Will higher mortgage rates weigh on home sales?

Key Concepts

• Bond Yields: The interest rate return an investor realizes on a bond; they move inversely to bond prices and are a primary driver of fixed mortgage rates.
• Basis Points (bps): A unit of measure used in finance; 100 basis points equals 1%.
• Fixed vs. Variable Rates: Fixed rates are tied to bond market yields, while variable rates are directly influenced by the Bank of Canada’s (BoC) overnight lending rate.
• Bond Vigilantes: Investors who sell bonds in protest of government fiscal policies (e.g., excessive spending), which drives up yields.
• Strait of Hormuz: A critical maritime chokepoint for oil transit; geopolitical instability here directly impacts global oil prices and, by extension, inflation and interest rates.

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1. The Impact of Geopolitical Conflict on Mortgage Rates

The current volatility in the Canadian mortgage market is primarily driven by the conflict in Iran. The logic follows a direct causal chain:

• Conflict in the Strait of Hormuz → Increased oil prices → Higher inflation expectations → Higher bond yields → Higher fixed mortgage rates.
• Current Data: Since February, bond yields have risen by approximately 60 basis points, leading to a near point-for-point increase in fixed mortgage rates. Fixed rates that were previously in the 3.69%–3.79% range have climbed to 4.49%–4.69%.

2. Fixed vs. Variable Rate Dynamics

• Fixed Rates: Highly sensitive to bond market fluctuations. They are currently trending upward due to inflation concerns linked to the war.
• Variable Rates: Remain stable (currently between 3.30% and 3.65%) because they are tethered to the Bank of Canada’s policy rate, which has remained unchanged.
• Strategic Outlook: Ron Butler suggests that if the conflict resolves, bond yields would likely drop, making variable rates a "safe haven" for borrowers. However, he notes that while bond markets react quickly to news, energy prices and inflation take longer to stabilize.

3. Bank of Canada (BoC) Policy and Economic Pressure

• The BoC’s Stance: According to Butler, Governor Tiff Macklem has signaled that the Canadian economy is weak, and the Bank has no inherent desire to raise rates.
• The "Inflation Trap": The BoC is forced to act based on its mandate. If the war persists and inflation remains "persistent," the Bank may be forced to raise rates despite the economic weakness.
• US Influence: The US mortgage market is experiencing more severe pressure, with rates reaching the 7% range. This creates a global environment of high yields that exerts indirect pressure on Canadian rates.

4. Impact on the Housing Market

• Short-term "Bump": There is currently a slight increase in home sales. Butler attributes this to buyers who secured pre-approvals at lower rates (in the 3% range) weeks ago and are now rushing to close deals before those pre-approvals expire.
• Future Tamping: If fixed mortgage rates reach or exceed 5%, Butler predicts a significant cooling effect on housing market activity.

5. Secondary Economic Factors

Beyond the conflict in Iran, the market is monitoring "bond vigilantes." These traders are concerned that current levels of government fiscal spending are unsustainable. This skepticism regarding fiscal policy acts as a secondary, persistent pressure that keeps bond yields elevated, independent of the geopolitical situation.

Synthesis and Conclusion

The Canadian mortgage landscape is currently in an "unusual" state where consumer borrowing decisions are heavily dependent on Middle Eastern geopolitical developments. While the immediate trend is toward higher fixed rates, the market is highly reactive to any news regarding a potential peace deal.

Key Takeaway: Borrowers are currently caught between the security of fixed rates and the potential long-term savings of variable rates. Butler’s advice is to assess one's personal risk tolerance regarding the duration of the conflict: those who believe the war will be short-lived may favor variable rates, while those concerned about long-term inflation and conflict duration should opt for the stability of a fixed rate.