With the Canada 5 year bond crashing below 1.50, the lowest level since mid 2017, there remains cautious optimism that banks will slash mortgage rates- providing a shot in the arm to the Canadian housing market just in time for the spring market. It would certainly be welcoming news for an industry witnessing the fewest home sales in a decade and mortgage credit slowing to its weakest pace of growth since the 1980’s. However, those hopes could very well disappoint for several reasons.

Canada 5 year bond
Canada 5 Year Bond

A regime shift from policy makers continues to move further away from an economic growth model propelled by the Canadian consumer. Given record levels of household indebtedness and elevated home prices, policy makers have shown little desire to encourage more borrowing. This stance was reaffirmed following a Federal Budget which killed consensus views for the re-introduction of a 30 year amortization, while also keeping the mortgage stress test firmly in place.

Meanwhile recent developments in the bond market illuminate slowing growth which has officially inverted a good portion of the yield curve. Yield curve inversions have presided before nearly every recession. This is partly due to not only compressing net interest margins at banks, technically making it less enticing to provide longer term loans, but also stokes a more conservative lending environment as banks proceed with caution given the deteriorating economic bank drop. Thus it is not so much the inversion of the yield curve which causes the recession but rather the banks desire to slowing lending in a weakening economy. Hence with the Canada 5 year bond plunging nearly 100 basis points banks have been hesitant to cut mortgage rates, only cutting by about 20 basis points thus far. We must also remember that just because bond yields are falling does not mean mortgage rates will automatically follow suit. Australia is a perfect example of this, the Aussie 10 year yield recently fell to all time record lows yet mortgage rates are actually rising.

Australia 10 year bond yield
Australia 10 year bond yield

We have already seen negative year-over-year growth in total mortgages in Alberta & Saskatchewan where growth is much weaker, and it appears total mortgage loans are also drifting towards negative territory in BC as well.

Mortgage growth in BC
Total Mortgage growth year-over-year in BC

This should continue to propel the growth in the private mortgage industry which has benefited from a low interest rate environment. With interest rates being artificially  suppressed through Quantitative Easing investors are having to push further out on the risk curve in a search for yield, thus investing in private mortgages at an 8-10% return becomes increasingly more attractive given yields on safer assets are largely negative in real terms. Although this type of short term, high interest lending inherently makes things more unstable.

Ultimately household credit growth must accelerate significantly in order to support current valuations and the current economic backdrop is making that increasingly more difficult to achieve.