How Government Bond Yields Relate To Mortgage Rates

Bond yields and fixed mortgage rates are closely connected. But trying to understand the bond market can get complicated. Here's a simple way to understand bond yields to see where fixed rates are going. Let's (shallow) dive right in.

Fixed mortgage rates follow bond yields up or down. Simple, right?

Tracking bond yield trends can give you a good idea about where fixed mortgage rates are going:

  • Watch 5-year bond yields, which trade daily. Are they going up? Steady increases over days mean banks are likely to raise their 5-year fixed mortgage rates, too.
  • Are 5-year bond yields going down? Steady decreases over days mean banks are thinking of bringing their rates down, and eventually they'll do so if the trend continues.
  • Large swings up or down in a short period of time doesn't necessarily mean banks are pushed to action faster, but they'll definitely take notice.
  • The highest and lowest yields are tracked for the last 52-week period, which can provide context for how current bond yields are performing.

Banks are quicker to raise their fixed rates and slower to lower them in relation to bond yield movements. That's because they want to ensure their costs are being covered during market changes.

So watching the 5-year bond yield doesn't tell you the exact timing of fixed rate changes or how much banks will actually move rates up or down.

But understanding the trends can provide a valuable heads up for your mortgage rate decisions. You'll be better able to decide whether you should get pre-approved right away to hold your rate, or talk to our expert brokers about a fixed vs a variable rate strategy for your best mortgage savings.

Good with that? Great. Then off you go to watch bond yields, or better yet — apply now to hold your best fixed rate while you get to know the trend.

Want to know more? Let's dive a little deeper.

Why do bond yields affect fixed rates?

Banks use bond yields to help determine how high or low to set their fixed mortgage rates. That's because their mortgage rates compete with bond yields to attract capital. Both are sources of 'fixed' interest income and compete on similar terms.

  • Banks buy government bonds as a low-maintenance source of interest income.
  • Bonds are then traded in the bond market above or below par (its face value) which determines its yield in relation to the fixed interest rate it pays.
  • Bond yields, expressed as a percentage, are the current trading value of bonds (for a particular term).
  • Banks use bond yields to competitively anchor their fixed mortgage rates.
Fact: The bond market is MUCH bigger than the stock market and the pillar banks use to determine their fixed mortgage rates.

Why are fixed rates usually set higher than bond yields?

Mortgages are a 'high maintenance' source of income for banks. They come with more costs and risk, so fixed mortgage rates are set higher than 'safer' bond yields — referred to as the 'spread relationship.'

But the spread isn't always consistent — it can expand or compress depending on several economic factors, including where the Bank of Canada's benchmark rate may go.

Lenders also compete with each other for your mortgage dollars, so the spread isn't consistent among them — with each deciding on their bottom line if they can notch rates down even more. Big banks, who offer a multitude of investment products, often have less wiggle room to lower your rates (compared to a monoline lender, like our in-house THINK Financial).

Fact: Variable (floating) mortgage rates follow different influencers than fixed rates.

How much higher are fixed rates over bond yields?

In a normal market, the average 'spread' or markup of fixed mortgage rates above secured government bonds is roughly 100 to 200 basis points, or 1% to 2% (there are 100 basis points in a percentage point).

Why not higher? Back to the word 'compete.' Banks need cash to operate but have to compete with other banks and entities — and products — for investment. The nature of competition regulates rates and prices based on supply and demand. So fixed rates are priced higher than bond yields, but competition dictates the 'spread' that keeps a leash on how much higher they should be.

What can impact the spread relationship?

Times of financial uncertainty can trigger 'mood swings' in the spread between 5-year bond yields and 5-year fixed rates. For example, in 2020, as the Canadian markets were tossed around by the COVID-19 pandemic, some fixed rates were briefly raised despite bond yields falling — because lenders were anticipating housing market volatility.

Or, the 5-year bond yield will often move to anticipate the Bank of Canada's rate mandate — whether on a cycle to increase or draw down its trendsetting overnight rate. For example, if there's an expected increase in the next rate announcement, bond yields will 'forward' price to where the market will be, which may compress the spread more than usual. Fixed rates will eventually be bumped up to re-establish the typical spread relationship.

So the central bank's policy rate can influence bond yields?

Yes, but indirectly through responding market factors that anticipate coming policy changes. Prevailing interest rate policy has more effect on short-term bond yields (5 years and under).

Long-term bond yields are more influenced by the market forces behind supply and demand — if investors feel that current policy hasn't set the right tone to keep inflation and other disruptive factors in check, long-term yields may reflect that caution (projecting the impact on revenue farther down the line).

Why use the 5-year bond yields, and not 4 or 6?

Or 3, or 2 — you get the idea. Why watch the 5-year yield for fixed-rate moves? Banks use the 'standard' length of 5 years for setting other rates and prices, so it becomes the one to watch for simplicity's sake.

If you really want to get technical, 4-year bond yields are likely a closer index to watch. Why? Because even though 5 years is standard, the average time that mortgage holders actually 'hold' their 5-year term is around 4 years. That average absorbs homeowners who find that they need to make a change before the end of their term — like refinancing or switching — because life happens.

(That's why we advocate for your best mortgage product with your best rate — to save more on hidden fees or higher penalties later when you need it).

The 5-year yield is a good indicator of the market trend, though the 4-year may show a tighter 'spread relationship' to better predict banks' timing on rate moves.

The bond bottom line

Bonds trade daily, which means the 5-year mortgage rates can move at any time. And while fixed mortgage rates don't move in lock step with bond yields, keeping an eye on the spread­ relationship may help you determine where rates may be headed.

Are fixed rates changing? We can help.

Watching bond yields? It's fascinating to see banks increase or decrease their fixed mortgage rates as the bond market moves.

See that fixed rates may be going up? Give us a shout! If you're looking for a home, get pre-approved now to hold your best rate for up to 4 months. Your rate will be protected from increases for the next while as you try to find the perfect place.

Or, if you're about to renew or refinance, we can hold your rate for a short time AND help provide insight on your best strategy to save more.

We'll also help you assess the latest federal mortgage stress-test regulations and their impact on your qualifying rate and mortgage affordability.

Check out our latest volume-discount mortgage rates here.

Whether fixed rates may be going up or down — we're here to save you time, money and stress.

More bond yield FAQs

What exactly is a bond yield?

Bond yields are the real 'rate of return' set for that bond's term length.

After a bond is purchased, it can be traded at a higher or lower price than its original face value. This trade price combines with the amount of its annual fixed interest (coupon payment) to calculate its current return based on the new price.

Bond yields for each term length offered (e.g. 5-year) are expressed as a percentage that is tracked over time.

How is a bond yield calculated?

Here's the bond yield percentage formula:

Annual coupon payment (original interest) divided by bond price = bond yield.

For example:
Original 5-year bond price of $1,000 comes with an annual coupon of $50 (provides 5% interest each year until maturity). If sold for a higher price of $1,100, then its bond yield becomes $50/1,100 = 4.55%. If sold for a lower price of $900, its bond yield is $50/900 = 5.55%.

So when bond prices go up, yields come down and vice versa.

What happens when bond yields go up?

When bond yields go up, it usually signals a higher-interest rate environment (or that governing interest rates are anticipated to go higher) — indicating that fixed mortgage rates will be higher.

What happens when bond yields go down?

When bond yields go down, it usually signals a lower-interest rate environment (or that governing interest rates are anticipated to go lower) — indicating fixed mortgage rates will be lower.

Lock in your best rate, now.