By Richard Chu
Financial turmoil across the Atlantic is benefiting Canadians considering refinancing a mortgage or buying a home.
For much of 2010, posted five-year fixed-rate mortgages have declined at most Canadian financial institutions, dropping from a high of 6.25% in late April to a current low of 5.19%. Rates remain extremely attractive when taking into account the significant discounts most financial institutions provide for their posted rates.
As of last week, BMO was offering a five-year fixed rate of 3.54%; RBC and TD had a posted special rate of 4.04%. Coast Capital Savings had a posted “no haggle” five-year fixed rate of 3.45%.
The main reason for the past year’s fixed rates decline is the international flow of money coming into Canada.
Norm Krannitz, vice-president of treasury at Coast Capital Savings, noted that global investors who fear the default of financially strapped countries like Portugal, Italy, Ireland, Greece and Spain (known as the PIIGS) are putting their money in relatively safer sovereign investments like Government of Canada bonds.
“Global investors are looking for countries that have fair government fiscal management,” said Krannitz. “We have a tonne of [government] debt ourselves, but … in the global scheme of things, we’re well run.”
With greater demand for Canadian bonds, their yields have fallen to near historic lows. Yields for five-year bonds fell from a high of 3.2% this year to 1.8% in early October. Declining yields have lowered fixed-term mortgage rates. The result is a historic anomaly of a narrowing difference between variable and fixed rates.
Variable mortgage rates and lines of credit generally follow changes in the Bank of Canada overnight rate. So with the overnight rate moving to 1% from 0.25%, the prime rate for most institutions has risen to 3%, which isn’t far off a comparable fixed rate. The difference would be somewhat larger taking into account rate discounts by institutions, pushing variable rates below prime for eligible borrowers.
“Normally, what would happen in a rising [Bank of Canada] rate environment is that long-term mortgage rates would go up before the Bank of Canada would even consider moving its rate, because the market would anticipate rates going up,” Krannitz said. “So mortgage rates would normally go up as well as Bank of Canada rates. But this time, rates are moving for very different reasons.”
Many of the drops in Canada’s bond rates have been forecast by analysts, including Ed Devlin, executive vice-president at Pacific International Management Co. LLC (PIMCO), which manages more than $1.2 billion in assets.
At a CFA Vancouver event this summer, he noted that Canada is seen as a global safe haven and would likely have more capital inflows. That would lead to lower real interest rates over the long term and a flatter yield curve for Canadian bonds in general (see “Expect lower investment returns in slow-growth environment, advisers told” – issue 1091; September 21-27).
Krannitz said because of the continued economic uncertainty in Europe, Canadian fixed mortgage rates are unlikely to rise significantly in the short term. A couple of weeks ago, some banks briefly raised their five-year fixed mortgage rate to 5.44% over fears of the fallout from the European debt crisis. But a week later they dropped the rate.
“The market is on eggshells about the European thing,” said Krannitz. “Bond yields are bouncing around as investors don’t really know what to do. When they’re fearful, they sell their European bonds, but instead of buying Canadian bonds, which would lower yields, they’re leaving it in cash. It looks like money is going back into bonds, hence the yields are declining.”
Despite the uncertainty that’s benefiting Canadians who are either refinancing their mortgage or thinking of buying a home, rates could easily start rising if, or when, inflation becomes an issue in the U.S. With the U.S. Federal Reserve embarking on a second wave of “quantitative easing” that will reduce the value of the U.S. dollar by pumping billions into the economy, the U.S. government might have to raise rates for its own government bonds to attract global investors.
Overall, Krannitz warned that bond yields don’t generally move slowly and there’s a significant level of uncertainty in the market.
“They always tend to move for reasons no one thought of. They move rapidly because of some crisis or event somewhere in the world that no one expected or anticipated.