Canadian Mortgage Rates Face 2026 Japan Shock

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How the Yen Carry Trade Unwind Could Affect Canadian Mortgages

The yen carry trade unwind—driven by Japan's rising interest rates, a strengthening yen, and repatriation of capital—reduces global liquidity and increases volatility in bond markets. This indirectly pressures Canadian mortgage rates through interconnected financial systems. Canadian mortgages are predominantly fixed-rate (about 75% of outstanding loans), but these are funded by short-term bonds like Government of Canada (GoC) bonds. As global yields fluctuate, Canadian bond yields follow suit, influencing the rates banks offer on new fixed mortgages. Variable-rate mortgages (tied to the Bank of Canada's overnight rate) face more direct hits from domestic policy responses.In late 2025, with the Bank of Japan (BoJ) hiking to 0.5% and signaling more, Japanese investors are selling foreign holdings (including US Treasuries and potentially Canadian bonds) to cover losses, pushing up global yields. This echoes the August 2024 unwind but is accelerating amid US tariff uncertainties and sticky inflation. For Canada, the net effect is upward pressure on rates, though the Bank of Canada (BoC) is countering with easing to support growth amid trade headwinds.

Key Transmission Mechanisms
  1. Global Bond Yield Spillover: Rising Japanese Government Bond (JGB) yields (e.g., 10-year at 1.7%+) and US Treasury sales by Japanese holders increase Canadian 5-year GoC yields, the benchmark for most fixed mortgages. A 20-50 basis point (bps) spike could add 0.2-0.5% to new mortgage rates.
  2. CAD Weakness and Inflation: Yen strength boosts the yen vs. USD/CAD, weakening the loonie (USD/CAD recently above 1.40). This raises import costs, adding 0.2-0.5% to CPI inflation and limiting BoC rate cuts.
  3. Liquidity Crunch: Reduced yen-funded flows hit risk assets, slowing global growth (projected at 3% in 2026 per BoC). Canada, export-reliant, faces softer demand, prompting BoC caution on easing.
  4. US Trade Tariffs: Trump's policies (e.g., 25% on Canadian autos) amplify uncertainty, potentially hiking inflation and delaying BoC cuts, per the October 2025 Monetary Policy Report (MPR).
  • Base Case (55% odds): BoC pauses at 2.25% on Dec 10, with inflation at ~2.2% but trade risks rising. Mild yen unwind adds modest yield pressure; rates stabilize by mid-2026 as BoC eyes 2.00% by year-end.
  • Mild Case (30% odds): Slower unwind allows BoC 25 bps cut in Dec; fixed rates dip to 4.0%.
  • Severe Case: Full liquidity drain (yen to 140/USD) triggers global recession fears; BoC holds rates, yields surge, pushing average renewals up 0.5-1%.
Impacts on Borrowers and Housing Market
  • Higher Payments: A 25 bps rise on a $500,000 mortgage (25-year amortization) adds ~$65/month. For the 1.5 million Canadians renewing in 2026, this could mean $1-2 billion in extra annual costs, straining budgets amid 7.1% unemployment.
  • Affordability Squeeze: Home sales (down 5% YTD) could fall another 10-15%, prices soften 3-5% in Toronto/Vancouver. First-time buyers face qualification hurdles if stress tests (at 5.25%+2%) bite harder.
  • Renewal Shock: Many locked in at sub-3% during 2020-22 now face 4%+; unwind volatility could delay refinancing options.
  • Opportunities: If BoC cuts prevail, variable holders save ~$100/month per 25 bps. Fixed-rate shoppers should lock soon if yields peak.
 
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