Lower fixed rates could be on the way as bond yields fall

For those looking to break into the mortgage market – or who are about to renew or refinance – current interest rates only seem to be trending in one direction: up. But, as fears of a recession begin to solidify, it could pave the way for some of the first mortgage discounts seen in months.

Yields on government bonds, which serve as a benchmark for setting fixed mortgage rates, have recently fallen due to weaker economic news; the five-year yield currently stands at 2.65%, marking a 1% decline from the peak reached in early June. It’s an abrupt about-face from the sizzling ride seen earlier in the year; overall, five-year yields have risen 135 basis points since the start of the year.

Investors react to a multitude of negative indicators; Expectations that a recession is indeed upon the economy are bolstered by the bearish language the US Fed used in announcing federal funds rates last week. That Canadian inflation has peaked is also a possibility, as the June reading came in at 8.1%, lower than analysts had expected. National GDP data released today show that the Canadian economy stagnated in May, despite a strong labor market.

“The ‘two and 10’, the ‘two and five’ — everything is reversed. Recession signals are flashing everywhere,” Ratesdotca editor John Shmuel told STOREYS. “Historically this has signaled a recession, especially when reversed as deeply and for as long as they have been.”

The big question now, as yields continue to fall, will lenders follow suit with their fixed rate offerings?

Leah Zlatkin, licensed mortgage broker and LowestRates.ca expert, says she’s started to see downward movement in rates in the insured mortgage space (financing for borrowers paying less than 20% that’s government backed against payment defaults). Smaller monolines – lenders that only offer mortgage products – are usually the ones that have started making cuts.

“We’re starting to see mortgage rates come down a bit on government-insured rates. But uninsured mortgages haven’t really gone down because the cost of funds not guaranteed by the government hasn’t come down at the same rate,” she says.

Shmuel says if yields continue to fall, it’s only a matter of time before more lenders start offering discounts – although it’s unclear when the big banks will join them.

“I think you have to look at the broader market right now; everyone desperately needs business,” he says. “There’s been a huge downturn in mortgage lending and that’s putting pressure on every lender and broker in the country to find business. This has been a great value proposition for them, with mortgage rates steadily rising.

“So it’s kind of the first time you’ve seen fixed rates come down from some lenders. Now the big banks haven’t moved at all, that’s kind of the big question mark that everybody’s poses at the moment: when will they move?

The biggest issue for lenders, he says, is credit risk, as borrowers are increasingly in debt as economic factors ease – a recipe for rising mortgage defaults. .

“Everyone is trying to balance the fact that yields have come down and that in a normal market fixed rates would follow. But this is not a normal market, there is a lot of fear and the risk of credit is increased,” he says. “So the current value is between credit risk and what the market is signaling, and the deciding factor could be business. Everyone desperately needs business, who’s going to move first and say, “Yeah, credit risk is increased, but I need customers, so I’m going to offer a lower fixed rate.” So that’s where we are right now. »

However, lenders may not be able to hold out for long, especially in markets like Toronto where only a small portion of the market might qualify for an insured mortgage. the average home price in 416 hit $1,146,254 in June, according to the Toronto Regional Real Estate Board.

“There’s a lot of business here that’s uninsured and you’re not going to make more of it if your rates don’t go down,” Shmuel says.

Fixed return in favor?

Variable mortgage rates have been the obvious choice for borrowers over the past couple of years, given their attractive price compared to fixed rate offerings. As house prices soared during the pandemic, more consumers opted to take on floating debt, given the savings it offered at the time. These days, while the spread between the fixed and floating rate is still attractive, it is rapidly narrowing as the Bank of Canada has made a series of interest rate hikes since March, and at least three more are planned for this year.

Given this, are fixed rates on their way to becoming the first choice – and perhaps even the cheapest –?

Zlatkin says she personally doesn’t see the favor shifting as dramatically to a fixed solution in the near future, and in fact sees them as having a higher risk profile.

“I don’t like IRD penalties, and I think for many Canadians flexibility is key, especially with what we’ve seen over the past five years, everything changes overnight,” she said. . “People like to be flexible, and fixed-rate mortgages lock you in…The challenge is that two years from now, if variable rates come back down, those same customers are going to be the customers who are going to call and say, ‘Why are you m let go with a fixed rate product that is now two points above the market.

“I think if you really, really want a fixed rate product, go for a two or three year fixed rate product, wait what happens right now. Wait for things to normalize a bit, let’s see what happens with the recession, let’s see what happens with the next announcements from the Bank of Canada and let’s go from there.

Shmuel adds that variable rates have been the most popular choice, according to surveys conducted by ratesdotca over the past few years, especially when bond yields started to climb earlier this year. However, he adds, the borrowing environment could end up looking like the “bizarro market” in 2019, when fixed rates were briefly cheaper than their variable components.

“The question is, will this happen again if there is a lingering fear of recession? The day it happens, you will see almost 100% [demand] for fixed rates. If anyone can take a cheaper safe bet, they’ll probably take it.

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