Canada’s government bond market is seeing yields surge, and it’s going to be felt in real estate. The Government of Canada‘s (GoC) 5-Year benchmark bond yield jumped yesterday. We know, we already covered rising yields just a few days ago. I promise this is kind of a big deal, and I’m not just harping on it.
Yesterday’s increase is noteworthy due to the sheer size. The daily move was big enough to drop mortgage borrowing power by over a point. Compared to last year’s low, mortgage sizes have rapidly shrunk, largely over the past month. This is likely to act as a cooling measure for the upcoming spring market.
Canadian Government Benchmark Bonds and Fixed Mortgages
If you read the bond article earlier this week, you can probably skip this. For those that didn’t, credit markets compete for the same investors. The yields rise and fall with demand for the instrument. Lower yields mean more demand, and higher yields mean low demand.
In plain english, the more investors want a bond, the less you have to pay them. The less investors want a bond, the more you have to pay them. It’s how the free market self-determines risk. The higher the risk of losing money, the more reward needs to be given to the lender.
It’s important to understand risk isn’t just related to someone’s ability to pay. It’s your ability to make a return. Today we’re looking at GOC bonds, a borrower that’s not likely to stiff you on the payments. However, risk does exist – and in this case, it’s inflation. If you’re making 0.5% on your loan, and inflation is 1%, you’re actually losing 0.5% in real terms. There’s few cases where you would accept a negative real yield, but generally it’s not sought after.
How does this relate to your mortgage rate? Mortgages compete with investors for capital. If the government is a better yield, investors would buy it over riskier products. The GoC 5-year benchmark bond is the example we’re looking at. It’s tied closely to the 5-year fixed rate, with experts estimating a 120 bps spread. It can be higher or lower, depending on what the market determines is appropriate.
Canadian Government Bond Jumps 47% In A Week
The Government of Canada’s 5-year benchmark bond yield made an unusual jump. The yield reached 0.94% on Thursday, increasing 20 bps from just a day before. Yields have now increased 59.15% from last week, more than doubled from a month before. It’s also about 3x where they were at last year’s low in August.
5-Year Government of Canada Benchmark Bond YieldThe yield of a 5-year Government of Canada (GoC) benchark bond. Source: Bank of Canada, Better Dwelling.
Investors see the most risk since the beginning of the pandemic. Yesterday, yields made the biggest daily increase since March 17. This time is a little different, because in March it was only 6 days after the pandemic. At the time, people were in fear the economy wasn’t doing well. Now they’re most likely worried about too much stimulus and the economy doing too well. In other words, they’re expecting inflation to come fast. Much more than previously expected.
Higher Mortgage Rates Are Likely To Slow Real Estate Price Growth
I know, that has no meaning if you’re not in finance or real estate – so let’s look at an example. Let’s assume the average 120 bps markup applies to mortgage rates. Buyers yesterday will have lost ~2.2% in buying power from the previous day. From last week, it would be a ~3.8% drop, and a ~5.8% drop in borrowing power from a month before. It would also mean a ~7% decline in maximum mortgage borrowing power from the August low.
In plain english, someone who would qualify for a $1,000,000 mortgage, would qualify for $930,000 after a 7% drop in power. That’s about the median after-tax income of households. Conversely, they got to borrow an extra year of their income on the way down, which helps explain prices.
Generally, borrowing power helps control liquidity. If homebuyers have fewer dollars to spend on a home, it’s harder for them to absorb price increases. Buyers would have to adjust their budgets, or spend more time saving larger down payments. The latter pushes purchases out, meaning fewer near-term buyers. It’s the opposite impact of lowering rates, and pulling purchasing forward.
How long will this take to get down to the mortgage market? It’s anyone’s guess how long the full movement would take. The industry expects most lenders will increase mortgage rates by the end of today. They tend to do this more gradually than bonds though, increasing the spread over time.
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What is something worth? – Normally what someone is willing to pay.
For real estate – It’s what someone is willing and able to borrow.
Will be very interesting to see how this plays out. Could BOC start buying bonds again to flatten yields – absolutely.
Will they stop if inflation starts to run wild or the currency starts to feel a lot of pressure? Figuring out the answer to that question could make you rich
It’s a really hard one to figure out. Will they destabilize housing further, or adopt higher inflation?
Will they modify inflation to reflect a different basket of goods so it’s not clear? Waiting for the fall to see if they adopt the system they tried to sneak by anyway, just at a later date.
It’s my bet that the BoC will care more about controlling runaway inflation than crashing our housing market, but time will tell…
I already own and don’t consider it an investment, but it’s funny to watch how people think they’ll be locked out of the market.
If you have a job that’s skilled or academic, your pay rises with the cost of real estate. If it rises too long for too long, the cost of goods detaches, and the jobs go elsewhere.
The stronger CAD already has us considering more US employees, since the cost basis is more stable. In Vancouver you’re paying people 10% more per year. They aren’t happy, you don’t like paying 10% more for a labor input, and customers hate passing the cost on.
Eventually this catches up. It needs another government though.
That’s because anyone intelligent will tell you your principle residence isn’t an investment. It’s sad how few homeowners understand that. Rapid price acceleration has distorted people’s perception of housing as an asset pretty badly.
Also, if you’re paying Vancouver people 10% more per year I’d like to know where you’re comparing that to in the USA. Despite a slightly stronger dollar my tech company still pays American employees more money than Canadians when you convert the currency. Salaries in Vancouver are absolute trash for a lot of industries, thus why Vancouver housing affordability is in a crisis-state right now. Even if we were at dollar parity we’d be paying Vancouver people less than most of the metros in the USA.
You stated: “If you have a job that’s skilled or academic, your pay rises with the cost of real estate.”
I think you’re out of touch with reality. This is not true for the vast majority of those positions – I don’t know a single person working in those sections seeing similar pay raises to match increases in real estate. For many, they get similar to 2% raises (maybe a bit more if lucky), and due to cost of rising goods / housing quite a number don’t have as much buying power compared to a decade ago despite making more.
Canada’s scrambling to add more residents to the system. Prices will only go up from here.
Those are people already in the country. No difference to housing consumption, but it’s going to suppress wages since there’s so much slack in the labor market.
There’s going to be a massive glut of housing because even though net migration was near-zero for 2020, housing construction barely slowed down at all.
On the upside, loving this strong loonie.
Almost makes up for the horrendous shipping costs we’re forced to pay because we can’t drive down to Point Roberts right now. haha
For the BOC to flatten the yield curve means they have to go back printing more dollars and then buying more government bonds, which many call the NEW economic plan. This plan has a big problem as the yield on long bonds is moving dramatically higher.
For the BOC to purchase long bonds and lower their yield , even more cheap dollars need to be put into circulation, which causes even higher inflation.
Right now every bond trader in the world is selling off these long bonds with low yields, leaving the only buyer as Central Banks..
As yields move higher holders of long bonds lose money as prices continue to fall.. the more they fall they more they sell..
What eventually will occur is rates will be forced higher..and mortgages will begin to look expensive.
Government could start paying off mortgages for people to continue propping up housing or buy up all foreclosed homes and rent them at a discount.
Housing is too big to fail.
Housing is not too big to fail. It’s far from ideal due to the overall negative impacts, but nothing is too big to fail. Look at the 2008 US housing crash, and also the 80s/90s Japan real estate crash. Both times those markets were “too big to fail” and yet they did.
Forgive me for being dense. When GOC issues a bond, it will offer a yield, presumably. But it sounds like the market will set the yield. How does that happen?
The yields are set by the market. They bid on it, then the bonds are traded in the secondary market as well. If bond prices fall, the yield stays a same percent of the full value, but the actual bond was cheaper, hence higher yields. i.e. you bought a $100 with a 5% yield for $95, the yield rises to 5.3%.
The overnight interest rates also involve liquidity operations in order to keep bond prices higher or lower.
So the way real estate market rising due to COVID-19 my assumption is should u keep ur investment property or should u sell it out
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