Let us indulge for a moment in a game of what-if.
The 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 scenario
Suppose 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:
- Its 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in trade wars with allies that violated its president’s own trade pact and relied on legally questionable, untested and out-of-date trade laws.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 relevance
Now, 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.
So when U.S. yields surge , Canadian yields — including those that drive fixed mortgage rates — are usually not far behind.
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.
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. You can follow him on X at @RobMcLister.
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