes we saw over the past few years.

However, the situation has shifted in recent months. Despite the Bank of Canada continuing its efforts to lower interest rates, we’re seeing upward pressure on fixed-rate mortgage pricing. This has less to do with the Bank of Canada’s actions and more to do with changes in global bond markets. As bond yields have begun to climb again, mortgage rates are following suit, which leads to a more uncertain outlook for fixed-rate borrowers in the short term.

U.S. Politics and the Global Bond Market

One of the main drivers of the recent bond yield increases is the changing political and economic environment in the United States. With the upcoming U.S. presidential inauguration and speculation surrounding potential policy shifts, markets have been reacting to expectations rather than concrete actions. For example, when Donald Trump’s election prospects began gaining traction, we saw bond yields start to rise in anticipation of potential inflationary pressures, even though he had not yet taken office.

The bond market reacts to these expectations of future events. If investors believe that inflation will rise due to new policies or political changes, they may begin selling off bonds, which increases yields. This is exactly what happened in the months leading up to the U.S. election. The expectation that inflation could increase, coupled with political uncertainty, led to a corresponding rise in Canadian bond yields and, subsequently, fixed mortgage rates.

While it may seem like U.S. political decisions don’t directly impact Canadian rates, the reality is that the Canadian bond market is closely tied to the U.S. market. Canada is a much smaller economy relative to the United States, and as such, the U.S. economic and political environment has a significant influence on Canadian financial markets, including mortgage rates.

Inflation and Government Spending: The Role of the Bank of Canada

Another important factor influencing mortgage rates is inflation. The Bank of Canada has been actively trying to control inflation by lowering interest rates, but inflationary pressures are still present. For example, recent inflation data in Canada came in slightly higher than expected, at 2.0% instead of the forecasted 1.9%. This may seem like a minor difference, but when the market is expecting one thing and gets another, it can trigger a market reaction.

Inflation can put upward pressure on bond yields, which, as we mentioned earlier, affects mortgage rates. The Bank of Canada has been working to reduce inflation by lowering rates, but the recent uptick in inflation could mean slower rate cuts than previously expected. As the central bank adjusts its policies in response to these inflationary signals, mortgage rates will likely remain in flux for the time being.

On top of inflation, government spending can also play a role in shaping economic conditions. Recently, the Canadian government announced a $250 payment to most workers, as well as a reduction in the Goods and Services Tax (GST) for certain products. While these measures are aimed at helping individual households, they could also fuel inflation in the long term. By injecting additional money into the economy, particularly through borrowing, the government is potentially contributing to a more inflationary environment. This could slow down the Bank of Canada’s efforts to control inflation and impact mortgage rates moving forward.

The Impact of Potential Tariffs

In addition to inflation and bond market movements, another factor worth considering is the threat of new tariffs, particularly from the U.S. government. Recently, former President Donald Trump announced the possibility of imposing tariffs on Canadian and Mexican imports, as well as additional tariffs on Chinese imports. If these tariffs are implemented, they could lead to higher prices for goods, contributing to inflationary pressure in both the U.S. and Canada.

Tariffs essentially make imported goods more expensive, and when those goods become more expensive, it leads to higher overall prices, or inflation. If the U.S. moves forward with these tariffs, it could create an even more inflationary environment, further pushing up bond yields and influencing fixed mortgage rates in Canada. This uncertainty surrounding the potential impact of tariffs is something that markets are actively monitoring.

What to Expect Moving Forward

Given all of these factors, what can homeowners and prospective buyers expect in the near future? It’s clear that the mortgage market is currently in a period of uncertainty. While the Bank of Canada is still expected to lower rates in the long term, there may be slower movement in that direction than initially anticipated due to inflationary pressures and global economic factors.

For those considering fixed-rate mortgages, it’s important to be aware of the potential for further rate fluctuations in the short term. As bond yields adjust to inflation and political changes, we could see more volatility in fixed rates. On the other hand, variable-rate mortgages may become more attractive for some, as fixed-rate options become more expensive in response to bond yield increases.

In the coming weeks, the Bank of Canada will make another important announcement on December 11, 2024. This could provide more clarity on the central bank’s approach to interest rates moving forward. However, with inflation, government spending, and international political developments in the mix, it’s hard to predict exactly how mortgage rates will behave in the months to come.