If you read a lot of mortgage rate commentary, you'll see Canada's 5-year yield continuously cited as a fixed-rate indicator. It's a handy, rough guide to the direction of 5-year fixed funding costs—most of the time.
Practically speaking, insured 5-year fixed rates approach 100% correlation with the 5-year government bond over the long run, says Home Trust SVP and Treasurer Krishna Gadhraju.
However, the 5-year GoC is not the absolute best proxy for uninsured loans. It's widely cited by commentators—mainly because it's a foundational interest rate (i.e., a rate that other borrowing rates are linked to) and partly because it's easy to find free access to it.
In reality, there are better measures of funding costs for big banks—one being swap rates. Swaps are instruments big banks use to hedge interest rate risk. Banks use them, for example, to turn fixed-rate mortgage payments into floating-rate payments. In this case, banks would enter into a "pay-fixed-receive-floating" swap.
Since banks are funded mainly through short-term liabilities (e.g., deposits, one-day borrowing, etc.), these swaps help them match their funding to their lending.
In practice, banks often hedge newly originated fixed mortgages by taking an opposite position in government bonds. They then use swaps to hedge once there's a big enough pool of loans (this reduces transaction costs).
Banks use a variety of swaps to hedge, like 3-, 4- and 5-year swaps. In practice, the 4-year swap rate most closely matches the average 3.8-year duration of a 5-year fixed. As a result, the 4-year swap approximates banks' base 5-year funding costs with roughly 95% accuracy.
For these reasons, Canada's 4-year swap rate is MLN's preferred proxy for basic fixed-mortgage funding costs. Of course, there are many other lending costs, such as overhead, staffing, originator compensation, marketing, etc. Those are above and beyond basic funding costs.
Note: Swap data is not easy to find online. MLN generally quotes its swap data from professional sources like CanDeal DNA and trading terminals. You'll find it posted daily in our Mortgage Command Centre.