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With global bond yields surging to multi-decade highs, a previously mundane corner of the financial world is now a hot topic on Wall Street.
For the average Canadian, it means higher borrowing costs for some products, such as mortgages and auto loans, but also stronger returns on other products, such as other guaranteed investment certificates (GICs) and money market funds.
Let’s start with the basics. When you buy a bond, you’re effectively lending money for a predetermined amount of time to the issuer. That could be the federal government, provinces, municipalities or a private company. Investors are typically paid interest until the maturity date, when they get the face value of the bond back.
So, what’s a bond yield? It’s the annual return an investor earns from holding a bond, expressed as a percentage. After bonds are issued, they can be traded on the open market, causing their prices to shift. When bond prices drop, yields rise. This is because investors get the same interest payments for a lower buy-in price.
Until recently, the global bond market was pretty sleepy. That’s because central bankers around the world kept interest rates at near-zero for more than a decade following the 2008 financial crisis. Now, a growing number of investors see rate hikes on the horizon as central banks look to tamp down sticky inflation.
When a central bank raises interest rates, newly issued bonds offer higher payouts, making existing lower-paying bonds less valuable.
Higher inflation puts pressure on central banks
Right now, the bond market is experiencing a steep, global sell-off. From the United States, to Germany, Japan and Canada, yields have jumped to multi-year or even multi-decade highs.
“What’s going on there? Well, when you see a substantial movement, usually it’s because there is more than one thing happening at once,” Bank of Canada Governor Tiff Macklem said on Wednesday, after the central bank’s latest interest rate decision was announced.
Inflation fears and concerns about ballooning government debt are feeding expectations for the Bank of Canada and its global peers to raise their trend-setting interest rates.
“Central banks’ tolerance for higher inflation is limited,” said Macklem. “That is causing the market to build in the possibility of future interest rate hikes.”
According to the latest Statistics Canada data, gas prices were a key driver of higher inflation in July. On Wednesday, the Bank of Canada said global oil prices are persistently high, with no end in sight for the U.S.-led war with Iran, which has disrupted seaborne crude traffic in the region. U.S. benchmark oil prices have soared nearly 60 per cent year-to-date.
At the same time, the bank sees the Canada-U.S. trade war pushing up costs for businesses, which could feed into consumer prices over time. Macklem noted the AI infrastructure buildout is stoking demand for new corporate bond issuance, lowering prices for previously issued bonds.
“All those things are tending to work in the same direction to boost global bond yields,” Macklem said.
Bank of Canada governor Tiff Macklem says the central bank will update its estimates, but as of now officials assess the ‘inflationary impact of those counter-tariffs is fairly modest,’ adding that the situation in the Middle East remains the ‘bigger issue’ for inflation.
Canada’s 10-year government bond yield hit a two-year high on Wednesday, after the Bank of Canada signalled inflation risks are rising.
Because Canadian banks can invest risk-free with the government, government bond yields set the floor for all other lending. Fixed-rate mortgages, auto loans and other forms of credit are linked to five-year and 10-year government bonds, meaning the higher the yields for those bonds are, the higher the banks set their interest rates for those loans.
For those looking to invest their savings, rising bond yields force banks to raise their GIC rates to stay competitive, boosting guaranteed returns.
‘A good time to lock in your mortgage’
True North Mortgage founder and CEO Dan Eisner says savvy borrowers are locking in rates.
“Fixed mortgage rates won’t drop substantially until yields do. Yields aren’t likely to enter a sustained downward trend unless signs of deeper economic softening gain momentum and inflation pressures ease,” Eisner wrote in a blog post on Wednesday.
“It’s a good time to lock in your mortgage rate if you’re looking to buy a home or renew your mortgage, as fixed rate movement is likely to resemble a rollercoaster for the next while, or at least until we see some clarity on geopolitical activity and U.S. trade.”
Google Trends data show Canadians are taking a keen interest in the ongoing bond market upheaval. The volume of inquiries about the bond market over the past month is up 5,000 per cent on a yearly basis, according to the search engine giant.
No ‘dysfunction’ in Canada’s bond market
Macklem said while there has been some “spillover” from higher global yields into Canada’s bond market, Canada’s yield curve sits well below that of U.S. government bonds.
Speaking at Wednesday’s press conference in Ottawa, Bank of Canada Senior Deputy Governor Carolyn Rogers reassured investors that Canada’s bond market, while affected by global trends, is not necessarily in dangerous territory.
“I think it’s important to distinguish between volatility and dysfunction or instability when prices and yields are moving, because investors are repricing risk,” she told reporters.
“The vulnerability that we have talked about in our previous financial stability reports really comes when you get leveraged investors unwinding their positions quickly, and liquidity starts to dry up,” she added, referring to investors such as hedge funds and non-bank asset managers who use borrowed money to fund their investment strategies.
“That’s the risk we worry about. We don’t see that happening right now.”
