With the Bank of Canada announcing another interest rate hike, it’s a great time to revisit your investments that are more sensitive to fluctuating interest rates.
Canada’s central bank has raised its key benchmark rate
another 50 basis points (0.5%), to 4.25%. This is bad news for those holding
variable rate debt (such as adjustable-rate mortgages and lines of credit), and
those holding investments that are highly sensitive to changes in borrowing
rates (such as longer-term bonds).
When investing in bonds, there is an inverse relationship between
bond prices and interest rates. This means that when interest rates rise, bond
prices fall, and vice versa. This occurs because the present value of future
interest and principal payments falls as the opportunity cost of tying up your
money rises (you could invest your money into other assets now paying a higher
rate of interest if given the opportunity – this makes your existing fixed rate
investment assets less attractive). Preferred shares, which often have fixed
dividend payments, also experience this problem.
When investing in stocks, the present value of any future
cash flows also falls as rates rises. These future cash flows could be dividends,
or the anticipated value of earnings that new projects might bring. For this
reason, as well as more than a fair share of economic uncertainty on the
horizon, we have seen many stock prices fall in tandem with bonds year-to-date.
Often, those stocks most sensitive to declines of this nature are those with
fixed payments coming from their customers, such as utilities, or those with
cash flows only coming far into the future, such as some in the technology
space.
On the bright side, the Bank of Canada might be nearing an
end to the rate tightening cycle. Perhaps even just another 25-basis point, or
50-basis point move coming down the road in January. The housing market is showing
signs of weakness, and inflation pressures are easing. These are both good
sings for those waiting for lower rates.
Thank you.
Matthew Clarke
Some additional reading:
https://www.bankofcanada.ca/2022/12/fad-press-release-2022-12-07/
