For many of our clients, debt control is not as important as the investment strategy, tax planning and cash management. Mortgages have largely been paid off, unpaid credit card balances are kept low and if there is a car loan, chances are it is because it was a zero-rate offer that made more sense than liquidating a portion of their portfolio that was making significantly more. Yet, we are entering a period where many Canadians are going to have to pay closer attention to the liabilities side of their balance sheet – a period where debt servicing costs could increase alongside the prices of much of the household goods and services consumed. 

This week, the Bank of Canada decided to leave its official overnight target rate unchanged at 2.25%. This was exactly what the market expected, though there was some trepidation going into the policy meeting that the Bank’s language might present guidance of higher rates in the future. As it turns out, the Bank’s official statement and Governor Maklem’s comments in Q&A were balanced. Canada’s economy has been essentially flat over the past year (aka weak), suggesting room for rates to perhaps go lower, but the risk that higher prices out of the Iran war could manifest in elevated consumer expectations of future inflation leaves the door open to a potential hike in the Bank’s rate. Indeed, the market has priced in one lift before the end of the year.

If you remember back to the post-Covid period, when inflation was deemed to be only “transitory”, the Bank and other central banks around the world were late to the game in terms of hiking interest rates to cool inflationary pressures. It and they are not going to make the same mistake again, and considering that the Iran war is back on, price pressures look more likely to remain in place than quickly disappear. Governor Maklem phrased it perfectly in stating that “economic weakness combined with rising inflation is a dilemma for monetary policy. Raising rates to dampen inflation could further slow the economy. Easing rates to support growth increases the risk that higher inflation becomes persistent.”

But while the Bank may have kept its official rate unchanged, thus anchoring short-term interest rates in Canada, the market is pricing in more risk into longer-dated yields from inflation to rising government deficits. This is why we have seen the 5-year Government of Canada bond yield push higher since the end of February, as you can see in the chart below. About a month ago, we peaked at around 3.35% and that was the highest we have seen the yield since July 2024. In October 2023, we hit the post-pandemic high of close to 4.5%.

Why are we focused on the 5-year bond yield? Because it is a useful barometer of 5-year mortgage rates. And that is important because we have entered a very important phase for Canada’s housing market. Cast your mind back six years. The 5-year government bond had just broken below half a percent as central banks put in place emergency measures to rescue an economy that effectively shut down in an attempt to put an end to the pandemic. Mortgage rates went down as well to levels that we haven’t seen in generations. The economy rebounded in response and so did home prices. Well, “rebounded” might be an understatement. Prices went through the roof, pardon the pun, and so did mortgages. But this was okay because mortgage rates were still ridiculously low. I mean, by June 2021, the 5-year bond yield was still sub 1% and they wouldn’t climb above this level until September of that year. And then they started to move and move fast. Borrowers did the rational thing back then and locked into the longest mortgage they could get their hands on and, yes, that’s a 5-year fixed.

Three years later, panic set in. We saw the worst bond market correction in half a century and mortgage rates followed bond yields sharply higher. But calm returned as central banks lowered rates in 2024 and 2025 and by the end of last year, economists were still calling for further rate cuts and lower yields. So, when that 5-year mortgage that you took out in 2021 came due, the sticker shock may not be as bad as you thought. Don’t get me wrong, the rate was going to be higher but not so much that the household budget would be shattered. Where the 5-year government bond yield might have trended back down towards 2%, Trump 2.0 and its ensuing policy mayhem put a hard floor in on yields.

The Bank of Canada identified the risks stemming from mortgage renewals taking place this year and next in its recent Financial Stability Report. Over the next 12 months, the last of the 5-year fixed mortgages taken out during the pandemic will come due and this segment represents about 12% of the entire market. According to the Bank, this group will see their payments increase by 15% - similar to what mortgage renewals saw over the past year. Thankfully, Canada implemented stricter mortgage application thresholds in terms of the interest rate used to determine a borrower’s ability to service the mortgage. Instead of the rate the bank might offer you, it was the Bank of Canada’s indicated 5-year rate that was used. Since this was done before the pandemic, the threat from this wave of mortgage renewals is smaller than it could have been.

While the general view in the Bank’s report is that the situation is still relatively good, there are some problems beginning to surface. For one, while Canadian household debt to net worth has been declining, this is stemming more from increasing equity market valuations and not home prices, which have been falling. The stock market may very well remain buoyant over the coming months, but we are likely pushing the bounds of realism in a mid-term year with two wars continuing.

Meanwhile, the ratio of debt to disposable income hit a low in the third quarter of 2024 and has been creeping higher. This is the one we need to watch, not just in Canada but everywhere else. The reason is that if the recent recovery in job growth turns out to be a blip, and unemployment rises, then there is going to be a major challenge faced by households to deal with higher borrowing costs and prices of the things they consume. That throws into question the realistic outlook for consumer spending and hence overall economic growth.

But let’s leave the macro world and come back home to the household balance sheet. When I was on the show with my friends and PeakFM hosts John and Mel this past Monday, they asked me the same question they always do after we discuss the developments in the economy and market over the previous week – what should listeners be doing right now?  Normally, it’s a portfolio slanted question but this time around I told them that this is becoming more a debt management question for listeners. My suggestion was to examine the level of debt in the household, from credit cards to car loans to lines of credit to mortgages and see what impact higher rates would have. As they say, plan for the worst and hope for the best.

Speaking of planning, for those in the group I referenced at the start of this discussion, there is probably going to be an inclination to help children or grandchildren that might be caught in a challenging situation because of what mortgage renewals or just day-to-day cost pressures. It might even advance gifting aspirations that were originally nestled in one’s will. Ally and I have talked about this great intergeneration wealth transfer that is here and growing and how the financial industry has looked at this mainly through the lens of simply how we pass a bucket of stocks and bonds to the next cohort. Depending on how things shake out, the transfer mechanism for some families might be from liquidation of the stock and bond bucket to write a cheque to cover higher monthly expenses or a mortgage renewal. And, as you can probably surmise, this in turn takes us back to the macro world.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.     

Andrew Pyle