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After tumbling in late February, Government of Canada bond yields have since bounced back and beyond, reaching a three-year high on Wednesday.

Canada’s 5-year bond yield, which generally leads 5-year fixed mortgage rates, closed at 2.02%, a level not seen since December 2018.

5yr bond yield chart

So, what’s behind this latest rally?

“Investors have had more risk appetite and markets are pricing in more inflation risk, both of which weaken bond prices,” explains rate analyst Rob McLister. “As bond prices drop, yields rise.”

Concerns about rising inflation grew on Wednesday when Statistics Canada released February inflation data that came in at a 30-year high of 5.7%.

“Without a doubt, central banks have left the barn door wide open. The inflation horse has now run down the road,” McLister noted in a Globe and Mail column. “Those who weren’t around in the 1970s and ‘80s don’t know how hard it is to bring it back in the stable.”

Have inflation expectations become unanchored? Yes, says Scotiabank

Following the release of the latest inflation data, Scotiabank came out with several research notes criticizing the Bank of Canada for not acting sooner to tackle rising prices.

“…as of late 2021, the Bank’s priority should have been squarely on inflation. We also find that inflation expectations have been completely de-anchored from the 2% target since late 2021,” Scotia economist René Lalonde wrote. “This recent de-anchoring of expectations means that the Bank’s monetary policy will need to be more aggressive to bring inflation back to target.”

As a result, Scotiabank hiked its Bank of Canada rate forecasts and now expects an additional two percentage points (or 200 basis points) of rate hikes this year alone, followed by an additional 50 bps of tightening in 2022.

This would bring the Bank’s overnight target rate to 3%, up from its current 0.5%.

“There is no doubt that this is an aggressive call in relation to the views held by others, but we believe the inflation outlook requires such a response,” Scotiabank’s Jean-François Perrault wrote in a separate note. “Given the serial upside surprises to inflation in recent months, the balance of risks to inflation and its consequences has shifted up…”

The impact on mortgage rates

Even before this latest leg-up in bond yields, mortgage lenders had been steadily hiking their fixed mortgage rates, and some variable rates to a much lesser degree.

Among national mortgage providers, the average deep-discount uninsured 5-yr fixed rate is currently 3.37%, up from 2.90% in early January. For high-ratio 5-year fixed mortgages (those typically with less than a 20% down payment), the average rate is 3.19% vs. 2.76% two months ago.

That’s an average increase of 45 basis points in just two months. For every 10-bps of rate increase, the monthly payment for 5-year rates increases about $5 per $100,000 of mortgage debt.

Fixed-rate borrowers are protected from any near-term hikes, of course, but will face higher rates at renewal time. Over a third (37%) of mortgage holders will be renewing their mortgages over the next two years, according to recent data from Mortgage Professionals Canada.

For today’s homebuyers who may be considering a fixed rate, these increases are more pressing, especially with more hikes likely on the way.

“Lenders can’t ignore surging bond yields, particularly with margins already below long-term averages and risk premiums rising for banks,” McLister told CMT.

And while variable rates are currently priced about 130 bps lower than comparable fixed rates, that spread is about to tighten and likely disappear at some point this year as the Bank of Canada continues raising rates.

“With central banks so far behind the curve and inflation expectations becoming unanchored, today’s variable rates have a good chance of breaking above parity with fixed rates,” McLister added. “The question then would be, given yield inversion is virtually inevitable, how long will variable rates stay up there? In other words, we don’t know how long it will take for central banks to reverse course on rate hikes.”

Latest rate forecasts

The following are the latest interest rate and bond yield forecasts from the Big 6 banks, with any changes from their previous forecasts in parenthesis.

  Target Rate:
Year-end ’22
Target Rate:
Year-end ’23
Target Rate:
Year-end ’24
5-Year BoC Bond Yield:
Year-end ’22
5-Year BoC Bond Yield:
Year-end ’23
BMO 1.50% 2.00% NA 1.85% (-10 bps) 2.25%
CIBC 1.25% 1.75% NA NA NA
NBC 1.50% 1.75% NA 2.00% 2.05%
RBC 1.25% 1.75% NA 1.85% 2.10%
Scotia 2.50% (+50 bps) 3.00% (+50 bps) NA 3.00% (+50 bps) 3.10% (+50 bps)
TD 1.50% 1.75% NA 2.10% 2.00%


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