Rising Rates and Canada’s Institutional Investors

What can investors expect from rate hikes?

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kid-reaching-upThe Bank of Canada is set to announce a decision on the target for its overnight rate on Wednesday.

Widely expected to be a 25 basis point increase, in line with the hawkish tone of the bank’s latest policy notice, the decision comes amid a backdrop of market and trade volatility.

However, Canada’s economy is currently well-placed for a rate hike, according to Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, in a recent commentary note. “Unfortunately, we can’t ignore the trade uncertainty even if much of it is Twitter-driven,” he said. “The U.S. tariffs and Canadian retaliation will dent growth, even if modestly, but more importantly reinforce that there’s some risk of further U.S. action.”

Yet, as Reitzes noted, Bank of Canada governor Stephen Poloz has stated policy won’t be shaped by trade rhetoric. However, the tensions are likely to continue to be a driver of the bank’s decision-making going forward, according to Reitzess, who noted that other risks, such as the Canadian housing market and consumer debt levels, have eased recently.

If a rate hike proceeds, institutional investors will want to watch closely for any signals indicating whether this is a solitary move upwards or the beginning of many, says Randall Malcolm, managing director and portfolio manager, Canadian public fixed income at Sun Life Investment Management.

“One of the things that we’ve noted in Canada is that the curve has moved very differently in the short end and relative to the long end. We have one of the flattest curves in the G8,” he says, noting most pension plans take their natural home in the long end of the curve. Longer-term investors have stuck to their guns in that sense and have been rewarded for it, he says.

Canadian plans can view a rate hike as another vote of confidence in the Canadian economy, adding to the Bank of Canada’s broadly positive view, he says. “We have a strong sales outlook and employment is relatively strong as well, so hiring intentions are up. Firms are noting that labour shortages could prevent them from meeting demand.”

Such confidence in the labour market could boost Canada’s attraction as a location for investment, says Malcolm, even considering the headwinds of trade tensions. One area of doubt, he notes, is the federal government’s purchase of the Trans Mountain pipeline, which he says “showed a lack of clarity on energy policy,” a key indicator for Canadian business.

Overall, Canada’s pension plans have been undertaking significant action to mitigate return levels in a historically low interest rate environment, says Joe Cerullo, a senior consultant at Segal Rogerscasey Canada.

He notes that on the fixed-income side, Canada’s money managers have ensured a much greater diversity in the past and aren’t likely to feel a heavy impact from a Canadian rate change. Indeed, many fixed-income managers have been focusing on short-term securities, with more of what makes up these portfolios set to mature relatively soon. Managers will then be able to take advantage by redeploying capital at a higher interest rate, should the hike take place, says Cerullo.

This story originally appeared on our companion site, BenefitsCanada.com 

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