Lift Off! Why the US interest rate matters to Canadians

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Just last Wednesday the Chair of the Federal Reserve, Janet Yellen, finally took the first step to normalizing interest rates in the United States. This was done because it was finally prevalent that the US economy was starting to hold its own and no longer required emergency level interest rates to sustain growth. Despite the fact that the interest rate hike happened south of the border, it will likely have a profound effect on Canadian life.

Watch Your Mortgage Rate

The summer of 2015 might be remembered for having the lowest mortgage rates that we have ever seen in Canada. I distinctly remember seeing 1.89% fixed rates being offered up by credit unions and at one point BMO was offering 1.99% 3 year fixed loans. Today it’s a different story.

I wrote about how mortgage rates are not set by the Bank of Canada, but rather by bond rates. Bonds are traded on the market just like stocks. When a large respectable government like the United States starts issuing bonds that carry higher interest rates, bank bonds will tend to creep up a little higher. This happens because, quite frankly, the bank is riskier than the government. When bank bond rates rise, so do mortgage rates.

Today, on ratehub, you’ll find variable rates as low as 2.00% and a 5 year fixed at 2.4%. This isn’t as low as the summer, but the rates have been creeping up. With the US decrying their intent to raise interest rates over the next 3-5 years to 2-3%, it might be a smart time to think about locking in the mortgage for a 5 year term. Unlike our friends south of the border, Canadians don’t get to enjoy the luxury of locking in to long term 25 or 30 year fixed rate mortgage at these historically low rates.

If your mortgage rate is not up for renewal, then it’s time to start saving up for a large lump sum payment so that when renewal time comes more principal can be paid off. This will help offset any pains you might experience when you renew your mortgage at a higher interest rate.

The Falling Loonie

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If you travel a lot or you enjoy shopping in the US, no doubt you’re already aware that the value of the Canadian dollar has plummeted over the last year. In fact, it’s down almost 17% and dropping on a daily basis. The Bank of Canada has stated that it has no plans to follow the US Federal Reserve in raising interest rates. In fact, with the decline in oil prices over the last year, the Bank of Canada has even entertained the idea of cutting Canada’s interest rate.

This doesn’t bode well for our Canadian dollar. It will most likely continue to fall and thus make our imports much more expensive. This means that consumers can expect goods to be more expensive in the stores. Food costs will most likely rise and the one thing this might stoke is inflation.

This kind of inflation is the kind that the Bank of Canada and the government doesn’t want. When the price of necessities rise without wage increases, then the standard of living for all Canadians drop. That’s why it will be important for the Bank of Canada to watch inflation very carefully, especially for necessities, to ensure that the dollar doesn’t fall too far. If it does then don’t be surprised to see the Bank of Canada raise rates just to protect the value of the dollar rather than dropping it to spur the economy.

Diversity Your Investments

From aflagsn investment standpoint, it would be wise to diversify your investment portfolio to include equities outside of Canada. This will give you exposure to currency gains from a falling Canadian dollar. Had you held US equities like the S&P Index, you would be up over 16% from currency gains, despite the fact that the stock market has gone nowhere this year.

The same holds true for investing in other parts of the world like Europe or Asia. Similar to the American dollar, the Euro has risen over 8% against the Canadian dollar. Having this kind of diversity in your investment portfolio can help offset the poor performance that Canadians have experienced domestically with the TSX.

It’s not going to be a stretch to believe that as interest rates rise in the US, that commodity prices will continue to stay low. This will have a negative effect on Canadian investments because most of Canada’s industry is resource intensive. Don’t stick to stocks and mutual funds of Canadian companies only. Being biased towards your own country is not a way to protect your own personal wealth.

Back To Normal

There were many people who believed that interest rates would never go up. A lot of people were and still are negative about the prospects of the global economy, but the raising of US interest rates was a monumental first step in getting back to normal.

The world has been awash with easy money, leading to many asset bubbles like the Chinese stock market. As interest rates start creeping back to normal, savers will finally be rewarded, asset bubbles will pop, and easy money will no longer be available.

It’s been a long road back from 2008. Let’s hope for the best in 2016!

 

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