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Issue #51 – Rising Rates, Rising Loonie

The Canadian Dollar has appreciated almost 10% in less than 3 months with interest rates following suit. This month, we examine the meteoric rise of the loonie and the sudden increase in interest rates with a focus on the impact for you as an investor and whether or not it is time to “fix” your mortgage rates.

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The Canadian Dollar or Bitcoin?

A few short months ago, our faithful loonie was trading near its 10 year low, hovering just above the 72 cent mark.  Shortly afterwards, a brief rally in the oil sector pushed the price of crude oil up to $50, and along with it, buoyed the $CAD to just shy of 75 cents.  This price rise was enough to push the ticker for inflation beyond the comfort level of Stephen Poloz, the governor of the Bank of Canada, who controls the levers of Canadian interest rate policy. 

Citing fears of inflation, a recovering Canadian economy, and concerns over the housing bubble, on June 28th Mr. Poloz signaled to the markets that a rate hike was imminent, stating that low interest rates had “done their job”.  Less than three weeks later, he held true to his word and raised overnight lending rates by 0.25% which sent bond markets tumbling and the Canadian dollar skyrocketing at a pace not seen since the Bitcoin craze. 

This sudden jump in the value of the Canadian dollar is caused in large part by investors moving money across borders.  When interest rates jump as suddenly as they did here in Canada, global investors see the opportunity to make additional returns on their investments by snapping up newly issued bonds that benefitted from the recent rise in rates.  Their strategy is to sell US dollars and convert them to Canadian dollars which are then used to buy the Canadian-dollar denominated government bonds.  This sudden boom in demand for Canadian dollars at the expense of US dollars is causing the loonie to appreciate rather quickly. 

The appreciation in the loonie further fuels demand for this investment strategy as the rising loonie means additional returns for US investors who can now convert their loonies back to US greenbacks for even more money. The predictability of the market to react in this way following a rise in interest rates has made it a common hedge fund strategy.  As such, the moment these circumstances materialized in the Canadian markets the Canadian dollar began its appreciation, moving from 75cents to 80 cents. This appreciation occurred in less than 30 days since Mr. Poloz’s June 28th comments.

Impressively, these changes all occurred during a significant pause in the Toronto real estate market which should have meant significantly reduced inflows of capital from foreign buyers.  According to some, the attempt to cool the GTA real estate may have been yet another motivator for Mr. Poloz’s sudden increase in rates.

Where does the Loonie go from here?

In our opinion, the loonie’s fair market value is approximately 0.75 cents.  As such, we at Innova view the Loonie as overinflated at the moment and have positioned our portfolios accordingly.  Furthermore, an article[i] published on July 31st by the Globe and Mail cites the following reasons why the dollar may have reached its peak at the 80 cent mark:

  • Historically disconnected from its correlation to oil.
  • Canadian consumer debt levels still very high, thus the economy is vulnerable to interest rate increase.
  • NAFTA about to be renegotiated, which means uncertainty for the Canadian economy.
  • Current account deficit still negative, which means we import more than we export.  Rising interest rates are detrimental to resolve this issue.

Most likely, we have seen the top of the currency boom for the near term at least. Given the significant impact of Mr. Poloz’s latest increase on the markets and the rumours that Ottawa wasn’t pleased with the governor’s aggressive policy, it is unlikely that we will see another rate increase in the near future.  As such, hedge funds will cash in their profits and move their money somewhere other than Government of Canada bonds.

Mortgages:  Fixed vs variable rates  - A commentary from Innova Wealth Builders

Since the recent rate increase, we have received a few inquiries asking whether or not it is worth fixing their variable rate mortgages.  If history serves as a guide, variable rates have outperformed over all cycles.  Even though the past few weeks have seen fixed rates climb considerably, they still remain attractive.  At present, 5 year rates hover between 2.7% and 2.95% depending on the lender, while variable rates are closer to 2.2% to 2.5%.  In other words, fixed rate borrowers are “pre-paying” one interest rate increase in the next 5 years – not a bad bet for a gambling man. 

Those who are concerned with rising rates may want to consider an early exit from their existing mortgage in favour of locking-in a fixed rate.  Whether or not this is financially savvy depends largely on your existing rate and the cost of breaking the agreement.  Tanya Edwards, a licensed mortgage broker for Innova Wealth Builders, would be happy to help you calculate your “break-even point”, or the point at which fixing your rate would become beneficial for you.  A current mortgage statement along with an estimated cost of breaking the mortgage, which must be requested from your current carrier, are required to run this calculation.

For those of our clients who already have their mortgages through Tanya, she has already completed the comparisons for many of you and will contact those who may benefit from locking their rate.

Impact on Investors?

Both the increase in interest rates and the rise in the Canadian dollar are bad news for diversified, risk conscious investors.  Firstly, rising rates hurt bond prices since only the newly issued bonds are put out at increased interest rates.  Existing long-term bonds are no longer as attractive to investors since interest earnings on older bonds earn less than new bonds, despite having almost exactly the same risk levels.  For this reason, existing long-term bonds fall in value.  Even corporate bonds are not immune to this phenomenon as they appear less attractive to investors than newly minted government bonds issued at the new rate. 

Similarly, a rising dollar hurts the internationally diversified investors.  Having purchased foreign stock in another currency, the appreciation of the loonie means that converting those foreign dollars back to local currency will result in fewer $CAD for the investor, thus reducing their rate of return in an amount equal to the appreciation of the dollar. 

Companies who export from Canada as well as international companies with labour and production in our fair country will also feel the pinch as their margins get squeezed.  For these reasons, a rising currency is seen as bad news for a country’s growth prospects.

The benefactors of rising rates and currency are limited.  Vacationers to the US and importers benefit from having their loonie go further, while commodity producers, apart from Gold, tend to outperform in rising interest rate environments.

How has this affected your portfolio?

The month of June and July were not particularly kind to investors in general.  Canadian investors saw the following loses throughout July:  

  • Canadian Bonds:          -2%
  • CAD Equities:              -0.5%
  • USD Equities:              -2%
  • European Equities:       -3%
  • Emerging Markets:       -1%

Fortunately, our overweight cash positions in most accounts considerably reduced the damage.  Furthermore, the tactically managed Pimco Monthly Income fund posted positive returns over both June and July despite its heavy exposure to bonds, due in large part to having loaded up on the cross-border trading discussed earlier.

Despite this pull-back, we have not seen the worse of things to come.  With investor complacency and consumer debts nearing all-time highs, we continue to feel as though the markets are ripe for panic.  As such, we continue to err on the side of caution with our portfolio construction, waiting for a better opportunities to get greedy.

As always, we are available to you as needed so please do not hesitate to contact us! 


Jean-François Démoré


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The information contained herein was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any securities mentioned. The views expressed are those of the author and not necessarily those of ACPI.

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