With the Bank of Canada in a rate-cutting cycle, many Canadians expect mortgage rates to continue to drop. This may be true for variable mortgage rates since they track changes in the Bank of Canada rate. However, fixed mortgage rates do not directly follow the Bank of Canada’s overnight rate. Instead, they are tied to the bond market, which has shown mixed signals recently.

Real estate professionals should be aware of the current dynamics and how they may impact clients.

Let’s break down how fixed rates are determined, where they stand historically, and why we might be near the bottom for fixed mortgage rates.

How Are Fixed Mortgage Rates Priced?

Unlike variable rates, which move in lockstep with the Bank of Canada’s rate decisions, fixed mortgage rates are driven by government bond yields. Bond yields reflect investor expectations about the economy, inflation, and future interest rates. When bond yields rise, fixed mortgage rates tend to follow suit, and when they fall, fixed mortgage rates usually decline.

Pricing in the bond market reflects market views and expectations for the future. In this sense, the bond market is ‘forward looking.’ The future expectations that are priced into current bond yields currently include the expectation of future Bank of Canada rate cuts. When the Bank of Canada cuts rates as expected, the bond market will only have a muted reaction because that expected rate cut is already ‘price-in.’

For example, consider the 0.50% rate cut on December 11, 2024. This was a larger than usual cut (0.25% is more common) and the second large 0.50% rate cut in a row. What did the bond market do that week?

	Dec 9, 2024	Dec 10, 2024	Dec 11, 2024	Dec 12, 2024	Dec 13, 2024
5-Yr Bond Yield	2.83%	2.81%	2.87%	2.93%	2.97%

Bond yields actually rose after the rate cut was announced. Over the past two months, bond yields have been relatively flat, despite the two large rate cuts by the Bank of Canada. Variable mortgage rates dropped 1.0% in the past two months and fixed mortgage rates remained unchanged. This demonstrates how further Bank of Canada rate cuts may not affect fixed mortgage rates at all. This lack of movement is unsurprising, as the bond market had already anticipated these cuts. When an event is fully priced in, significant shifts in bond yields are unlikely.

What Influences Bond Market Prices?

Bond market pricing reflects several factors, including:

Inflation concerns – core inflation remains above 2% but inflation concerns have moderated.
US Federal Reserve statements – the US Fed has stated they are not in a hurry to cut rates. Economic activity in the US is healthier than in Canada so they may not need rate cuts to stimulate their economy.
Economic resilience – strong job reports and GDP growth in Canada and the U.S. have prompted bondholders to demand higher yields. Everyone’s forward projections are now uncertain due to the threat of a tariff war with the US.
Geopolitical uncertainty – escalating tensions in other parts of the world, especially concerning Russia and the Middle East, put upward pressure on bond yields.
Government debt – continuing profligate government spending leads to increasing amounts of government debt financing. This increasing supply of government debt needs higher yields to fund if demand for the debt doesn’t match the growth in supply.

Today’s Fixed Rates Match Historical Norms

To understand today’s rates, it is helpful to look back. Fixed mortgage rates prior to the financial crisis in 2009 were regularly above 4% and often higher than 6%. At the time, this was considered normal. The financial crisis led to central banks cutting rates to lower-than-normal levels and also saw them purchasing increasing amounts of bonds to drive down bond yields.

While this was considered to be short-term emergency activity, it has persisted. During the pandemic, rates hit historic lows due to unprecedented monetary stimulus and a demand shock. The interest rate environment during Covid does not have a historical precedent.

If we are now in a more normalized economic environment, then today’s mortgage rates are within the historical range considered normal and sustainable. We have an entire generation of borrowers who have never experienced a truly high-interest rate environment like we had in the past. But it is important to understand that the Covid low-rate environment was an anomaly. We should not expect low rates like that again.

Fixed Mortgage Rates May Not Drop Further

There are two key things for mortgage borrowers to understand when setting expectations for the future of fixed mortgage rates:

As explained above, fixed mortgage rates do not change with every Bank of Canada interest rate decision;
Several factors currently indicate that fixed mortgage rates may be at or near their bottom:

Bond yields have held steady recently and even began to increase.
The economy seems to be normalizing, with inflation no longer at crisis levels and steady economic growth. The super-low rates of the Covid era are not expected in this kind of environment.
Fixed mortgage rates are currently in the range of normal historical expectations.
Economic forecasts are muted. The factors that would place downward pressure on bond yields are not currently present in economic forecasts.

Fixed Rate Mortgage Advice

Fixed-rate mortgages are generally preferred by risk-averse Canadian borrowers. Exposure to interest rate risk does not make sense for most mortgage borrowers. For property investors, locking in a rate takes a significant risk off the table – interest rate risk.

If you prefer a fixed-rate mortgage and are waiting for rates to drop you may be disappointed. Bond yields have risen slightly, and fixed mortgage rates may move slightly higher in the near term as well. Our expectation is that fixed mortgage rates will move around within a range over the next few months, absent a material economic or geopolitical surprise.

Trying to time the lowest fixed mortgage rate is nearly impossible. You are better off simply looking at the rates available today and locking in a rate if it works for you and is affordable.

Clients who are shopping for a mortgage may want to consider securing a rate hold now to protect against potential fixed-rate increases.

A rate-hold does not commit you to anything. Rate holds are good for up to 120 days, providing you protection against rising rates while you shop for a home. They are a smart choice. If rates drop during the 120-day rate-hold period, you are not stuck with the rate on the rate-hold – you will get the lower rates available when you are ready to transact.

Conclusion

Anticipating more rate cuts is reasonable but understanding how fixed mortgage rates are set can help you make a smart decision with your mortgage. Fixed mortgage rates have dropped by close to 1.5% in the past year. You can benefit from this normalized rate environment by locking in a fixed mortgage rate now. If you want to take advantage of future Bank of Canada rate cuts, then a variable-rate mortgage may be the right choice.

We do not anticipate fixed mortgage rates declining much further. The five-year fixed mortgage rates for rental properties are currently in the mid 4% range. Our best guess is that fixed mortgage rates for rentals will range from the low 4% range to the high 4% range in the first half of 2025. The bottom line is that fixed mortgage rates are likely near their floor. Waiting for significant drops could leave you disappointed in a market where bond yields are resisting any further decline.

For help with mortgage decisions, talk to an expert. A lot goes into mortgage decisions and an experienced mortgage broker can help buyers navigate today’s market dynamics.
For more insights and advice, connect with Frank Mortgage! We can be found at www.frankmortgage.com or 1-888-850-1337.