Why worries about the coronavirus are pushing mortgage rates down

Economists are busy trying to calculate the potential economic toll of the coronavirus outbreak that's currently making its way around the world. But there's one marketplace that is already, quite unexpectedly, quantifying the full force of the bug: mortgages.

Rates for fixed- and variable-rate home loans are based on a variety of factors, but one of the biggest is the price that lenders have to pay to borrow money themselves.

For fixed-rate Canadian home loans, the benchmark that sets the price that consumer rates are based on is the five-year Government of Canada bond.

Investors who covet bonds like that one do so because they are perceived to be safe. Investors are willing to accept the relatively meagre returns that government debt offers because it's better than the alternative — losing money on whatever other, riskier investment they would have had to buy instead.

Counterintuitively, the price of a bond and its yield move in opposite directions. So when appetite for bonds goes up, the amount they pay out goes down, because lenders don't have to offer quite as good a deal to find a buyer for their debt.

The price of bonds tends to increase when people are feeling fearful, a situation that certainly describes the state of affairs today amid a mysterious coronavirus emanating from mainland China that has killed more than 100 people and infected thousands more.

That fear is prompting investors to pour money into the safety of government bonds, and all that buying is pushing down the yield on that debt.

As recently as the start of the year, the yield on the five-year Canadian government bond was about 1.7 per cent. This week, it dipped as low as just above 1.3. In the staid world of bonds, a 40-point drop in a relatively short period is huge, and it's filtering down into the mortgage market.

Bond yields influence loans

Fixed-rate loans are highly influenced by bond yields, because a mortgage lender makes money on the spread between the bond rate and what they offer to consumers. If the five-year bond yield goes up, they can just pass that cost on to consumers. If it goes down, as it is now, the lender's cost of borrowing goes down, so they can turn around and lower their rates for consumers to drum up new business.

That's what seems to be happening.

Fixed-rate loans are falling, according to James Laird, CEO of mortgage broker Canwise Financial and co-founder of rate comparison website RateHub.ca. While specific rates will vary based on the borrower and what part of the country they're in, currently the best deal on offer for a five-year fixed loan is 2.64 per cent with a trust company and 2.74 per cent from a big bank. Barely a month ago, those rates would have been roughly 10 to 20 points higher.

While bond yields have fallen by about 40 basis points in that period, that means lenders so far have only passed on about a quarter of those savings to consumers. But that is likely to soon change.

Lenders are always slower to pass on savings than they are to pass on added costs, Laird said, but they can only hold off for so long.

"If bond yields were up by 40 points, you can guarantee far more [lenders] would have changed rates and by a greater amount," Laird said. "On the way down they're a little slower ... they enjoy thicker margins for a while."

Coronavirus fears have really only sped up the process of a move toward lower rates that was already underway, he said.

In its policy decision last week, the Bank of Canada elected to keep its benchmark interest rate where it is for now. But by singling out concerns over the job market, international trade and other factors, it's clear the bank is leaning more toward rate cuts than hikes, Laird said.

Variable-rate mortgages set their rates based on what the Bank of Canada is doing, not bond yields. And based on the central bank's last statement, traders think there's about an 80 per cent chance of at least one rate cut by the end of 2020. That means home buyers with variable-rate loans can expect some relief soon, too.

Spring buying

There's also some seasonality at play in all this. All things being equal, lenders like to hit the ground running on the busy spring home buying season, so Laird often sees rate cuts in mid-February or March, regardless of what bonds are up to. 

The sudden impact of the coronavirus is just causing that to happen a little earlier and a little more dramatically than anticipated.

"It's not like rates were on the rise and the coronavirus caused them to do a U-turn," he said. "I'd say this is another area which is putting downward pressure on bond yields, and therefore downward pressure on mortgage rates."