What the Bank of Canada’s Supersized Rate Cut Could Mean for Investments

The Bank of Canada’s (BoC) 50-basis-point interest rate cut on October 25 was certainly big news, but in some ways, it overshadows the larger shift in rates this year. For the first time since November 2022¹, the BoC’s overnight rate is sitting at 3.75 per cent, down from 5 per cent in May.

With some economists, including some from RBC, forecasting another 50-basis-point cut² in December, and further reductions in 2025, here are some things to consider.

Fixed-income yields falling

As rates climbed over the last two years, so did bond yields, giving investors an opportunity to generate more yield in fixed income than they have in more than a decade. That’s starting to change. “For new money going into bonds, you’re investing at lower yields,” says Josh Nye, a fixed-income strategist at RBC Wealth Management.

Still, as Nye points out, yields are higher today than they were for most of the last 15 years when the BoC’s overnight rate hovered between 0.25 per cent and 1.75 per cent. “This is a relatively high yield compared to what most Canadians had become accustomed to, so bonds remain attractive in that sense,” he says.

While fixed income may not offer the same yield and return potential as it did at the start of this year, it can potentially provide some income and capital appreciation, plus diversification. (Of course, like with any investments, there’s no guarantee of gains – some fixed income products can go to zero, too.)

Equities experience gains

Unless the BoC is cutting rates because the economy is crashing, which Nye says isn’t the case today, lower interest rates historically tend to lead to higher equity returns. When bond rates fall, investors tend to look to the equity markets for investment income and growth.

At the same time, lower rates often mean that businesses can borrow money at a lower cost, making it easier to fund expansion. Consumers may also start feeling better about spending, which helps improve company earnings and, ultimately, share prices. “Rate relief is seen as a positive thing for companies and potentially for consumers going forward, and that could be supportive of the equity market,” says Nye.

Historically, sectors that include a lot of dividend-paying companies, such as utilities or Real Estate Investment Trusts (REITs), do well as rates decline. As of October 31, over the past six months, the S&P/TSX Capped Utilities Index, for example, has climbed by 14.63 per cent, compared to 12.79 per cent for the broader S&P/TSX Composite Index. The S&P/TSX Capped REIT Index has returned 11.72 per cent over the same period, according to S&P Capital IQ³.  

One thing to consider is that when demand for equities climb, company valuations can start to increase, potentially making  more expensive to buy. Higher valuations could make it more difficult for returns to climb higher, too. According to S&P Capital IQ, as of October 31, the Canadian index’s forward price-to-earnings ratio (a popular metric that measures how expensive a stock or index might be; the higher the number the more expensive it is) was at 15.63⁴, up from 12.46 a year earlier. “The equity market has become a bit pricier,” says Nye.

With some economists predicting⁵ more rate cuts, investors may want to pay close attention to how the different assets in their portfolios are performing – whether that be price or income return. It’s also important to do your research, and keep track of the outlook for the economy and individual companies and sectors, which can vary according to news and events.

¹_{Source: Bank of Canada, “Canadian interest rates and monetary policy variables: 10-year lookup”}

² Source: RBC Thought Leadership, “Don’t stop me now – rate cuts to multiply from the BoC, ECB and the BoE”, October 2024

³ Data taken from S&P Capital IQ on October 31

⁴ Data taken from S&P Capital IQ on October 31

⁵ Source: RBC Thought Leadership, “Don’t stop me now – rate cuts to multiply from the BoC, ECB and the BoE”, October 2024