1. Direct Correlation
- Fixed-rate mortgage rates are largely tied to long-term government bond yields (often the 5-year government bond yield in many countries). When bond yields increase, mortgage rates tend to follow, and when yields decrease, mortgage rates often drop.
- Banks and mortgage lenders look to bond yields as a benchmark since they represent the risk-free rate lenders could earn on the bond market. When bond rates rise, lenders adjust fixed-rate mortgages to stay profitable and competitive.
2. Inflation and Rate Adjustments
- Bond yields often rise with inflation expectations, as investors demand higher returns to compensate for decreased purchasing power. Central banks may raise interest rates to cool inflation, which can increase bond yields. As a result, fixed-rate mortgage rates can climb since lenders anticipate higher future rates.
3. Market Sentiment and Economic Outlook
- The bond market reflects investors' economic outlook. For example, if investors are worried about a recession, bond yields may drop as people flock to safer assets like government bonds. Lower bond yields can lead to reduced fixed mortgage rates, as lenders pass along some of that reduced yield in the form of lower mortgage rates.
4. Impact on Mortgage Payments and Affordability
- Rising bond yields leading to higher fixed mortgage rates can significantly affect affordability. As rates climb, borrowers face higher monthly payments, which can reduce demand for home purchases and impact the real estate market.
Since bond yields are sensitive to economic factors, shifts in global or domestic economic conditions can ripple through to the fixed mortgage market, impacting borrowing costs for consumers.