The Canadian economy is currently showing an inverted yield curve for the first time in twelve years. Historically, an inverted curve has been an excellent indicator of an upcoming recession, with ten of the last fifteen inversions being followed by at least one quarter of economic contraction. This translates to many implications for the economy, including how mortgage rates are set moving forward.
What does an inverted curve mean?
First and foremost, it’s important to understand the terms behind an inverted yield curve. In the mortgage industry, the Bank of Canada’s overnight lending rate and the rates for Canadian government bonds are particularly important.
As you may have read in our latest Bank of Canada announcement, the current overnight lending rate is sitting at 1.75 percent. This is the rate at which Canada’s central bank lends out money to financial institutions, such as banks and mortgage lenders. These financial institutions borrow money on the bond market.
Canadian bonds are investments available through the federal government, where the investor is essentially lending the government money and the government agrees to pay the investor interest on that money for a certain period of time. When the bond “matures,” this signals the end of the investment and the face value of your investment is returned to you.
Right now, the rate on almost all Canadian government bonds is lower than the overnight lending rate of 1.75 percent. The last time this happened was between 2006 and 2007 and this is what causes an inverted yield curve (in this context).
Simply put, a bond yield is the return the bond-holder sees on their investment. With a normal curve, the yield is higher for a longer term. With an inverted curve, the yield decreases the longer the term of the bond.
What does this mean for Mortgage Rates?
In the midst of this gloomy forecast, mortgage holders actually benefit in terms of interest rates. Based on previous inverted yield curves, rates are likely to stay below last year’s high for at least a few years. Additionally, the mortgage qualifying rate may drop which means it will be easier for people to buy and refinance their homes.
Out of the last nine inversions (where Canada’s 10 year government bond yield was below the bank’s overnight lending rate), eight of them signaled prime rates either staying the same or decreasing one year later.
Fixed rates are primarily determined by the yield on Canadian government bonds. With a decrease in the yield (such as when there as an inverted yield curve), five-year fixed rates are likely to follow suit.
What Comes Next?
The Bank of Canada meets again on April 24, 2019 to publish their next rate announcement. Stay on top of rate announcements and other important industry news by following our blog, Facebook or Instagram.