Current 5-Year Bond Yield has been highlighted.
Government bonds are a relatively safe investment, and in terms of Canadian and U.S. government bonds, they can even be considered to be risk-free. The maturity for government bonds can range from 2 years to 30 years. The 5-Year Government of Canada bond yield is particularly important for homeowners, as 5-year fixed-rate mortgages follow the bond yield. Government bonds of different maturities, such as 5-year bond yields and 10-year bond yields, are also used by analysts to assess the conditions of the economy.
Government bonds are risk-free investments, while mortgages are risky investments. To make up for the risk, there is a risk premium added onto mortgage rates above bond yields. This compensates investors for the additional risk that they take on.
5-year bonds have the same maturity as 5-year fixed mortgages. If given these two options, an investor can either invest in the 5-year bond and receive a safe return, or they can invest in mortgages. Mortgages have additional risk in a variety of ways. They have default risk, where the homeowner cannot afford to make payments, and there is prepayment risk, where a homeowner pays back the mortgage early.
Although there are prepayment penalties if a mortgage is paid back early, the lender will still no longer receive future interest payments. As mortgages are usually paid off early when interest rates fall, such as to refinance, the lender would then only be able to lend to a new mortgage at a lower interest rate.
If 5-year bond yields increase, then 5-year fixed-rate mortgages will also increase. The reverse is also true, however mortgage lenders can be inclined to increase rates faster when yields rise rather than decrease them should bond yields fall.
Mortgage rates follow the bond yield, but there is a spread between them. This spread is usually between 1-2%. This means that if the current 5-year bond yield is 1%, then we can expect mortgage rates to be around 2-3%.
For example, on February 1, 2021, the benchmark 5-year bond yield was 0.42%. We can then expect mortgage rates to be between 1.4% and 2.4%, which they roughly are.
|5-Year Canada Bond Yield||Last Seen||Mortgage Rates Range|
|0.4%||January 2021||1.4% - 2.4%|
|1.6%||January 2020||2.6% - 3.6%|
|2.4%||November 2018||3.4% - 4.4%|
This spread can widen during times of financial uncertainty, as investors move towards safer investments such as government bonds. In March 2020, as the COVID-19 pandemic affected Canadian markets, some lenders briefly increased mortgage rates even though bond yields fell.
The same mortgage spread movement was seen in the United States. The 30-year mortgage rate spread above the 10-year Treasury yield increased from just under 1.8% in January 2020 to over 2.72% on April 23, 2020. This 2.72% spread over the Treasury yield was a record high not seen since 2008.
Bond yields have been recovering after hitting record lows in 2020. From a current yield of 0.421% on February 1, 2021, the 5-year bond yield can be expected to be from 0.7% to 1.15% by the end of 2021. This is still well below pre-2020 levels.
Mortgage rates for fixed mortgages can be expected to increase by 0.3% to 0.7%.
Variable-rate mortgages move with the Prime Rate, which is determined by the Bank of Canada’s overnight rate. This policy interest rate is not expected to change in 2021.
|Bank||End of 2021 Forecast|
|Bank||End of 2021 Forecast|
The yield of a bond is an annual return that the bond provides in percentage terms. The yield of a bond is not just the interest that you receive, but also takes into account the market price of the bond versus its face value.
Government of Canada bonds pay interest every six months. This is known as coupon payments. Each bond has a face value, with the bond's coupon rate being a percentage of the bond's face value. The bond’s coupon rate does not change over the life of a bond, but the price of the bond can change, in turn affecting returns. Generally, bonds with longer maturities will be more sensitive to market interest rate changes, and will have larger price changes than shorter maturity bonds.
The bond’s face value, or par value, may not be the same as the price that you paid for the bond. If you purchased a bond below face value, you will get a higher yield. Conversely, paying more than the bond’s face value will mean that you will have a lower yield.
Government of Canada bonds are regularly issued through auctions. In these bond auctions, primary dealers bid on the price of the bond that they are willing to pay, given a set coupon rate.
Some primary dealers include RBC, TD, Scotiabank, CIBC, BMO, HSBC, Desjardins, and National Bank. Primary dealers are the only ones authorized to bid directly in Government of Canada bond auctions, and so they set the price for the market. Primary dealers are also Government Securities Distributors. These Government Securities Distributors then sell these bonds to clients.
The 5-Year Government of Canada bond is auctioned off roughly every month. For example, the 5-year bond was auctioned on January 14, February 11, March 9, and March 31 of 2021. These bonds will mature in five years, in 2026.
Government of Canada bonds are priced with a par value of $100, although they have a face value of $1,000. For example, if a bond is priced at $99.50, one bond would cost $995.
During auctions, if primary dealers feel that the set coupon rate is too low for current market conditions, then they may bid for a price lower than par. For example, the 5-year bond auctioned on January 14, 2021 had a coupon rate of 0.25%. The result of the auction was an average price of $98.719. Since the price is lower than par, the resulting bond yield is higher than the stated coupon rate. The yield for that particular bond was 0.504%.
If a bond’s coupon rate is attractive, dealers may bid up the price, as they are willing to pay more to get a higher coupon rate. For example, the 30-year bond auctioned on January 21, 2021 had a coupon rate of 2.00%. The resulting price of the auction was $112.285, well above par. This reduced the bond’s yield to 1.501%.