Can anyone explain why mortgage rates are attached to bond market (if they are)? | Mortgages | Discussion forum

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Can anyone explain why mortgage rates are attached to bond market (if they are)?
January 10, 2023
11:06 am
butterflycharm
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It is often said that mortgage rates are tied to bond markets (probably). But those who say it, can not explain or don't explain why. Just because bond markets go up or down is not good enough reason for mortgage rates to go up or down.

If the mortgage rates are attached to bond markets - fully or partially - why is that?
How does the money cycle that goes through bond market, then into banks, and eventually become a mortgage that makes them tied together?

In all of this process, of course banks are making a dealers fee and they would probably never lend (mortgage) without making a margin. I think they have no worry whatsoever if they have lend at 1% or at 5% to a home buyer because the money they lend out is not their own money mostly. They borrow it from somewhere else at a lower rate and then lend it out at a higher rate. If that is the case, how does bond market play a role? do they borrow against their bonds? do they borrow from bond market? do they sell bonds and lend the money to mortgage holders? do they borrow from BoC?

1- Can someone details this bond market/mortgage money flow process?

2- Is there statistics on where the mor

January 10, 2023
12:20 pm
savemoresaveoften
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butterflycharm said
It is often said that mortgage rates are tied to bond markets (probably). But those who say it, can not explain or don't explain why. Just because bond markets go up or down is not good enough reason for mortgage rates to go up or down.

If the mortgage rates are attached to bond markets - fully or partially - why is that?
How does the money cycle that goes through bond market, then into banks, and eventually become a mortgage that makes them tied together?

In all of this process, of course banks are making a dealers fee and they would probably never lend (mortgage) without making a margin. I think they have no worry whatsoever if they have lend at 1% or at 5% to a home buyer because the money they lend out is not their own money mostly. They borrow it from somewhere else at a lower rate and then lend it out at a higher rate. If that is the case, how does bond market play a role? do they borrow against their bonds? do they borrow from bond market? do they sell bonds and lend the money to mortgage holders? do they borrow from BoC?

1- Can someone details this bond market/mortgage money flow process?

2- Is there statistics on where the mor  

Google is your best friend.

January 10, 2023
1:07 pm
butterflycharm
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savemoresaveoften said

Google is your best friend.  

Haven't found a logical answer. And no money flow examples.

Seems it is a guess or non-existent relationship.

Unless someone can exemplify the money flow between bond market and mortgages it is a guess I think.

There might be a reason but I haven't seen so far.

January 10, 2023
2:06 pm
savemoresaveoften
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butterflycharm said

Haven't found a logical answer. And no money flow examples.

Seems it is a guess or non-existent relationship.

Unless someone can exemplify the money flow between bond market and mortgages it is a guess I think.

There might be a reason but I haven't seen so far.  

The big picture / generalization is as follows:

Govt issues 5y govt bonds, which are the most credit worthy and say at 3%
Bank issues 5y bonds, obv investor demands a credit spread on top of Govt yield, say bank ends up issuing at 4%.
Now bank can lend it out to home buyers, hopefully at a spread of 150bps over. 5y mortgage rates is therefore at 5.5%

As bond yield changes, the implicit funding cost for the banks will change too, all else being equal. Thats when when govt bond yield changes a lot, so will mortgages. Its not a make up, but a real pricing mechanism.

Even if a bank is flushed with depositors' money at 0%, mortgage wont be at 1.5%. Reason being deposit fluctuate and the treasury certainly dont want to have a capital shortfall all of a sudden. Thus mortgage is still priced off the bond yield+spread method regardless.

January 10, 2023
2:43 pm
AltaRed
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butterflycharm said

Haven't found a logical answer. And no money flow examples.

Seems it is a guess or non-existent relationship.

Unless someone can exemplify the money flow between bond market and mortgages it is a guess I think.

There might be a reason but I haven't seen so far.  

If you google "how do mortgage rates relate to bond yields", you will get a plethora of links to read.

Post #4 is a good example. Banks sell bonds at yields which have to be slightly higher than government bond rates (because investors in corporate bonds insist on higher yield than government bonds). They turn around and lend that money out in fixed rate mortgages at a spread of 100-200bp, partly because mortgages can default and there is a bit of risk to be covered and partly for a profit component (Net Interest Margin). The spread varies depending on credit quality and competition in the mortgage market.

GICs are another source of funds for lending institutions and most likely second tier banks and credit unions that cannot really tap the bond market. Most of the FIs on the GIC chart here. They have to offer enough in interest rate to attract investors that might otherwise invest in the bond market.

The bond market is huge so investor sentiment in the bond market is the elephant in the room when it comes to rate setting.

January 10, 2023
2:48 pm
Norman1
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butterflycharm said

In all of this process, of course banks are making a dealers fee and they would probably never lend (mortgage) without making a margin. I think they have no worry whatsoever if they have lend at 1% or at 5% to a home buyer because the money they lend out is not their own money mostly. They borrow it from somewhere else at a lower rate and then lend it out at a higher rate. If that is the case, how does bond market play a role? …

There's no dealer fee. The bonds and the GIC's are the banks' borrowings.

The banks do care very much because they pay the interest on the bonds and GIC's no matter what. So, if a bank has to pay 4% per annum on its five-year bonds before any bond investor will buy the bank's bonds, the bank is not going to be offering five-year mortgages at 4% and make nothing for their effort.

If a bank could issue five-year bonds and GIC's that pay 0%, then the bank could offer 1.5% five-year mortgages. The bank will have difficulties finding investors who are willing to put money into those 0% bonds and GIC's when Government of Canada five-year bonds are yielding around 3¼% right now.

No, the banks don't lend out their 0% chequing account deposits as five-year mortgages. That would leave the banks with no money to honor any cheques that are written against those accounts.

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