Tighter Mortgage Rules May Lower Bond Yields: Canada Credit

February 17, 2010, 12:24 AM EST

By Greg Quinn

Feb. 17 (Bloomberg) -- Canada’s decision to tighten mortgage requirements may ease pressure on the central bank to raise interest rates to slow gains in housing prices, said David Rosenberg, chief economist Gluskin Sheff & Associates Inc.

Yields on futures contracts tied to bets about the central bank’s target rate fell yesterday after Finance Minister Jim Flaherty laid out his plan. The yield on the six-month overnight index swap declined to 0.285 percent from 0.30 percent on Feb. 15, the biggest drop in more than a month. The yield on Canada’s benchmark one-year government debt decreased to 0.55 percent from 0.59 percent.

“The Canadian bond market will probably catch a bid” from the policy changes, Rosenberg said in a telephone interview from Toronto. “So long as you can take any residual Bank of Canada tightening out of the Canada curve, that will be more beneficial than detrimental towards bond yields.” Policy makers won’t raise interest rates this year, he said.

The regulatory changes may make it easier for Bank of Canada Governor Mark Carney to keep his commitment to leave the benchmark rate at a record low 0.25 percent unless the inflation outlook shifts.

“The Bank of Canada does not need to raise rates to address inappropriate housing market strength,” said Eric Lascelles, chief economics and rates strategist at Toronto- Dominion Bank. “The market will likely need to price out a smidgen of nearer-term rate hikes due to this rule change,” said Toronto-based Lascelles, who predicts the central bank will start raising rates in the fourth quarter.

Spreads, Offerings

Elsewhere in Canada’s credit markets, the extra yield investors demand to own corporate bonds instead of government debt narrowed one basis point to 122 basis points, or 1.22 percentage points, according to Bank of America Merrill Lynch’s Canadian Corporate Index. Overall yields fell to 3.773 percent from 3.795 percent on Feb. 12.

Canada will auction C$1.5 billion ($1.44 billion) of 30- year bonds today, according to a statement on the Bank of Canada’s Web site. The 4 percent securities mature in June 2041. Canada Housing Trust, the financing arm of the nation’s housing agency, said yesterday it will sell at least C$1.08 billion in fixed and floating-rate debt to finance mortgages.

The yield on the September 2010 bankers’ acceptances futures contract, a barometer for expectations of interest rates at that time, fell to 0.88 percent yesterday, the lowest since Feb. 9, indicating traders are paring bets on rate increases.

Longworth Speech

Bank of Canada Deputy Governor David Longworth will give a speech in Toronto, with the text available at 12:20 p.m. local time. Statistics Canada reports wholesale sales at 8:30 a.m., and the median estimate of economists surveyed by Bloomberg is for a 0.8 percent increase for December. Canadian home prices and resales will increase to records this year boosted by low borrowing costs, then decline in 2011, the Canadian Real Estate Association said in a report last week. The average rate on a one-year mortgage was 3.6 percent last week, compared with 5.39 percent on a five-year loan, close to the widest spread since 2004, Bloomberg data show. The one- year rate is the lowest since at least the start of 1993. Variable mortgage rates are at the lowest since at least 1990, with the prime rate they are tied to at 2.25 percent.“We’ve had a period in which variable-rate mortgages are at extremely low levels and are likely to stay at historically low levels for the coming year or two,” said Avery Shenfeld, chief economist at CIBC World Markets in Toronto. “It’s prudent to ensure that people taking on those mortgages will be in a position to pay them as rates rise.”

Bubble Debate

Record Canadian home prices fed by low mortgage rates led Stephen Jarislowsky, 84, chairman of Montreal-based investment adviser Jarislowsky Fraser Ltd., to say last week he’s “convinced” there’s a bubble in the nation’s housing market.

Bank of Canada Adviser David Wolf said in a January speech the bank is monitoring home prices, and that raising rates to slow them would crimp the recovery as the economy emerges from recession. While Flaherty reiterated that the market isn’t overheating, he said yesterday that starting April 19, buyers will have to meet standards for five-year, fixed-rate mortgages even if they opt for variable rates.

Canadian bonds due in one to three years have returned 0.06 percent this month, after gaining 0.67 percent in January, according to Bank of America Merrill Lynch indexes. That compares with losses of 0.29 percent on average this month for corporate bonds, which gained 2.37 percent in January, the indexes show.

Canada Housing Trust’s offering consists of a C$580 million reopening of 3.75 percent notes due in March 2020 that may price to yield 35.5 basis points more than federal government bonds of similar maturity. A reopening of at least C$500 million of the 0.58714 percent issue maturing in March 2015 may price at about C$100.25. The deal will be priced today. Both maturities were first sold in November.

With assistance from Chris Fournier in Montreal. Editors: Paul Badertscher, Andrew Barden

To contact the reporter on this story: Greg Quinn in Ottawa at +1-613-667-4805 or gquinn1@bloomberg.net.

To contact the editors responsible for this story: Christopher Wellisz at +1-202-624-1862 or cwellisz@bloomberg.net; David Scanlan at +1-416-203-5722 or dscanlan@bloomberg.net.