Since November of 2018, the decrease in the spread between short and long term bond yields (for the purpose of this post, “bond yields” and “yields”, represent the bank of government marketable bond yield) has been a fairly well publicized trend, particularly in the United States. That being the case, there has been significantly less coverage north of the border leaving the majority of private investors in the dark on what this could be telling us about the future state of the economy. As such, I want to bring this to readers’ attention and hopefully generate some questions and curiosity on the topic.

Over the past 10 years, the 10 year bond yield has been significantly higher than the 5 year bond yield.  For example, from 2008 to 2018 the spread between the 5 year and 10 year bond yields averaged over 60 basis points (“BPS”); but, that has not always been the case, and the current situation is much different.  Over the past 60 business days, the spread between the 5 year and 10 year bond yield has averaged around 6.5 BPS. To visualize this, I have charted the 5 year and 10 year bond yields, as well as the spread between them.


What does this mean for real estate? Although the answer to that question warrants more than what can be covered in a blog post, the most concise explanation would be that bond yields tend to correlate with interest rates (full article on this linked below), and interest rates with cap rates; therefore, it would seem to suggest that the long term expectation is for interest rates to remain relatively low, with indication that we may even see interest rates on the decline again in the near future.

A well-established view of this story is the belief that the trend of declining spread between long and short term bond yields typically precedes a recession, and more specifically, recessions have historically been preceded by an ‘inverted yield curve’, which is when the long term yield is lower than the short term yield.  

This is evidenced when you look at the data over the past 25 years.  The chart below shows the difference between 2 year and 10 year bond yields.  Where the line crosses over the axis is where the yield curve ‘inverts’. As you can see, the yield curve inverted prior to the two most recent recessions in 2001 and 2008.

That said, it is important to also note that over the past 25 years, the bond yield has become less volatile, with less dramatic swings.  Perhaps this is a sign of central banks becoming more adept with monetary policy and utilizing target rates in controlling inflation, policies that only became more widely accepted and implemented in the 1990’s.

Without delving too deep on the topic, I hope this post has served its purpose in bringing a relevant market factor and influence into focus – or at least to your attention – and perhaps will spur you into further investigation.  I have included links below to articles that I found insightful. If you have any articles to recommend, information to share, or would like to discuss further, please do not hesitate to connect with me at the contact information noted below.

FCIQ – Factors That Determine Mortgage Rates in Canada.  Dated article from 2011, however, I believe it does a good job explaining and summarizing the factors that determine mortgage rates in Canada, including the Bank of Canada Bond Yields.  

The Balance – Inverted Yield Curve and Why It Predicts a Recession.  Albeit based on the US economy, this is an easy to digest article that is interesting and relevant to the inverted yield curve.

Forbes – The Yield Curve As Recession Predictor: Should We Worry Today?  Another US based article, however, I would consider it worth a read as it provides a less ‘gloom and doom’ perspective than many other posts on the subject.

 

Contact: cleonhardt@form.ca | 604 638 1999