Fixed Mortgage Rate Outlook – February 2012

Canadian Interest Rate

Like variable mortgage rates, the outlook for fixed mortgage rates is flat over the short term.  The longer term outlook for fixed rates however is a little less certain.  Fixed mortgage rates have been flirting with record lows for the past 30 days so it wouldn’t be surprising if over the near term there was some modest increases.  However to get a better sense of where fixed rates are going we need to better understand what drives them.  Unlike variable mortgage rates, fixed mortgage rates are largely set beyond our borders and are driven by international bond markets.

Bonds

Canadian lenders have to come up with 5 year fixed money in order to be able lend it out as 5 year fixed rate mortgages.  A large portion of this money comes from bonds; the most popular is the Mortgage Backed Bond (MBB).  MBB’s are generated by lenders by amassing a large portfolio of mortgages, insuring them with the Canadian government and then selling the bonds on the open market.  If investors are demanding a return of 2% for these government insured bonds then the lenders need to add their costs and profit on top of that so they will, for example, charge a homeowner 3.5% for a 5 year fixed mortgage rate.

Bond Yields

The confusing part for most of us is the understanding that as bond prices are driven up, their yields are forced lower.  Say for example you had a 5 year fixed bond that cost $1,000 and it paid a yield of 2%.  In other words, the bond paid you $20 every year you held it.  If before the end of the 5 years you wanted to sell the bond you could do so on the open market only you wouldn’t necessarily get $1,000.

Bond Supply and Demand

OK, we’re all familiar with this fundamental law of economics.  If more people demand a product and there is limited supply, then we drive the price up.  Similarly if international investors are clamoring to buy Canadian bonds and we have a limited supply, the price will go up.  You may be in luck, and able to unload your bond for $2,000.00 and earn a tidy profit of $1,000.  The bond issuer doesn’t care who owns the bond or what they paid for it; they’ll continue to pay the $20 per year.  So the new investor, who bought the bond at $2,000, will only be getting a yield of 1.0%.  In this exaggerated example, the lower market yield would suggest mortgage lenders should be lowering the 5 year fixed mortgage rate to 2.5%.  Of course if investors decided to sell off Canadian bonds, then we’d see the opposite result.

Bond Trends

We live in an international marketplace and investors and companies with millions if not billions need safe investments to harbor their funds.  Whether it’s to keep a portion of their funds in secure investments or to park some money while they wait for the next big project, bonds are a popular choice, especially government insured bonds.  Now suppose there was the threat of some European countries going bankrupt.  For example, any government insured Greek bonds are currently seen as high risk.  Investors looking for the security typical of bonds would sell the Greek bonds and buy safer bonds, perhaps Canadian bonds.  This flight to safety is often associated with the United States, however Canada is in a favorable position to attract investors.  The fact that we’ve avoided a US style housing crisis, maintained decent employment levels, and are in control of our fiscal budgets makes us a shining star for many investors.

Fixed Mortgage Rate Outlook

We will continue to see low 5 year fixed rate mortgages for the foreseeable future.  Canada’s economy, while not robust is stronger than most and the general consensus among economists is that we will continue to see steady growth over the next 2 years.  The rest of the world however is in a much more precarious position.  Debt crisis’s in Europe, civil unrest in the Middle East, Japan’s slow recovery from natural disasters and the inability of the US to emerge from their housing crisis will maintain Canada as an attractive safe haven for investment, keeping our bond yields and in turn our 5 year fixed mortgage rates low.

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