PERSPECTIVES

APRIL 2016

Negative interest rates in Canada?

There is a quick rule for calculating roughly how long it takes to double money, called the “Rule of 72”. Dividing that number by your expected rate of return will give you a rough idea of how long it will take for your money to double. If the equity market is expected to provide 8%, its historical average, then every nine years your money should double – if you earn the average every year. As the rate of expected return is tied to risk, investment counsellors may find this Rule instructive when constructing the asset mix for clients. The Rule even works for a zero return as money invested without a return will obviously never double. But who would invest for zero return?

“The is now confident that Canadian financial markets could also function in a negative interest rate environment,” said Bank of Canada Governor Stephen Poloz in December of 2015. How many years would it take to double an investment at negative rates? What is the case for investing in bonds if rates go negative? Who would buy a bond with a negative return?

First, we should clarify the position. Bonds could trade to negative yields in Canada, but there are no guarantees of this drastic policy action coming from the Bank of Canada. The current overnight rate is 50 basis points, which is historically quite low, but the Central Bank still has room to move before rates go negative – and to be sure other, less blunt implements are likely to come into play before rates move below zero. The Bank, as evidenced by Mr. Poloz’s comments above, is likely to do a great deal of talking about negative rates before imposing them as “going negative” has some pretty extreme attachments to it.

Canadians are used to being charged a fee for their banking, but a negative rate environment could mean that a deposit of $10,000 falls to $9,950 in a year. Over and above a fee for maintaining a bank account, money will effectively disappear from the account each month. The intent of negative rates is to push deposits into the sys- tem, either through consumer spending or through investment. This experiment has been run in Europe, and the answer is that it works – sort of. Savers are prepared to accept some level of negative yields to maintain liquidity, which on its face seems odd, but it can also be understandable behaviour.

Which brings us to buying bonds with negative yields, and who would do that? Lots of people. Insurers looking to match liabilities, funds who have to own Government debt, those who believe that a small negative yield is worth the guarantee for repayment of principal, and those who are avoiding all risks other than trivial losses. Negative yield bonds are unlikely to be seen in Canada, and corporate bonds will continue to offer spreads which will create positive returns. The trend for real returns on fixed income has been around 2% in the past, this trend may be tested by negative rates – if we see them in the future. Negative rates could feel deflationary, they would test both conventional math and patience. We have seen negative rates in Europe, and European investment continues. The markets, and , remain open. The great continental experiment with negative rates should give everyone a sense of relief, the markets continue on.

Fixed income has always involved being patient, prudent investment involves thinking the long game. No matter where rates go tomorrow, there is no need to fear them.

This document includes information and commentary concerning financial markets that was developed at a particular point in time. This information and commentary are subject to change at any time, without notice, and without update. This commentary may also include forward looking statements concerning anticipated results, circumstances, and expectations regarding future events. Forward-looking statements require assumptions to be made and are, therefore, subject to inherent risks and uncertainties. There is significant risk that predictions and other forward looking statements will not prove to be accurate. Investing involves risk. Equity markets are volatile and will increase and decrease in response to economic, political, regulatory and other devel- opments. The risks and potential rewards are usually greater for small companies and companies located in emerging markets. Bond markets and fixed-income securities are sensitive to interest rate movements. Inflation, credit and default risks are also associated with fixed income securities. Diversification may not protect against market risk and loss of principal may result. This commentary is provided for educational purposes only. It is not offered as investment advice and does not account for individual investment objectives, risk tolerance, financial situation or the timing of any transaction in any specific or asset class. Certain information contained in this document has been obtained from external parties which we believe to be reliable, however we cannot guarantee its accuracy. Guardian Capital Advisors LP provides private client investment services and is an indirect, wholly-owned subsidiary of Guardian Capital Group Limited, a publicly traded firm listed on the Stock Exchange.