Rising interest rates: are there any upsides?

Ashleay: Welcome to the “In Your Interest!” podcast from iA Financial Group, where we discuss your need-to-know economic news and how it affects your finances. All this in under 10 minutes. Lines of credit and mortgage rates going up… the future may look a little complex financially, but is there any good to the rising interest rates? My name is Ashleay. I'm here with my colleague, Sébastien Mc Mahon, our Chief Strategist and Senior Economist here at iA Financial Group. Hi, Sébastien.

Sébastien: Hi, Ashleay.

Ashleay: Sébastien, can you explain why interest rates fluctuate over time and who is behind these movements?

Sébastien: Sure. So, it's not a simple question. So, there are two reasons. First, there's the central bank, so, the Bank of Canada here, that, according to its view on inflation, on the economic cycle, they will be raising interest rates or lowering interest rates just to keep the economy stable and in a good place. So, this will have a direct impact on shorter term rates that impact things like mortgages, lines of credit. So, there's one part and the other part is the markets. So people that are investing in bonds, buying or selling, they're putting some pressure upward and downward on the price of bonds, which is reflected in interest rates and depending on their view of the economic cycle, the investor sentiment in the markets that will also make interest rates fluctuate. So, interest rates move for multiple reasons, it’s whether the institutions that are moving that or the investors. But if interest rates are moving higher, the impacts, the negative impacts are well known. As I mentioned, if the key rate rises, well, if you have a variable mortgage rate, that means that you'll be paying more every single week, two weeks, every month for your mortgage payments. If you have a line of credit, the same thing. The link between the rate that you pay on your line of credit and the rate from the Bank of Canada is direct. So, when they tighten, that means that you will pay more. For longer rates, it's more about the returns that you'll have on your bond portfolio. So, if you're an investor, you have a pension fund, you're investing for the long run, probably you have bonds in your portfolio. Well, when interest rates are going higher in the short term, that's a headwind for the returns on your bonds.

Ashleay: I see. And there are some positive points, though, which are not necessarily obvious in the short term.

Sébastien: Yeah, of course, the stability of the economic cycle is the main positive point. So, before the arrival of central banks, let's say in the late 1800s or early 1900s, economic cycles were very short, they were very unpredictable. And central banks were created then to make sure that we managed these cycles so that they would be less extreme. So, there are some benefits. Now we have longer and more stable economic cycles. If interest rates are rising higher, the market rates, that means that you'll have better bond returns in the future. So, interest rates being higher - at first, it's detrimental, but in the long run that means that you're going to be making more money out of your bonds. So that's a good thing. You have better GIC rates and this is probably where we could spend some time here today. For example, last year on the same date, so in August of 2021, the interest rate on a guaranteed interest fund for the one-year term was only 0.65%. And now in 2022, one year later, it's 3.25%. So, quite a step up. And in the high interest savings account, the rate was 0.4 last year and now it's 2.35.

Ashleay: So, if I understand correctly, there are opportunities even though the markets are turbulent these days.

Sébastien: Yep. Behind the recent market declines, rising interest rates are having a positive effect on guaranteed interest funds and high interest saving account returns. In this context, these options offer an enviable and often desired security in times of market volatility. For example, giving you a 100% capital guarantee, they’re redeemable at any time, unlike some banks’ GICs. And there's, more importantly, no management fees.

Ashleay: So since generally I'm more conservative with my savings, my financial advisor told me about a simple way to ladder my investments so that I have a cash flow each year. Can you tell us about this strategy?

Sébastien: So, by simultaneously depositing three tranches of amounts with respective maturities of one, two and three years, the strategy allows you to anticipate future liquidity needs while enjoying an optimal return over time. So, let's say, for example, that you have $60,000 on hand - you could invest $20,000 for a one-year term, a second tranche of $20,000 for a two-year term, and the last tranche of $20,000 for a three-year term. So, the advantages of that are that you have better management of interest rate risk, because if investment rates fall, only a portion of the principal would be at risk at renewal. And conversely, if rates were to rise, the short term of one year, for example, could benefit from a better rate in the second year when it is renewed for a three-year term. You have also higher long-term rates of return because the investment that you make for three years will typically give you a higher rate than the one that you invest for two years or for one year. So you're able to catch that too and finally you get some liquidity every year, meaning that every year that comes you have an amount of liquidity, the liquidity that becomes available to reinvest in the markets, for example, with dollar cost averaging or to contribute to your RRSP or your TFSA or simply to be reinvested in the laddering strategy, if this is what you need. So, remember, it's your money and depending on your needs, you need to be able to sleep on both ears at night. And there are options and strategies out there that will surely fit your profile.

Ashleay: Absolutely. So, thanks again, Sébastien and you know what? It's fun to see this positive spin on the rising interest rates. Love this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast available on all platforms, visit the economic news page on ia.ca or follow us on social media.