If all the other banks join RBC and TD and mortgage rates rise further, popping a Canadian house price bubble, that might seem a high price to pay for a lesson in world finance.
But Canadians contemplating the effect of rising rates on real estate are now getting an exceptional insight into why the so-called "bond vigilantes" are angry at president-elect Donald Trump.
They are also getting a ringside seat on the interconnectedness of global financial policy that creates winners but leaves many losers suffering the consequences.
A lot of Canadians truly understand the real estate market. Many others talk as if they do. Interest rates, short- versus long-term mortgages and whether current house prices are real or a bubble are the stuff of modern bar chatter.
Canadians work hard to understand because they realize house prices matter to their own finances. That's how the bond market matters to the world.
Think about the pain of a sharp fall in house prices. It hurts the borrowers. It hurts the lenders. And it hurts the entire marketplace where the business is being conducted.
Pulling the trigger
Slowing house prices and falling bond prices have the same trigger.
If we look back 15 years or so, interest rates were much higher. A mortgage would cost you between seven and eight per cent.
In a story explaining the RBC rate change yesterday my colleague Pete Evans showed that paying off a $300,000 mortgage that cost $1,360 per month before the rate hike would cost about $1,400 per month after.
But back when mortgage rates were eight per cent, paying off that same $300,000 mortgage would have cost about $1,000 more per month — about $2,300. The lifetime cost of that loan would also be much higher.
Clearly one of the effects of falling interest rates over the last 15 years was that it gave potential homebuyers access to more borrowed money.
As interest rates fell, quite reasonably, banks decided people who could afford to pay an eight per cent loan on $300,000 could afford to borrow much more at three per cent.
And all that extra money in the market allowed house prices to rise.
When almost everyone borrows to buy a house, the true cost of a house in any year is the carrying cost on the money you borrow. So as the carrying cost fell, the nominal asset value of the house rose.
That is the same thing that happens in the bond market. There are various online calculators to help you do the math. The asset price of a bond that was earning eight per cent a few years ago will go up and up as interest rates fall.
But of course in bonds and in houses, everything changes once interest rates change direction.
Change at the Fed
Trump's promise to spend $1 trillion and cut taxes has bond (and mortgage) markets worried that Federal Reserve Chair Janet Yellen must begin to raise interest rates.
Just as eight per cent bonds get more valuable as rates decline, bonds that pay half a per cent fall in value as interest rates rise.
Feed some numbers into a bond calculator to see how it works. Remember many bonds have a 30-year term and interest rates have been 0.25 per cent and less.
There are many ways that house markets and bond markets are different. Bonds work on a hair trigger, traded in huge blocks on international markets.
Bond markets anticipate future rate rises, as they are doing now.
The house market, where units are traded one by one, mostly by amateurs, is slower to react.
For most Canadians, houses are not principally investment assets. They are a place to live and raise families.
Canadians may find the housing market more familiar, but in many ways it's more complex than the bond market.
Housing markets are fractured, dependent on human values and decisions that don't fit into bond tables.
But everything else being equal, rising interest rates would eventually have the same effect on houses that it has already had on bonds. Higher rates make existing assets fall in value. In both cases there will be large effects on the wider economy as asset values disappear.
If that happens in the property market, Canadians will not like the feeling.
The president-elect may not care how Canadians feel. But the global bond industry with its traditional headquarters in the U.S. has enormous clout in Washington.
Trump's plan to pump $1 trillion into the U.S. economy will further tighten a tight job market, increase wages and could well stimulate private sector investment.
But with $1 trillion already lost in the bond market, Trump will have to use all his skills as a brash, hard-nosed entrepreneur to turn his stimulus plan from talk into action.
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