An ominous warning shows relief in mortgage rates – finally

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The bond market is flashing code red on our economy.

It’s a vivid warning of what could happen, and what will lower borrowing costs for millions of Canadians by the end of next year.

What we’re talking about here is the yield curve, which has a compelling track record of predicting recessions — and falling mortgage rates.

What is a yield curve, you say?

Think of it as a graph – one that shows how the interest rate or yield changes based on how long you owe the government. People looking at the curve often focus on the difference, or “spread,” between the yields on the 10-year bond and the two-year bond.

Generally, long-term yields are higher than short-term yields (reflecting higher risk in lending for longer periods). Not today.

As we speak, the 10-year yield is about 100 basis points lower than the two-year yield. It’s wonderful. (A basis point is one-hundredth of a percentage point.) In fact, it hasn’t happened in more than three decades — and the last time it did, in the early 1990s, we had the longest recession since the Great Depression.

10-year and two-year yield reversals are not a reliable signal, but deep reversals – the type we’re seeing today – are highly reliable. This is basically the market’s cry that Canada is on a crash course with recession, possibly in 2023.

What does this mortgage mean?

By this time next year, odds are good we’ll see two-plus quarters of negative GDP and a significant jump in unemployment. The Bank of Canada’s answer to a recession is virtually always the same: rate cuts. The only thing we can’t be confident about at this point is when that will happen.

Markets are betting it will happen next December, but inflation remains a runaway train. If core inflation doesn’t fall fast enough, rate cuts could be the story of 2024 instead.

Either way, the bond market indicates that now is not the time to lock in a long-term fixed mortgage. Indeed, for well-qualified borrowers who can handle rate risk, a short-term fixed is the way to play this point in the rate cycle.

Unfortunately, like Canada’s yield curve, our mortgage rate curve is also inverted. The lowest uninsured one-year fixed is now a high 5.89 percent. This is 60 bps above the five-year low.

But the interesting thing is, if you plug all of this into a rate simulator and assume that the bond market is correctly predicting another 50 basis points – more rate hikes. And then Falling rates by the end of 2023, today’s inflated one-year fixed is still understandable. That is, it would still lead to the lowest hypothetical cost of debt over five years, compared to all other conditions.

This, again, is due to the expectation that you will be able to renew less towards the end of next year.

Going with a one year fixed may look good on paper but therein lies the risk. If Bank of Canada rate hikes don’t drive inflation down fast enough (I think they will), this particular go-short-and-reset-lower strategy will flop.

That’s why the two-year fixed is a more conservative game. It doesn’t let you reset your rate as quickly, but it costs 35 basis points less than today’s one-year minimum. (This is based on HSBC’s uninsured 5.54 per cent offer, which leads all national lenders.)

This week the rate is lower

Optimism about falling inflation is pushing bond yields lower. This led to a decline in fixed mortgage rates in all terms except the one-year fixed.

Amid strong demand for one-year maturities and expectations of rising overnight rates, the nationally advertised minimum one-year fixed actually rose 20 bps this week. That’s the most logical theoretical term for risk-tolerant borrowers at this point in the rate cycle.

For default insured permanent mortgages, the picture looks even better: 4.99 percent or less for terms of one to five years. As always, check online rate sites for good regional offers

Lowest mortgage rates available nationally

duration uncertain provider insured provider
1 year fixed 5.89% Alterna Bank 4.99% Quest mortgage
Lasts 2 years 5.54% HSBC 4.99% Quest mortgage
Lasts 3 years 5.44% HSBC 4.92% something
Lasting 4 years 5.54% first national 4.99% Quest mortgage
Lasts 5 years 5.29% HSBC 4.84% CANWISE FINANCIAL
Lasts 10 years 5.94% HSBC 5.59% something
changeable 5.45% Merix Financial 4.75% something
5 year hybrid 5.42% HSBC 5.56% Scotia is home
HELOC 5.95% HSBC N/A N/A

Rates in the accompanying table are as of Thursday from providers that advertise rates online and lend in at least nine states. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching an existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.

Robert McAllister is an interest rate analyst, mortgage strategist and editor mortgagelogic.news. You can follow him on Twitter @RobMcAllister.

An ominous warning shows relief in mortgage rates – finally

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