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How Government Bond Yields Relate To Mortgage Rates

Bond yields are the setting factor for fixed mortgage rates.

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.

Jun 20, 2024

Updated from Jun. 18, 2024


What's Happening Now

Bond yields are up above 3.3%, pushed by a mixed U.S. jobless claims report (a sharper week-to-week decline, but higher for the month overall). Potential economic weakening there also surfaced in a recent lower-than-expected U.S. retail sales report. The timing of a first U.S. rate drop is still up in the air.

We saw the Bank of Canada's first drop on June 5 thanks to weaker Canada March GDP and Q1 2024 preliminary results and weaker U.S. PMI numbers (Purchasing Managers Index). Combined with a decline in our April headline and core inflation, the economic planets aligned to ease pressure on the BoC. Will more cuts follow?

Be sure to hold your rate while you make your mortgage decisions, as fixed rates have been volatile in response to bond market mayhem (which is typical during times of rate uncertainty). Catch the fixed-rate specials (like our great 1-year and 3-year fixed rates) popping up as lenders elbow for room to capture mortgage dollars.

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

Tracking Canadian government bond yield trends can give you a good idea about where fixed mortgage rates are going — the 5-year bond yield is the standard one to watch, correlating with 5-year fixed mortgage rates (at a spread).

Watching the 5-year bond yield won't give 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.

Watch bond yields for insight into fixed-rate movements.

  • Keep an eye on 5-year bond yields, which trade continuously during market hours. Are they going up? Steady increases over days mean banks are likely to raise their 5-year fixed mortgage rates soon, 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 don't necessarily mean banks are pushed to action faster, as they may wait to see if the trend calms down or reverses.
  • The highest and lowest yields are shown for the last 52-week period, which can provide context for how current bond yields are performing.

Banks are quicker to raise their fixed mortgage 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.

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 mortgage rates?

Banks buy bonds as a low-maintenance (read that as less costly) source of fixed-interest income. Conversely, the fixed mortgage rates they offer clients are a higher-maintenance source of income (it costs more to operate mortgage loans).

But fixed mortgage rates compete on similar terms with bonds to attract capital (e.g. 2-year, 5-year, etc.), so they look at the yield of those less-costly bonds to help determine how high or low to set rates of more-costly mortgages.

What exactly is a bond yield?

A bond yield (expressed as a percentage) is the real 'rate of return' during a bond's term length.

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

Banks buy government bonds at a set price for a set term (e.g. 5-year) for a set interest rate. (Sounds simple, right?)

After a bond is purchased, however, interest rates always change. To ensure that a bond is never worthless due to its original interest rate (why would a bank want a lower-interest rate bond if a higher one is available?), bonds are traded in a public market — at a higher or lower price than their original face value in order to 'equalize' their interest rate returns.

That continual exchange on the bond market produces the current 'yield' of bonds, categorized by term length. (Maybe not so simple, but it works.)

Here's an example:

  • An original 5-year bond price of $1,000 comes with an annual coupon of $50 (provides 5.0% interest each year until maturity).
  • If sold for a higher price of $1,100, its bond yield lowers to $50/1,100 = 4.55%.
  • If sold for a lower price of $900, its bond yield increases to $50/900 = 5.55%.

So when bond prices go up (interest offering is more desirable), yields come down and vice versa.

As bonds become less or more desirable on the market, the price at which they're bought or sold changes — which affects interest income yields. The 'meeting point' between the highs and lows is tracked as a whole, represented by the bond yield percentage.

Fact: The bond market is MUCH bigger than the stock market and is used by banks to determine where fixed mortgage rates are set.

Why are fixed rates set higher than bond yields?

Fixed-rate mortgages are riskier and more costly to operate, and so are set higher than less-costly bond yields — which defines their 'spread relationship.'

The spread between higher fixed mortgage rates and lower bond yields isn't always consistent — it can widen or compress depending on several economic factors, including the banks' perception of risk on the horizon (loan arrears and defaults).

Lenders also compete for your mortgage dollars, so the spread isn't consistent among them — with each deciding on their own 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 mortgage finance corporation (MFC), like our in-house THINK Financial).

Fact: Variable (floating) mortgage rates have different influencers than fixed rates, the main one being the Bank of Canada policy overnight rate.

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 bond yields 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 for investment. The nature of competition regulates rates and prices based on supply and demand. So competition keeps a leash on how much higher fixed rates 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 Canadian markets were tossed around by the COVID-19 pandemic, some banks briefly raised their fixed mortgage rates despite bond yields falling (widening the spread) because lenders feared a pandemic-driven recession and the resulting defaults.

Or, the 5-year bond yields can experience sudden spikes as bond traders react to surprisingly high inflation numbers. For example, when sky-high inflation numbers were reported last June, bond yields rose rapidly with the assumption that more interest rate hikes were on the way, compressing the spread until fixed rates were bumped up accordingly, re-establishing the typical spread relationship.

How are bond yields influenced by the central bank's policy rate?

Through the 'anticipation' of it all. Bond traders trade bonds much like stockbrokers trade stocks — they try to anticipate where things are going to avoid potential risk. Stockbrokers buy and sell stocks in anticipation of a company's positive or negative announcement. And bond traders trade government bonds in anticipation of BoC rate announcements (if rates are forecasted to go up or down).

So, for example, if inflation news is unexpectedly bad, bond traders will bid up bond yields because they anticipate a rate hike by the central bank (keeping inflation under control is the institution's primary purpose). But if inflation comes in lower than expected, bond traders will bid down bond yields in anticipation of a prime rate cut. Fixed mortgage rates are therefore indirectly influenced by the central bank's policy rate as yield trends go higher or lower.

What about longer-term bond yields? Under normal market conditions, long-term yields tend to be higher than short-term yields to attract investment in 'the future.' If bond traders fear that inflation is out of control now, short-term bond yields are bid up (leading to higher fixed mortgage rates in the short term).

What is the risk of central bank rate hikes to tame high inflation? That a recession (economic contraction) may follow.

During a recession, central banks generally want to lower the prime rate to stimulate the economy. So, if bond traders expect a recession, they will trade down long-term bond yields (e.g. 10-year term) in anticipation of future prime rate drops — which can lead to a curve inversion between short and long-term yields.

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

Or 3, or 2 — you get the idea. 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 a 5-year term is chosen, many mortgage holders end up only 'holding' it for an average of 4 years (3.89 years, actually). This 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 if you need a change.)

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 perpetually (during exchange hours), which means 5-year fixed mortgage rates can move at any time.

And while they don't move in lockstep with bond yields, keeping an eye on the spread­ relationship may help you determine where fixed rates may be headed, and give you a slight thrill when you do see banks move rates as bond yields go up or down.

Are fixed rates changing? We can help.

Hold your best rate now (for up to 4 months)! If you think fixed rates may be going up, we can quickly get you pre-approved to protect your rate from increases for the next while as you try to find the perfect place.

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 can 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.

No matter where fixed rates are going — we're here to save you time, money and stress.

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