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Lower Fixed Rates Could Be On the Way as Bond Yields Drop

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For those looking to break into the mortgage market — or are coming up for a renewal or refinance — today’s interest rates only seem to trend in one direction: up. But, as fears of a recession are starting to solidify, it may set the stage for some of the first mortgage discounts seen in months.

Government bond yields, which are used as the benchmark for pricing fixed mortgage rates, have taken a tumble as of late on softer economic news; the five-year yield currently sits at 2.65%, marking a 1% drop from the peak reached in early June. That’s an abrupt about-face from the sizzling run up seen earlier in the year; overall, five-year yields have risen 135 basis points year-to-date.

Investors are reacting to a slew of negative indicators; expectations that a recession is indeed on the economy’s doorstep strengthened on bearish language made by the U.S. Fed in last week’s federal funds rate announcement. That Canadian inflation may have reached its peak is also a possibility, as the June reading came in at 8.1%, lower than what analysts had forecasted. Domestic GDP data out today reveals the Canadian economy stalled out in May, despite a strong labour market.

“The ‘twos and 10s’, the ‘twos and fives’ — everything is inverted. The recession signals are flashing everywhere,” John Shmuel, Managing Editor at Ratesdotca, told STOREYS. “Historically that has signalled a recession, especially when they’re inverted this deeply and as long as they have been.”

The big question now, as yields continue to slide, is will lenders follow suit with their fixed-rate offerings?

Leah Zlatkin, licensed mortgage broker and LowestRates.ca expert, says that she’s started to see some downward rate movement in the insured mortgage space (financing for borrowers paying less than 20% that is backed by the government against default). Small monolines — lenders that only offer mortgage products — are generally the ones that have started to make cuts.

“We’re starting to see mortgage rates coming down a little bit on rates that are government insured. But mortgages that are uninsured have not really gone down because the cost of the funds for non-government-backed have not decreased at the same rate,” she says.

Shmuel says that should yields continue their plunge, it’s only a matter of time before more lenders start to offer discounts — though there’s no word on when the big banks will join in.

“I think you have to look at the broader market right now; everyone is desperate for business,” he says. “There has been a huge slowdown in mortgage originations and that’s putting pressure on every single lender and broker in the country to find business. That has been a great value proposition for them, with mortgage rates continuously climbing.

“So this is kind of the first time where you’re seeing fixed rates decline amongst some lenders. Now, the big banks have not moved at all, that’s kind of the big question mark that everyone is asking right now: when are they going to move?”

The biggest issue for lenders, he says, is credit risk, as borrowers are increasingly overly leveraged while economic factors soften — a recipe for rising mortgage defaults.

“Everyone is trying to balance that yields have come down and in a normal market, fixed rates would follow. But this is not a normal market, there’s a lot of fear out there and credit risk is heightened,” he says. “So the value right now is between the credit risk and what the market is signalling, and the deciding factor might be business. Everyone is desperate for business, who’s going to budge first and say, ‘Yeah, credit risk is heightened, but I need customers, so I’m going to offer a discounted fixed rate.’ So that’s where we are right now.”

However, lenders may not be able to hold out for long, especially in markets like Toronto where only a narrow slice of the market could be eligible for an insured mortgage; the average home price in the 416 hit $1,146,254 in June, according to the Toronto Regional Real Estate Board.

“There’s a lot of business here that is uninsured and you’re not going to win more of that if your rates aren’t coming down,” Shmuel says.

Fixed Back in Favour?

Variable mortgage rates have been the clear choice for borrowers in the last two years, given their attractive price point compared to fixed-rate offerings. As home prices spiked during the pandemic, more consumers chose to take on floating debt, given the savings it offered at the time. These days, while the spread between fixed and variable is still attractive, it’s shrinking fast, as the Bank of Canada has made a series of interest rate hikes since March, with at least three more slated this year.

Given this, are fixed rates set to become the top — and perhaps even cheaper — choice?

Zlatkin says she personally doesn’t see favour swinging all that dramatically toward fixed in the near future, and actually considered them to have a higher risk profile.

“I don’t like IRD penalties, and I feel for many Canadians that flexibility is key, especially with what we’ve seen in the last five years, everything changes overnight,” she says. “People like being flexible, and fixed-rate mortgages lock you in… The challenge is that, in two years, if variable rates go back down, these same clients are going to be the clients who will be calling and saying, ‘Why did you let me go with a fixed-rate product that’s now two points higher than the market.’”

“I think if you really, really want a fixed-rate product, go with a two- or a three-year fixed-rate product, wait out what’s going on right now. Wait for things to normalize a little bit, let’s see what happens with the recession, let’s see what happens with the next few Bank of Canada announcements and then go from there.”

Shmuel adds that variable rates have been the more popular choice, according to surveys conducted by ratesdotca over the past several years, especially once bond yields started climbing earlier this year. However, he adds, the borrowing environment could wind up looking like the “bizarro market” in 2019, when fixed rates were briefly cheaper than their variable components.

“The question is, is that going to happen again if there is a continued recession fear? The day that happens, you’re going to see almost 100% [demand] for fixed rates. If someone can take a cheaper sure bet, they’re probably going to take it.”

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