A Warning About Canadian Fixed Mortgage Rates

Will fixed mortgage rates keep falling?

The consensus thinks they will. I’m not convinced.

To explain why, let’s start with a quick recap.

The Bank of Canada (BoC) ratcheted up its policy rate when the pandemic ended because inflation was red hot. But now that inflation has returned to normal levels, tight monetary policy is no longer needed.

The BoC has cut its policy rate from 5.0% to 3.75% thus far, but even at that lower level, it is still restricting demand. The policy rate won’t return to a neutral level, where it is neither restricting demand nor stimulating it, until it is lowered to a range between 2.5% and 3%.

Not surprisingly, with all of that in mind, there is near universal consensus that the BoC will continue cutting. Most market watchers expect the Bank to cut by another 1.00% to 1.50%. That assessment has percolated into mainstream media articles that predict lower rates ahead for hopeful borrowers.

But there is an important detail that is usually omitted from the current mortgage-rate narrative, and I believe it will be the deciding factor in where our fixed mortgage rates are headed next.

While it is true that the BoC will almost certainly continue to cut its policy rate, those reductions will only impact variable mortgage rates directly.

Our fixed mortgage rates, which most Canadians still prefer, are priced on Government of Canada (GoC) bond yields. These yields factor in the BoC’s expected policy-rate path. But unlike our variable mortgage rates, they are not directly impacted by its specific movements.

GoC bond yields are also significantly influenced by the direction of US Treasury yields, which have moved steadily higher of late.

For that reason, our fixed mortgage rates may be set to rise even as the BoC cuts and our variable mortgage rates fall.

US Treasury yields began to rise as the odds that Donald Trump would win the US presidential election increased. After his victory they continued to move higher.

Last week, we learned that US inflation increased by 2.6% in October, up from 2.4% in September. While that result was in line with consensus expectations, it was also an uptick at a time when bond-market investors are less convinced that US inflation will cool sufficiently and that the Fed will cut as previously expected.

With all that in mind, I am cautioning borrowers who are holding out for lower fixed mortgage rates or who are opting for a variable rate on the bet that they will be able to convert to a lower fixed rate mid-term to reconsider their plans.

Bond yields are forward looking, which means they tend to move in anticipation of events to come. The BoC’s expected rate cuts are already priced into GoC bond yields at their current levels. If they are going to fall further from here, it won’t be just because the BoC followed through with cuts that were universally expected.

To be clear, I’m not saying there is no chance that GoC bond yields and our fixed rates will fall further. But if they do, it will only be because of an as-yet-unforeseen catalyst (for example, if we experience a sharper-than-expected economic slowdown).

The near-term catalyst that seems far more likely to impact GoC bond yields along with our fixed mortgage rates, is rising US Treasury yields.

Forewarned is forearmed.The Bottom Line: GoC bond yields were pulled higher by their US Treasury equivalents last week as US bond-market investors priced in a more gradual Fed rate-cut timetable.

For that reason, I think our fixed mortgage rates are more likely to rise than to fall over the near term.

At the same time, I expect that the BoC will keep cutting its policy rate and variable mortgage rates will continue to drop.

The current gap between our fixed and variable mortgage rates may soon close faster than most mortgage consumers expect.