Can anyone explain why mortgage rates are attached to bond market (if they are)? | Mortgages | Discussion forum

butterflycharm said
It is often said that mortgage rates are tied to bond markets (probably). But those who say it, can not explain or don't explain why. Just because bond markets go up or down is not good enough reason for mortgage rates to go up or down.

If the mortgage rates are attached to bond markets - fully or partially - why is that?
How does the money cycle that goes through bond market, then into banks, and eventually become a mortgage that makes them tied together?

In all of this process, of course banks are making a dealers fee and they would probably never lend (mortgage) without making a margin. I think they have no worry whatsoever if they have lend at 1% or at 5% to a home buyer because the money they lend out is not their own money mostly. They borrow it from somewhere else at a lower rate and then lend it out at a higher rate. If that is the case, how does bond market play a role? do they borrow against their bonds? do they borrow from bond market? do they sell bonds and lend the money to mortgage holders? do they borrow from BoC?

1- Can someone details this bond market/mortgage money flow process?

2- Is there statistics on where the mor  

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butterflycharm said

Haven't found a logical answer. And no money flow examples.

Seems it is a guess or non-existent relationship.

Unless someone can exemplify the money flow between bond market and mortgages it is a guess I think.

There might be a reason but I haven't seen so far.  

The big picture / generalization is as follows:

Govt issues 5y govt bonds, which are the most credit worthy and say at 3%
Bank issues 5y bonds, obv investor demands a credit spread on top of Govt yield, say bank ends up issuing at 4%.
Now bank can lend it out to home buyers, hopefully at a spread of 150bps over. 5y mortgage rates is therefore at 5.5%

As bond yield changes, the implicit funding cost for the banks will change too, all else being equal. Thats when when govt bond yield changes a lot, so will mortgages. Its not a make up, but a real pricing mechanism.

Even if a bank is flushed with depositors' money at 0%, mortgage wont be at 1.5%. Reason being deposit fluctuate and the treasury certainly dont want to have a capital shortfall all of a sudden. Thus mortgage is still priced off the bond yield+spread method regardless.

butterflycharm said
…
In all of this process, of course banks are making a dealers fee and they would probably never lend (mortgage) without making a margin. I think they have no worry whatsoever if they have lend at 1% or at 5% to a home buyer because the money they lend out is not their own money mostly. They borrow it from somewhere else at a lower rate and then lend it out at a higher rate. If that is the case, how does bond market play a role? …

There's no dealer fee. The bonds and the GIC's are the banks' borrowings.

The banks do care very much because they pay the interest on the bonds and GIC's no matter what. So, if a bank has to pay 4% per annum on its five-year bonds before any bond investor will buy the bank's bonds, the bank is not going to be offering five-year mortgages at 4% and make nothing for their effort.

If a bank could issue five-year bonds and GIC's that pay 0%, then the bank could offer 1.5% five-year mortgages. The bank will have difficulties finding investors who are willing to put money into those 0% bonds and GIC's when Government of Canada five-year bonds are yielding around 3¼% right now.

No, the banks don't lend out their 0% chequing account deposits as five-year mortgages. That would leave the banks with no money to honor any cheques that are written against those accounts.