Five Factors That Are Now Pushing Canadian Bond Yields Lower

Dave Larock in Interest Rate UpdateMortgages and Finances

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Bond yields continued to fall last week and it is starting to feel as though fear is overtaking greed as the dominant market sentiment.

We are entering a period of rising uncertainty and at times like this, money flows into safe-haven assets like Government of Canada (GoC) bonds as the return of one’s capital becomes a more pressing concern than the return on one’s capital. That rise in demand should help keep GoC bond yields, and the fixed-mortgage rates they are priced on, at today’s ultra-low levels.

Here are five of the biggest worries weighing on investors’ minds at the moment:

  1. Lofty Stock market Valuations: Price/earnings ratios are at historically high levels and that means that a lot of stocks are priced for perfection. Markets don’t go straight up indefinitely and the S&P 500 is in the midst of an eight-year bull run that is its second longest in history at the same time that the U.S. business cycle is turning. There is growing speculation that the U.S. economy may have actually entered a recession in the first quarter of this year, and if that’s true and past is prologue, stocks are at risk of a sharp correction. Anyone who shares this view is likely to be reducing their exposure to equities and parking their cash in safer assets, like sovereign bonds.

  • The U.S. Debt Ceiling Showdown: It’s still early days but the U.S. government must raise its debt ceiling (which is the limit it sets for how much it can borrow) by late fall or the U.S. government will run out of money. As unlikely as that outcome sounds, there are factions in the Republican party that won’t vote to raise the debt ceiling under any scenario and there is a lot of politicking around this issue. It’s basically a game of chicken with the global economy hanging in the balance, and the game now has a new main character with a reputation for being ill-informed and unpredictable.     
  • Chaos in Europe: When you’re drafting a worry list for Europe there are plenty of candidates: Brexit, French and German elections, the Italian banking crisis, the rise of nationalist movements across the European Union (E.U.) etc. All of these challenges are linked by a fundamental flaw at the heart of the E.U. experiment that requires its members to draw ever closer, bringing more of each country’s economic and social policy decisions under its supra-national authority in order to survive. As this noose continues to tighten, the citizens of each member country become increasingly unwilling to trade away more sovereignty for continued stability, and the political cost of defending the E.U. for politicians, who must win votes in their home countries, increases inexorably. To quote from Yeats, “the centre cannot hold”.
  • Rising Geopolitical Risks: The civil war in Syria continues, North Korea and President Trump are rattling their sabres, the Taliban continues to tighten its grip on Afghanistan and although ISIS has lost territory it still has plenty of fight left for a counter-insurgency campaign. Under President Trump the U.S. wasn’t supposed to be the world’s policeman anymore but his bombing of Syria belies the isolationist approach he successfully campaigned on. As such, predicting his next move is almost impossible. All we really know is that he will be tested, and in the eyes of many, that alone heightens the potential for a rise in geopolitical instability.
  • China’s Debt Overhang: Last year it looked as though China’s debt bubble was about to burst and the global economy shuddered in anticipation. Chinese growth slowed sharply as its policy makers tried to stem its rate of debt accumulation, and economic momentum was restored only once Chinese policy makers turned the debt spigots back on. The country continues to try to wean its economy off infrastructure spending and export-led growth while building up its service sector and focusing on domestic markets as an alternative. But this transition is a colossal undertaking for country whose debt-to-GDP ratio has risen from 150% to 250% since the Great Recession in 2008. Market watchers worry because much of that debt is held by state-owned corporations that are both unprofitable and inefficient. Most worryingly, history has shown that when a country experiences the kind of sharp acceleration in debt growth that China has seen, and reaches the debt-to-GDP ratio level that China now has, it has always ended badly. When you’re talking about the world’s second largest economy, especially one that has been the engine of global growth for the past decade, that presents a significant threat to global economic stability.                                                                                                                  

Investors aren’t the only ones who are becoming increasingly cautious in the current environment. The Bank of Canada (BoC) continues to emphasize its desire to remain flexible in the face of rising uncertainty in its policy language. The Bank can afford to espouse this wait-and-see approach in part because its concerns about our household-debt levels have been largely allayed by the combination of mortgage-rule changes and new tax initiatives that are designed to cool house-price appreciation in hot regional markets. Those policy changes reduce the likelihood that the BoC will feel compelled to raise its policy rate to slow household borrowing, and that is good news for our broader economy which is still not ready for monetary-policy tightening.

Five-year GoC bond yields fell four basis points last week, closing at 1.00% on Friday. Five-year fixed-rate mortgages are available at rates as low as 2.39% for high-ratio buyers, and at rates as low as 2.49% for low-ratio buyers. If you are looking to refinance, you should be able to find five-year fixed rates in the 2.64% to 2.79% range, depending on the terms and conditions that are important to you.

Five-year variable-rate mortgages are available at rates as low as prime minus 0.80% (1.90% today) for high-ratio buyers, and at rates as low as prime minus 0.70% (2.10% today) for low-ratio buyers. If you are looking to refinance, you should be able to find five-year variable rates in the prime minus 0.45% range (2.25% today), depending on the terms and conditions that are important to you.

The Bottom Line: GoC bond yields have been falling lately as fear has overtaken greed as the dominant market sentiment and our fixed-mortgage rates, which are priced on GoC bond yields, have started to drop as a result. At the same time, our variable mortgage rates have held steady and are likely to remain at current levels until the BoC can cross a few of the items off of the worry list outlined above.

David Larock is an independent mortgage broker and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave 

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