Navigating the Shifting Landscape of Bond Yields and Their Impact on Investments and Loans

Global financial markets are experiencing significant transitions, influenced by changing interest rates and evolving investor expectations. A key measure to consider is the U.S. Equity Risk Premium, which represents the additional return investors require for holding equities over "risk-free" government bonds. Recently, this premium has fallen to its lowest level in years, raising concerns about U.S. equity valuations. This decline indicates that equity returns are now closer to those of long-term bonds, reflecting elevated stock prices and rising 10-year bond yields.

In the bond market, the yield curve is undergoing normalization after a period of inversion. A typical upward-sloping yield curve—where longer-term bonds offer higher yields than shorter-term ones—generally signals expectations of economic growth and inflation. Recently, long-term bond yields have risen substantially, even as central banks reduce short-term policy rates. This unusual trend suggests that investors are revising their expectations regarding future economic growth and inflation. With ongoing rate cuts from the Federal Reserve and the Bank of Canada, short-term bond yields are likely to decline further, reinforcing the normalization of the yield curve.

Source: Bank of Canada, January 27, 2025.

These changes in the bond market have implications for Guaranteed Investment Certificates (GICs). As short-term rates decrease, GICs with fixed returns become increasingly attractive to investors seeking stability. Concurrently, rising long-term bond yields may lead to higher long-term GIC rates, presenting opportunities to lock in higher returns. A steepening yield curve, where the gap between short- and long-term rates widens, enhances the appeal of longer-term GICs, allowing investors to align their investments with their financial goals while benefiting from higher yields.

In Canada, mortgage rates are influenced by these trends. Fixed mortgage rates, which are partly driven by long-term bond yields, tend to rise when bond yields increase, often reflecting investors' optimism about market growth. This can lead to higher borrowing costs. Meanwhile, variable mortgage rates, tied to the central bank’s policy rate, usually decline when rates are cut. This divergence adds complexity to housing affordability and borrowing decisions, requiring prospective homebuyers to evaluate their options.

By understanding these trends—from equity valuations to bond markets and their effects on GICs and mortgage rates—investors and borrowers can better navigate the changing financial landscape. If you would like to discuss it further, contact us at +1.604.643.0101 or cashgroup@cgf.com.