So you’re at a hot-yoga-and-reno party in Leslieville when the convo turns to mortgage rates. All your Vespa-riding, post-Apple friends are talking about how they’re locking in to avoid the pain to come. “Well,” you say solemnly, “I’m not buyin’ it. The yield curve’s bitchy steep right now.” Then you wander off to look for termite tunnels along the basement walls. This will make a strong impression. Which, of course, is why you socialize.
What’s a yield curve? Simply econo-talk for the line on a chart that connects short-term interest rates (like your floating line of credit), with medium-term ones (a five-year mortgage, for example) and really long ones (a 30-year government bond). Normally this curve slopes up gently with time – which is exactly what it did six months ago. That meant the spread between a variable-rate mortgage and a five-year job was not that much – less than a point.
Sometimes the yield curve is completely kinky, and inverts. Then short-term money carries a higher rate than the long stuff. When inflation is out of control, for example, and the feds jack up rates to choke it off. Other times (like now) the curve gets more extreme, when longer-term debt rates pop while shorter-term ones don’t move.
Did you stop reading already? Bad. Get back here.
Central bankers, such as the guys at the Bank of Canada or the US Fed, set short-term rates. As you know, they’ve been in the dirt since 2009, making money cheap so people will borrow their brains out and buy stuff. Which they have. Longer-term rates are established in the bond market, where guys with Porsches trade debt to make money. The bond market, by the way, is massively larger than the stock market and consequently more important.
Since the summer, rates in the bond market have soared higher and that’s why five-year mortgages cost 1% more. Banks finance those mortgages there, while the short-term variable-rate mortgages are costed according to the Bank of Canada rate, which hasn’t moved for a long time. This means the yield curve got wacky – very low at the short end, and spiking at the other. It’s why a 5-year mortgage now costs 1.1% more than a variable.
But what does it mean to hipsters buying urban semis that people a century ago threw up as temporary McHousing?
Lots. Bond yields have risen (and bond prices fallen) since the US Fed (the central bank, which has more money than God) said in June it might taper down all the stimulus spending it’s been doing for several years to rekindle the American economy. The government has been buying up bags of its own bonds, injecting money into the economy and in so doing creating high bond prices and crazy-low yields. Now that will reverse – in fact, it all starts next Wednesday. In anticipation, traders sold billions in bonds to take profits, causing prices to topple and yields to swell.
And that’s how we got a yield curve that looks like an excited banana.
As I said, a key moment in yield curveology comes next week when Feb boss Ben Bernanke holds a presser and announces a tapering program. The bank will formally begin scaling back those bond buys by about $10 billion a month. That will leave $75 billion still being spent, so it’s hardly like turning off the tap. Bernanke will also make it clear that further cuts will take place only as the economy grows strong enough to stimulate itself.
There’s a market saying (sort of) that wise people emote on rumour and act on news. This will be news. The speculation that caused the market turmoil over the past few months – tanking bond prices and sideswiping preferreds and REITs at the same time – will be over, as authorities make it crystal what happens next. This probably means bonds will rally and yields drop, at least until everyone starts worrying about inflation.
Hence, my advice of last week. Don’t lock in to a five-year mortgage. Go variable.
The central bank rate won’t be moving for at least a year, thanks to a sucky Canadian economy, and those longer bond yields will be falling, bringing the five-year home loans back down at least a quarter point. So wait. After all, you missed the chance to lock into a 10-year at an even lower cost months ago (when I pointed it out), so you might as well be fluid now. Watch this pathetic blog for breaking details on when to call TNL@TB.