Bond yields are rising sharply around the world, with some government borrowing costs reaching levels not seen in years. The increase is putting upward pressure on fixed mortgage rates and auto loans in Canada and could affect other longer-term borrowing costs.
A bond is essentially a promise by governments to repay investors. Federal, provincial and municipal governments issue bonds to raise funds. Investors buy them, lending money for a fixed period in return for interest payments and repayment of the principal at maturity.
How Yields Feed into Mortgage Pricing
“Our governments at all levels borrow money because they spend in excess of their tax revenues, so the way they borrow money is through issuing bonds,” Ron Butler of Butler Mortgage Inc. told CTV News in a Zoom interview on Saturday.
A bond yield is the return an investor can expect based on the bond’s current market price and its promised payments. It differs from the coupon, which is the fixed interest rate set when the bond is issued. Government bonds also serve as a benchmark for other interest rates. The Bank of Canada has noted that the five-year Government of Canada bond yield is an important factor in setting five-year fixed mortgage rates.
“A bond yield, that is how we in Canada and all over the world, get mortgage rates, big banks use that as their guide,” Butler said. “The bond yield is for how they price their mortgages. As those yields increase, the bank needs to increase their fixed mortgage rates. It’s just as simple as that.”
Mortgage rates do not move in exact lockstep with bond yields. Lenders also take into account their own funding costs, risk, expenses and profit margins.
Why Investors Are Selling Bonds
Investors tend to demand higher returns when they fear inflation or interest rates will remain elevated, or when governments are issuing large volumes of debt. The current global selloff has been driven by rising energy prices, inflation concerns, expectations of higher interest rates and growing government debt. Uncertainty over Canada-US trade and broader geopolitical instability are also weighing on sentiment.
Toronto-based mortgage broker Sean Cooper told CTV News on Saturday that the Middle East conflict affects the US and, by extension, the wider economy. “It’s not just filling our cars, it’s for transportation of goods to the supermarket, food to the supermarket,” he said.
When investors sell existing bonds or become less willing to buy them, prices fall. Because the promised payments remain fixed, a lower purchase price produces a higher yield. New government bonds must then offer returns that are competitive with the market.
“When nobody particularly wants to buy the bonds, the sellers have to offer it at a more attractive price, and part of the price reflects as the yield,” Butler said. “In other words, how much money you’re going to be promised to get from that bond.”
Impact on Fixed and Variable Mortgages
The most immediate effect for many Canadians is on fixed mortgage rates. If Government of Canada bond yields remain elevated, lenders may raise rates on new and renewed fixed-rate mortgages. Some have already done so. Homeowners partway through a fixed term will not see their rate or payment change until they buy, refinance or renew.
Variable rates operate differently. They primarily track a lender’s prime rate, which is heavily influenced by the Bank of Canada’s policy rate rather than bond yields directly. Higher bond yields can also affect some business loans and other longer-term borrowing costs. The link to auto loans is less direct, as those rates depend on the lender, the borrower’s credit profile and manufacturer financing incentives.
There can be an upside for savers. Newly purchased bonds and some Guaranteed Investment Certificates may offer higher returns. However, rising yields typically reduce the market value of bonds and bond funds already held by investors. Higher yields also raise governments’ borrowing costs as existing debt matures and must be refinanced, adding pressure on public budgets over time.
Choosing Between Fixed and Variable
Borrowers should not assume either a fixed or variable product is automatically better. Tom Storey, a Toronto realtor, told CTV News on Saturday that many clients are leaning toward variable rates because the payment gap between variable and fixed options has widened.
Butler said some of his clients are starting with variable rates while waiting to see whether fixed rates ease. “If bond yields come down and fixed mortgage rates come down in the coming months, they have the opportunity to lock in at a fixed rate at a more reasonable level, instead of basically being forced to take whatever fixed rates are available today due to the elevated bond yields that we’re seeing right now,” he said.
That approach carries risk. A variable rate can rise if the Bank of Canada increases its policy rate, and a borrower who later converts would receive the fixed rate available from the lender at that time. The Financial Consumer Agency of Canada advises homeowners to begin shopping several months before a mortgage term ends, compare offers from different lenders and brokers, and negotiate rather than simply accepting a lender’s renewal proposal.
