Interest Rates on Hold. Why, and What Does it Mean for You?

December 12, 2017 Wesley Blight

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Last Wednesday, December 6, the Bank of Canada (BoC) held firm on its target for the overnight interest rate at 1.0%, as was widely anticipated by the market. The Canadian economy is currently on hold, positioned between forces that could lead to expansion or further inactivity.

Canadian growth and employment are strong…

On the expansionary side, Canada has been enjoying more robust domestic growth from improved business investment, increasing net exports and from other broad, sustainable sources. Employment data has been surprisingly strong; unemployment has declined with the creation of many new jobs. The global economy has continued to expand in line with the BoC’s expectations. These factors support a rate increase.

…but there are still concerns

Several factors continue to support no increases to interest rates. Underlying inflation is well under the BoC’s target, and wage inflation has not moved significantly higher. Having leeway to leave rates lower enables Canadian consumers to service their elevated debt while continuing to spend on goods and services. A wild card is also being watched closely: the future of the NAFTA agreement.

Upward pressure on rates remains

The messages the BoC decision sent to the market were subtle. Firstly, the decision signaled some divergence in policy with the U.S. Federal Reserve, which is being more forthright in its approach to controlling a strong economy. The Canadian dollar paid the price of a one-cent drop relative to the U.S. dollar as Canadian treasury yields declined. The market clearly interpreted the BoC decision as a sign that future decisions are perhaps less likely to be in favour of a rate hike. However, the BoC was clear about saying that this decision was made in an economic environment of upward pressure on rates, so we are still expecting at least a 0.25% increase in the next 12 months.

Leaving equity investments unhedged

In this kind of interest rate environment, MD is concerned about positioning portfolios to preserve capital and add value. From an equity perspective, we believe interest rate movements are expected to have a low impact, and that we can add the most value by leaving these investments currency unhedged. 

Opportunity in global fixed income and corporate bonds

With our fixed-income strategy, we need to be more elaborate. Recognizing that the BoC is not able to raise interest rates as aggressively, our domestic holdings are being kept duration neutral with a slight bias to the long. In many cases, we have hedged our foreign fixed-income exposure back to the Canadian dollar. Additionally, we are pursuing enhanced income through diversity in our fixed-income holdings. This will mean a higher allocation to global fixed-income and Canadian corporate bonds that are less sensitive to interest rate movements.

The good news is that the BoC is continuing in its tradition of thoughtful guidance for the economy. At times, there is no need for bold moves, and a wait-and-see approach can communicate a position of balance and stability. We view current economic events with a feeling of confidence, both for Canada and for MD’s investment portfolios.


Bank of Canada Leaves Rates Unchanged, Canadian Dollar Drops

Earlier today, the Bank of Canada left its policy interest rate unchanged at 1.0%.

The U.S. dollar immediately rose by nearly one cent versus the Canadian dollar, as the subtle implications of the decision contributed to a decline in Canadian treasury yields.

While the Bank of Canada’s announcement is no surprise, the market’s reaction suggests a slightly lower expectation for future rate hikes. A 0.25% increase is still expected sometime in the next 12 months. MD agrees with that probability and we are confident that we remain well positioned for a modest increase to Canadian interest rates. 

MD will follow up this blog post with more in-depth analysis about the announcement and what it means for your portfolios.

 

About the Author

Wesley Blight

Wesley Blight, CFA, CIM, FCSI, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He is responsible for the investment results of the firm’s fixed income and multi-asset products.

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