How Does the 5 Year Canadian Bond Yield Affect You

Navigating interest rates in 2022 has been no joke. Canadians have seen volatile bond markets and numerous increases to the Overnight Lending Rate leading to a mortgage interest rate market that we’ve not seen since the 1990s. Coupled with uncertainty from global events, such as the war in Ukraine, labour strikes, natural disasters and inflation pushing towards double digest in the United States, it’s never been more important to understand what indicators we can be looking at to help predict the direction of mortgage rates.

What is the 5-year Canadian bond yield?

The 5-year Canadian Bond Yield represents the return an investor gets by holding Canadian debt for 5 years to maturity.

It is considered the safest Canadian investment with a 5-year term. It is often used as a benchmark for other interest rates in Canada because of its risk-free status and high liquidity.

How does it work?

The government of Canada issues bonds with a set coupon. The market then dictates what those bonds are worth, thereby setting the yield in open market trading. When demands for bonds fall, bond prices fall. That causes bond yields to rise.

When demands for bonds rise, bond prices rise. That causes bond yields to fall.

Inflation is the number one factor that influences demand for 5-year bonds. High inflation drives down the value of bonds and drives up their yields. Low inflation drives up the value of bonds and drives down their yields. When inflation is expected to be above target, yields typically ride and when inflation is expected to be below target, yields typically fall.

Using current 5-year bond yields, banks will set their 5-year fixed mortgage rates higher to compensate for the added risk, this is called a 'spread relationship’.

How does this affect my mortgage?

Canadian banks use the 5-year bond yield market to determine their fixed mortgage rates, using the forecasted earnings from their bond investments. Both bonds and mortgages can be offered in a 5-year term, so banks use this standard timeframe of bond yields to determine their 5-year fixed mortgage rates. Bond yields may change daily, but it may not be reflected automatically in fixed rates. If an upward or downward trend continues, however, banks will typically follow with an increase or decrease to their fixed mortgage rates. In a normal market, the average markup of fixed mortgage rates is roughly 100 to 200 basis points, or 1% to 2% While the 5-year yield does not directly impact variable rates, the 5-year curve can help us predict the changes in the market and the overnight lending rates, (which is evaluated and regulated by the Bank of Canada via their 8 announcements per year). Of course, watching the 5-year bond yield doesn't tell you the exact timing of fixed rate changes, or how much banks will move fixed rates up or down, but it’s certainly a key indicator! Knowing that rates may be changing helps you make decisions about timing your mortgage rate hold or home purchase. Always make sure you’re working with a mortgage broker that understands the market to best help you navigate these decisions!