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Canadian 5-Year Notes to Be Cheapened by Home Buying, RBC Says

Home buying over the next few months will distort the yield curve for Canadian government bonds more than usual as consumers rush to take advantage of low mortgage rates they perceive as fleeting, according to Royal Bank of Canada.

“There are reasons to expect huge volumes of mortgage applications this year, which will contribute to a very weak four- and five-year sector of the curve,” Ian Pollick, a fixed-income strategist at Royal Bank of Canada’s RBC Capital Markets unit in Toronto, wrote in a note to clients titled “Bearish on the belly.” The yield curve plots rates according to maturity.

Five-year government note yields could increase 20 basis points, or 0.2 percentage point, during March and April as lenders move to protect their balance sheets against mortgage loans, according to the report, dated March 1. Banks use five-year interest-rate swap contracts to offset loans they make to homeowners. This year, demand for fixed-rate mortgages means banks will seek to pay fixed-rate in five-year swaps, leading to higher bond yields, Royal Bank of Canada said.

Yields on Canada’s five-year notes fell four basis points today to 1.40 percent. They have traded this year between 1.20 percent and 1.51 percent.

Canadian mortgage loans typically amortize over 25 years but have a five-year balloon payment or renewal date when the entire amount of the mortgage must be refinanced.

Average mortgage rates at a record low 5.14 percent on Feb. 1 have helped spark record debt to sustain Canada’s housing boom. The rate has crept higher to 5.24 percent, according to Bloomberg data, as banks reportedly withdraw offers of five-year loans as low as 2.99 percent.

U.S. housing prices plunged by a third between their peak in July 2006 and November 2011, according to the S&P/Case-Shiller Composite-20 Home Price Index. Canadian housing prices rose 30 percent in the same period, according to the Canadian Real Estate Association.

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