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The real reason mortgage rates are so low in Canada
4/23/2015 | Posted in Financial Markets by Paul DeAdder | Back to Main Blog Page
Canada’s overheated housing market is starting to feel the effect of Europe’s negative interest rates.
Yields on about $8.8 billion of Canadian mortgage bonds denominated in euros and francs are being pushed below zero as European Central Bank asset purchases help to drive down borrowing costs worldwide.
Canadian banks turned to Europe for cheap funding over the past few years as regulators and the Bank of Canada sought to keep the housing market from turning into a bubble. Although Europe is only one avenue for financing, that European investors are willing to pay for the privilege to park cash in the bonds shows how the ECB’s program is being felt across the Atlantic.
“That’s why you’re seeing five-year mortgage rates where they are,” Altaf Nanji, who helps oversee $17 billion for Manulife Asset Management, said by phone from Toronto. “Regardless of what the Bank of Canada does, it’s really a reflection of where the yield curve is.”
The Bank of Canada has provided stimulus of its own this year by cutting its benchmark interest rate in January by 25 basis points, or 0.25 percentage point, to 0.75 per cent. It called the move insurance against a collapse in the price of crude oil, Canada’s largest export.
Domestic Risk
Canada’s five-year government bond yield, the benchmark for the part of the domestic market where banks look when they want to finance mortgage lending in their home currency, fell to a record low of 0.58 per cent after the rate cut.
At the same time, the Bank of Canada has said the housing market is as much as 30 per cent overvalued and singled out the combination of record consumer debts and inflated home prices as a major domestic risk.
Home resale values hit a record in March, according to the Teranet-National Bank National Composite House Price Index.
Canadian lenders have been cutting rates on mortgages in the past month to the lowest levels in history, including a rate of 2.74 per cent on a five-year fixed mortgage by Toronto-Dominion Bank.
At the same time, the national housing agency has increased the cost of mortgage insurance for borrowers with less than a 10 per cent down payment.
“Lower yields globally are holding down our yields, too, and further juicing the housing market,” said Doug Porter, chief economist at BMO Financial Group, by phone from Toronto. “The extremely low yields in Europe will get money gravitating to North America, where yields look fat.”
Covered Bonds
Canadian banks use the European market to fund their mortgage lending because it is home to the largest and oldest market for a certain kind of mortgage backed security called covered bonds, first developed in Prussia during the 18th century.
In a bid to spark growth and inflation among countries that use the euro by getting cash flowing through the economy again the ECB now charges 0.2 per cent interest for cash deposits and plans to buy 1.1 trillion euros ($1.2 trillion) of assets by September 2016.
In an attempt to deter money flooding from the euro region into its own currency, the Swiss National Bank also dropped its deposit rate into negative territory.
That in turn has dragged yields negative on ultra-safe assets, such as many European sovereign bonds, mortgage-backed debt from Europe, and now Canada.
Negative Yields
The yields on Bank of Nova Scotia’s 1.25 billion euros of 0.25 per cent covered bonds maturing November 2017 and Royal Bank’s 1.25 billion euros of 4.625 per cent notes maturing in January 2018 both fell below zero April 8 and now each yield negative 0.02 per cent, according to data compiled by Bloomberg.
Five smaller issues from Canadian banks denominated in francs have also gone negative and another euro issue from Toronto-Dominion Bank, which comes due in a month, also has a yield below zero, according to Bloomberg data.
The idea is to push cash out of safe assets and into riskier investments that will drive growth, but one unintended consequence, aside from negative yields on covered bonds from Canada, is that some of that money will find its way to Canada directly, according to Luc de la Durantaye, who oversees $19 billion in assets as head of currency management at CIBC Asset Management.
“You’ve got foreign money coming into Canada, and helping to keep yields lower than probably they should be,” he said by phone from Montreal. “Part of the consequences of the decisions of the ECB is impacting the level of interest rates in Canada.”
