The rapid rise in Canadian bond yields has truly hit hyperdrive and is now rising even faster. canadian government (GoC) bond yields rose across the board on Tuesday. The move will drive up mortgage costs, particularly five-year fixed rates, and will push corresponding government bonds to their highest interest rates since 2007. There’s just one problem. At the time, interest rates had only been this high for a few weeks. Today’s borrowers may not be so lucky, as central banks tell markets to prepare for longer interest rates. Similar levels have not been maintained for long periods of time over the past approximately 20 years.
Canadian 5-year bond yield growth is accelerating, not slowing down
The Canadian government’s five-year bond yield soared today to its highest level in years. The yield reached 4.458% in this morning’s trading, and although it has since fallen back, it remains significantly higher. This is a 52-week high and is being discussed as the highest level since 2007. A bit out of context, but I’ll get back to that point. First, let’s touch on the recent speed of movement.
Canadian government bond yield (5 years)
Government of Canada (GoC) five-year bond yield in percentage points.
Source: Bank of Canada; Better Canada.
Virtually everyone knows that the five-year Treasury yield has skyrocketed over the past year. The increase over the past five days is equivalent to almost one-half of the 8 basis point increase in interest rates for the year. Just 5 of the past 365 days accounted for one-eighth of the total increase. It’s also so recent that even Stats Can doesn’t track the trading period yet.
Interest rates are the highest since 2007, but could last even longer this time.
Much media attention focused on yields reaching their highest levels since 2007. That’s true, and it was a long time ago, so the market is going to have a lot of correction pain. However, in 2007, interest rates were only around this level for a short time, and the impact was limited.
The last time interest rates were above current levels was in 2007 for less than three months (80 days to be exact). It probably wouldn’t have had a big impact on the market because it wasn’t an everyday occurrence. A year ago, the five-year Treasury yield was above today’s levels for just 14 days. At the time, the chances of becoming a borrower at this level were low.
To find when this level was normal, we have to go back to 2002-2003. We need to go to a period before unconventional policies become the norm. Isn’t it unusual for it to be used now, before the effects of previous policies have appeared?
Canadians should prepare for long-term increases in interest rates due to global factors
Bond yields affect similarly-termed mortgages, so a five-year bond only affects five-year fixed-rate mortgages. However, interest rates are rising across the board, so we expect this to be a widespread problem. The difference in yield between one-year bonds (5.31%) and five-year bonds (4.58%) is narrowing. It is also close to the overnight rate (5.0%), which has an impact on variable rate mortgages. The discount difference is very small, unlike earlier this year when the central bank suspended interest rates.
Overnight rates and yields this high were almost unthinkable just a few months ago. Remaining high inflation and global changes have led to a dramatic change in the outlook. Strong markets, strong wage growth, and a burgeoning population all lead to inflation. People keep saying the economy is weak, but it’s hard to understand that at a macro level.
Less discussed is the decline in international demand for bonds in Canada and the United States. After the Global Financial Crisis (GFC), the world sought these out as an escape to stability. Now, with rising inflation and rising domestic yields overseas, this shift is being reversed. Competition for where to park funds is now even more intense in Canada and the United States. It also doesn’t help that rising geopolitical tensions are forcing institutions to diversify.
Simply put, after the global financial crisis, Canada and the United States had excess capital, which led to lower interest rates. In a time of increased global competition, capital is being allocated more widely. Cheap debt isn’t the only reason Canada has found a new home overseas. It was also cheap cash that provided cheap mortgages.
It is unclear what kind of timeline “longer” means. BMO recently cut back on the expected number of rate cuts as inflation looks solid. However, at this point, we still expect rates to fall, but they won’t be as cheap as they were before 2020.
