Why America’s bond problem could become your mortgage problem

Skip to Content News Archives Economy Energy Oil & Gas Renewables Electric Vehicles Mining Commodities Agriculture Real Estate Mortgages Mortgage Rates Finance Banking Insurance Fintech Cryptocurrency Work Wealth Smart Money Wealth Management Investor Personal Finance Family Finance Retirement Taxes High Net Worth FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials More Innovation Information Technology FP500 Podcasts Small Business Lives Told Tails Told Shopping Financial Post Store Obituaries Place a Notice Advertising Advertising With Us Advertising Solutions Postmedia Ad Manager Sponsorship Requests Classifieds Place a Classifieds ad Working Profile Settings My Subscriptions My Offers Newsletters Customer Service FAQ News Economy Energy Mining Real Estate Finance Work Wealth Investor FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials This advertisement has not loaded yet, but your article continues below.HomeReal EstateMortgagesWhy America's bond problem could become your mortgage problemRobert McLister: When U.S. yields surge, Canadian yields, including those that drive fixed mortgage rates, are not far behindWhy should a mortgage shopper in Canada care about any of this U.S. bond drama? Because our federal bonds (and resulting mortgage rates) typically take their cues from their Treasury market. Photo by Francesco Carta fotografo/Getty ImagesLet us indulge for a moment in a game of what-if.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountThe goal being: to demonstrate how a growing interest rate risk can wreck a home financing plan.This is not some far-off, obscure hypothetical.It’s a scenario in which circumstances could significantly reshape a mortgage shopper’s net worth, in the wrong way.The scenarioSuppose some generous soul offered you a five per cent annual return.The catch is that you had to invest in the bonds of a nation with a few small administrative issues:SUBSCRIBER EXCLUSIVE: FP West: Energy Insider brings you behind the oilpatch’s closed doors with exclusive insights from insiders every Wednesday morning.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of FP West: Energy Insider will soon be in your inbox.We encountered an issue signing you up. Please try againIts federal debt load was a crushing, record-high US$40 trillion.Its deficit was projected at roughly 5.8 per cent of GDP, versus 3.8 per cent historically.Its central bank’s favoured inflation measure was 170 basis points above target.It effectively borrowed to pay the interest on its debt, what economist Hyman Minsky called ‘Ponzi finance.'”Its US$1.25 trillion in annual net interest payments exceeded its entire defence budget and was projected to soar from 18.5 per cent to 25 per cent of revenue in 10 years.A one per cent higher rate could explode its interest costs by US$3.5 trillion over ten years, accelerating a potential future debt spiral.The term (risk) premiums on its bonds were steadily rising.Its central bank was signalling a rate-hike bias.It had imposed widespread, largely unjustified and inflationary tariffs, including on its allies.It engaged in trade wars with allies that violated its president’s own trade pact and relied on legally questionable, untested and out-of-date trade laws.It was trapped in a costly, inflationary war with no end in sight.It had lost an array of key steady-keel investors, with foreign central banks and official entities having significantly reduced their share of its debt, from 40 per cent during the 2008 financial crisis to 12 per cent.Nervous foreign investment officials were increasingly announcing plans to pull billions in assets (e.g., gold) out of the country.Its debt was projected to grow faster than its economy.It was in the midst of the largest capital expenditure cycle in history (as measured in dollar terms) — a significant inflationary impulse.It hadn’t reached its two per cent inflation target in nearly five and a half years.Its aging population threatened to ramp up its entitlement costs and bond issuance.It relied on a risky rollover strategy of issuing short-term debt to pay off its long-term liabilities in a rising-rate market.Its immigration policies threatened wage inflation.Its bond prices were diving to multi-year lows.Its credit rating had been trending downward, and one more downgrade could cost it hundreds of billions in additional interest payments annually.Its president continually tried to manipulate its central bank into ignoring inflation risk — in order to keep rates lower and make the Treasury’s debt service easier.Its tariffs were alienating foreign investors.Other countries could slowly chip away at its reserve status, threatening international demand for its bonds.Its president had effectively proposed an inflationary $5,000 bribe to each adult citizen if his party were voted back into power in November.It hadn’t balanced a budget in a quarter century.Its debt ceiling limits continually threatened timely payments to bondholders, with ongoing government shutdowns signalling persistent dysfunction.Its politicians refused bipartisan cooperation to balance budgets by raising taxes or lowering benefits.If long-run growth disappoints, its fiscal status and credit could weaken.Depreciation of its currency created a risk of loss for investors — and currency hedging consumed too much yield.There was evidence that its bonds were becoming less liquid during times of stress, reducing its safe-haven status.The traditional safe-haven status of its bond market did not protect against the growing dangers of its own inflation shock or a confidence shock in itself.Arbitrary sanctions could freeze a foreigner’s bond holdings.Sound like an appealing place to plow your hard-earned savings?Global investors looking at our massive neighbour to the south are starting to ask that exact question.More and more, the answer comes back as something like, “Hell no. I won’t be buying Treasuries without significant yield premiums.”Mortgage relevanceNow, why should a mortgage shopper sitting in Canada care about any of this drama?Because American and Canadian five-year yields have had a sky-high 0.93 correlation over the last three decades, or 0.72 if measured by month-to-month changes.In other words, our federal bonds typically take their cues from the Treasury market.That’s a bit of a headache — especially since the world’s most important bond, the U.S. 10-year Treasury, has bounced more than one percentage point since February.And looking at the long-term 10-year chart, it’s as if the yield that has just taken off, retracted its landing gear and is rapidly gaining altitude.This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.All this is to say that if your plan is to reduce risk, you may want to consider a five-year fixed mortgage instead of a shorter-term or floating-rate mortgage.If you model projected borrowing costs based on today’s leading rates and market-implied future rates and add in the safety factor of longer rate stability, the five-year wins, subject to routine caveats.Some of those caveats are: you must have long-term financing needs, a mortgage of a decent size relative to your income and little reason to break your mortgage early.If nothing else, a five-year fixed provides the most cost-effective shelter from what could be turbulent years ahead.And term length could matter, because in three decades of writing about markets, I’ve never seen investors question Treasuries the way they are today.Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. 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