On January 21, the Bank of Canada cut its key interest rate by 0.25%. Here are our observations about this bold monetary policy move.

Seven Observations About the Bank of Canada Rate Cut

  1. In a move causing major surprise, the Bank of Canada has cut its overnight target interest rate by 0.25%, from 1% to 0.75%. The bond market delivered a dramatic response within minutes; the Canadian yield curve has steepened, as short term rates have decreased much more than long term rates:
  2. This is the latest from a series of signals that federal government officials believe that the negative effects of the recent months’ drop in oil prices will outweigh its positive effects, at least in the short run.The anticipated benefits to the sharply lower oil prices include a stronger U.S. economy and a lower Canadian dollar (which makes our exports more competitive in global markets), but it will take at least a few months for these effects to be fully realized. However, the negative effects have been immediate, as capital expenses are slashed in the Canadian oil patch. The Canadian market could go up or down from here – a period of economic uncertainty should not derail an investment strategy.
  3. The Canadian stock market has responded well to this announcement,as the S&P/TSX Composite Index has returned +1.8% today, compared to only +0.5% for the S&P500 Index.
  4. Bond returns have been very positive so far in January.For example, the Vanguard Short-Term Bond ETF has returned 1.0%, and the Vanguard Aggregate Bond ETF has returned 2.7% to date.
  5. This rate cut provides very little information about future stock and bond returns. The market’s initial reaction to this news has been positive, but nobody can accurately forecast its direction in the coming weeks or months. Market fluctuations remain unpredictable, as always, and long term investors should not change their strategy based on this news.
  6. Unexpected events like this highlight why savvy investors diversify their portfolios beyond Canada with U.S. and international stocks and bonds.Canadian stocks and bonds will outperform sometimes, and underperform others, but a globally-diversified portfolio brings stability due to the imperfect correlations of global markets. A wise investor will not put all of their eggs in one (asset class) basket.
  7. The financial media gets excited about bad news. Stories sensationalizing how the economy is nose diving sell a lot more quickly than an objective point of view on maintaining a long-term investment portfolio through changing market conditions. It may not be easy, but the more that investors can ignore the media, the better off they will be.