The Bond Yields
In April, the Government of Canada’s 5 Year Benchmark Bond Yield didn’t see too much action as it hopped around the 1.60 level. May, however, was a completely different story with the month starting off at 1.60 and falling lower day by day. On May 25th, the 5 year bond yield went as low as 1.31 – only 6 basis points over the lowest yield since the beginning of 2012. In fact, it marks the lowest rate over the last 4 months!
Global Markets and the Effect on Bond Yields
It’s the same old song and dance, really. There continues to be a great deal of uncertainty when it comes to global economic markets, which means that investors are not putting their faith or money there. Instead, they are turning to the resilient Canadian marketplace and Government-backed bonds to provide them with a sound investment.
Econ 101: What’s Happening Internationally?
Naturally, the inferior global market has fueled the demand for GoC bonds. This pushes bond prices up and as a result the bond yields decrease. It’s a no brainer to understand how an increase in demand for something increases the price of it – but what about the relationship between price and yield?
Econ 201: Bond Prices and Yields
If life were simple, investors would purchase a bond and hold it until maturity. But this isn’t always the case. Many professionals will buy and sell bonds on the open market before they reach maturity, which in turn affects the price and effective yield of the bond.
All that a bond really is, is an IOU from the Government. You purchase an IOU for, say, $1,000 (known as the face value of the bond) and in 10 years from now (upon maturity) the issuer will pay back your initial investment plus interest (a.k.a. the coupon rate).
To illustrate the relationship between bond prices and yields, we will use a 10 year GoC bond with a face value of $1,000 and a coupon rate of 5 per cent. Every year, the government will pay you the $50 coupon (5 per cent) and then in the 10th year pay back your initial investment of $1,000.
The current yield (5%) = Coupon ($50)
We know what can affect the price of a bond. But what if bond prices increase and are selling at a premium (as they are in the current environment) – what happens to the current yield? Remember, the contract states that you will receive regular coupon payments of $50 and the face value regardless of what the price of a bond is trading for on the open market. So let’s say that increased demand in the bond market has pushed bond prices up to $1,500 and now they are selling at a premium:
Current Yield = 50
Current Yield = 3.33%
Everything has to remain balanced… now you can see how an increased bond price decreases the effective yield when all other factors are constant.
Bond Yields and Fixed Mortgage Rates
Wondering where fixed mortgage rates are heading? Then take a look at the bond market! Bond yields are a key benchmark that lenders use to price their fixed rates. When yields increase, fixed rates increase and vice versa. The bond yields have been steadily decreasing over the last month, so many are anticipating a similar movement to fixed mortgage rates as well – especially if this trend persists.
What About Variable Rates?
Lenders use a different benchmark to set their variable rates mortgage prices. They follow the Bank of Canada’s overnight lending rate. When the overnight lending rate increases, lenders will also increase their prime lending rate, which has a direct impact on variable rates. The next scheduled meeting for the BoC is next Tuesday, June 5th, 2012. However, many speculate that there will be no changes to the overnight lending rate (yet again).
RateSupermarket.ca Week in Review
There is only one change to report from last week and that is in the 5 year fixed rate, which dropped a whopping 10bps. Back again are the 2.99 days – so it seems! All other rates stayed put on the Best Mortgage Rates page.
Do you want to know when the best mortgage rates change? Be the first to know and sign up for RateAlert, RateSupermarket.ca will e-mail you a daily digest of the mortgage rates that have changed in your area!
The 5 year fixed mortgage was the most popular searched rate last week (no surprise) with 45.8 per cent of visitors checking out the rates. Just over one fifth looked at the 5 year variable rates (22.6 per cent). And as always, the next most popular searched rates were the 10 year fixed (9.3 per cent), 3 year fixed (6.2 per cent) and 1 year fixed (4.0 per cent).