Last week, for the first time in over a decade, the Canadian Government Bond Yield Curve inverted. The inversion of the yield curve is seen as an economic shift to a more negative long-term outlook for Canadian investors and consumers. Those planning to borrow for the purchase of a new home may wish to take special note as this could also impact future retail interest rates as we explain in this installment of the Home Trust Mortgages Blog.

A bond yield curve plots the rate of return for bonds with similar credit ratings, but with different maturity dates. Placing the time to maturity along the x-axis, and the rate of return on the y-axis, creates a visualization of the expected yield for each bond series, plotted against the time to maturity.

Because one of the maxims of investing is that investors should receive a higher return in exchange for the added risk of holding an investment over a longer period of time, a line that curves upwards over time reflects this principle. As such, it is known as a normal yield curve. However, when shorter-term bonds are priced higher than long bonds as was the case recently for Canadian government bonds, the yield curves downwards along the y-axis forming an inverted yield curve.

The recent inversion of the Canadian yield curve marks the first time in over a decade that this event has occurred. The last time it happened was in 2007 and was followed shortly afterwards by the so-called “Great Recession” of 2008. It is also worth noting that Canada is the only developed country to have recently seen its yield curve invert.

What Does This Mean for Canadian Homebuyers?

The shape of the yield curve has two possible implications. For starters, an inverted yield curve suggests a general lack of optimism in the economy over the longer term and this often factors into the mindset of investors. In some cases, it can even help fuel a general slowdown in economic activity including a pull back in stock prices.

Secondly, and of greater importance to home buyers, the yield curve benchmarks other interest rates including bank lending rates and mortgage rates. Retail mortgage rates are based partly on long-term bond rates so if the outlook for these bonds is weaker, this could be seen as having a dampening effect on mortgage interest rates.

Of course, the yield curve is just one of many indicators that economists typically refer to when projecting where the economy is headed. Like any predictive tool there is no guarantee that things will unfold as suggested, but investors should at least be aware of the possible implications suggested by the most recent yield curve formation.

This article has been prepared by Home Trust and may be freely shared.