As global bond yields reach levels not seen in decades, a once-uneventful sector of finance has become a focal point on Wall Street.
For Canadians, this translates to increased borrowing expenses for certain products like mortgages and car loans, while also promising enhanced returns on alternatives such as guaranteed investment certificates (GICs) and money market funds.
Let’s break it down. Purchasing a bond means you are essentially lending money to the issuer for a specific duration. This issuer could be the federal government, provinces, cities, or private enterprises. Typically, investors receive interest payments until the bond matures, at which point they receive the bond’s face value.
So, what exactly is a bond yield? It refers to the annual return an investor gains from owning a bond, represented as a percentage. Once bonds are issued, they can be traded in the open market, impacting their prices. When bond prices decline, yields increase, as investors continue to receive the same interest payments but for a lower initial investment.
The global bond market has been relatively quiet until recently. Central banks worldwide maintained near-zero interest rates for over a decade following the 2008 financial crisis. However, an increasing number of investors now anticipate rate hikes as central banks aim to control persistent inflation.
When a central bank raises interest rates, newly issued bonds begin to offer better returns, depreciating the value of existing lower-yielding bonds.
Rising inflation pressures central banks
Currently, the bond market is undergoing a significant global sell-off. Yields in the United States, Germany, Japan, and Canada have surged to multi-year or even multi-decade highs.
“What’s happening? Generally, when you observe a significant shift, it’s often due to multiple factors occurring simultaneously,” Bank of Canada Governor Tiff Macklem stated on Wednesday following the central bank’s recent interest rate announcement.
Concerns about inflation and escalating government debt are fueling expectations that the Bank of Canada and other central banks will increase their benchmark interest rates.
“Central banks have a limited capacity to tolerate elevated inflation,” Macklem remarked. “This is prompting the market to adjust, incorporating the likelihood of future interest rate increases.”
Recent data from Statistics Canada indicates that rising gas prices were a significant contributor to inflation in July. The Bank of Canada noted on Wednesday that global oil prices remain high, exacerbated by the ongoing U.S.-led conflict with Iran, which has affected crude transportation in the region. Year-to-date, U.S. benchmark oil prices have surged nearly 60 percent.
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Additionally, the bank perceives the Canada-U.S. trade conflict as a factor increasing business costs, which could eventually reflect in consumer prices. Macklem pointed out that the demand for new corporate bonds, driven by investments in AI infrastructure, is lowering prices for previously issued bonds.
“All these elements are collectively contributing to an increase in global bond yields,” Macklem said.
Bank of Canada governor Tiff Macklem states the central bank will revise its forecasts, but currently, officials believe the ‘inflationary impact of those counter-tariffs is fairly modest,’ stressing that the situation in the Middle East remains the ‘larger concern’ for inflation.
On Wednesday, Canada’s 10-year government bond yield reached a two-year peak after the Bank of Canada indicated that inflation risks are on the rise.
Because Canadian banks can safely invest with the government, government bond yields establish the baseline for all other lending. Fixed-rate mortgages, car loans, and other credit types are tied to five-year and 10-year government bonds, which means that as yields for these bonds increase, banks will raise their interest rates for those loans.
For individuals seeking to invest their savings, climbing bond yields compel banks to enhance their GIC rates to remain competitive, resulting in improved guaranteed returns.
The recent actions of U.S. Treasury Secretary Scott Bessent in the bond market have raised concerns among numerous investors and analysts. Avneet Dhillon analyzes the fears that Bessent’s efforts to stabilize the markets and lower borrowing costs might inadvertently exacerbate inflation.
‘A good time to lock in your mortgage’
Dan Eisner, founder and CEO of True North Mortgage, suggests that astute borrowers are securing fixed rates.
“Fixed mortgage rates are unlikely to decrease significantly until yields do. Yields are not expected to enter a prolonged downward trend unless we observe signs of substantial economic slowdown and a decrease in inflationary pressures,” Eisner noted in a blog post on Wednesday.
“Now is an opportune moment to secure your mortgage rate if you are considering purchasing a home or renewing your mortgage, as fixed rates are likely to fluctuate significantly in the near future, or at least until we gain more clarity regarding geopolitical developments and U.S. trade relations.”
Data from Google Trends indicates that Canadians are showing a heightened interest in the current bond market changes. The number of searches related to the bond market in the past month has surged by 5,000 percent year-over-year, according to the search engine.
No ‘dysfunction’ in Canada’s bond market
Macklem indicated that while there has been some “spillover” from rising global yields into Canada’s bond market, the yield curve in Canada remains significantly lower than that of U.S. government bonds.
During a press conference in Ottawa on Wednesday, Carolyn Rogers, Bank of Canada’s senior deputy governor, assured investors that although Canada’s bond market is influenced by global trends, it is not necessarily facing a crisis.
“It’s crucial to differentiate between volatility and actual dysfunction or instability when there are fluctuations in prices and yields, as this indicates investors are reassessing risk,” she explained to reporters.
“The vulnerability we previously discussed in our financial stability reports arises when leveraged investors unwind their positions rapidly, leading to a liquidity crunch,” she mentioned, referring to investors such as hedge funds and non-bank asset managers who utilize borrowed capital for their investment strategies.
“That’s the risk we are concerned about. Currently, we do not observe that occurring.”