You may be wondering what do bonds have to do with my mortgage rates. The Government’s of Canada finances their activities and accumulated deficits, by issuing “bonds”. The duration and interest rate paid on new issues of these bonds depends upon the financial strategy of the Government in power. You have heard of “the national debt” well it is the accumulated outstanding amount of bond issues, past and present. New issues are constantly required either to refinance maturing issues or finance current Government deficits, and a bond is considered a “commodity” by the market. Like every other commodity, its price can go up or down.

A new bond issue may set a “coupon” rate of interest at current market, say $100 million at 5.6% for an issue of 5-year duration. If this issue is made coincident with an economic or political event which drives down its value the effect on interest mortgage rates is immediate. The individual $100,000 denomination bond may fall in value to $95,000, thus yielding a significantly higher return for the buyer at the lower price. The combined “yield” of interest and capital gains sets the new base market rate for wholesale funds. Any financial institution seeking funds from these same investors, for example to correct an imbalance in deposit and loan commitments, will have to pay this yield plus a small “premium over Canada’s” to secure them.

Investors who buy and sell these Government securities in large quantities, such as multinational corporations, pension funds and the like, weigh many factors, including the currency value and economic prospects of Canadian and other competing nations’ issues. They then determine what price they’ll pay for Government of Canada Bonds. The price they’ll pay immediately defines the base market rate for wholesale funds. Every day, trends in this rate are watched closely by all Financial Institutions, in order to be in a position to adjust their rates on deposits and loans if required.

All mortgage lenders are aware that their retail depositors can choose to put their money into none of the financial institutions GIC’s in a rising rate market, and instead buy other “fixed income securities” such as bonds, which yield a higher rate because they adjust immediately to market changes. They can even switch their funds into the stock market if this is performing relatively better.

This means the mortgage lending institutions are competing with other markets for the investor’s money. If a bank doesn’t attract enough depositors to fund all the mortgages, they’ll have to go where their depositors go – the money market – to make up the difference….and there, they pay the going rate!