The Bank of Canada has another interest rate announcement coming up on April 13th. In their last announcement on March 2nd, they raised interest rates by 0.25%. We expected this.
Will they announce another rate hike this time? It’s impossible to predict.
But why are they raising interest rates and what does it do to your investments?
Let’s dive in…
Why are interest rates rising?
Both the U.S Federal Reserve and the Bank of Canada raising rates to combat inflation.
There are many reasons for inflation, but a significant one is too much money being printed by the central banks. A lot of jobs were lost through the pandemic, so money was printed to help uplift the economy, but this ended up causing the rise in inflation we see today.
Another critical reason interest rates are rising are the supply chain issues that the pandemic caused.
Companies are looking for workarounds for these supply chain issues. For example, Ford was afraid of the semiconductor shortage and made agreements with semiconductor manufacturer GlobalFoundries inc. to develop chips. This semiconductor shortage is why used car prices are skyrocketing.
This is just one example of how supply chain issues have forced prices higher.
What is happening with rates now?
Both the Federal Reserve in the U.S. and the Central Bank of Canada aim to keep inflation at 2%. Well inflation is much higher than 2% these days.
So both countries announced a 0.25% interest rate hike. Many people expect more rate hikes from both countries this year. Fed chair Jerome Powell says that, with the high inflation rates, the committee anticipates raising interest rates some more “will be appropriate”.
The general assumption is that rising interest rates are bad for the stock market. David Stubbs, a high-level executive at J.P. Morgan Private Bank said, “What the market doesn’t like is rapid changes in the monetary landscape.”
There are generally two perspectives to look at when looking at the impact of interest rates on the market. One, higher interest rates generally mean higher borrowing costs for individuals and companies that need to borrow money to fund their expenditures/operations.
The second perspective zooms in on companies in specific sectors and how the sectors are affected by the rising interest rates.
How interest rates impact the housing market
Mortgage rates go up, specifically on variable-rate mortgages. Although fixed rate mortgages will increase as well if the federal interest rates stays higher over time.
Generally, this would cause the housing markets to dip or stall a little bit because of the higher borrowing costs. However, the Canadian housing market may not follow this time.
It depends how much people anticipate further rate hikes, rushing to buy now and lock in mortgages before rates become even worse.
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How interest rates impact growth companies
Growth companies generally have a large amount of debt and no positive cash flow to fund their “future growth”. When interest on their debt increases, it can cause problems.
So when interest rates go up, stock prices for growth companies can dip.
Although, if a growth company is cash heavy and can afford their debt, their stock can recover, even if their entire sector sees declines.
An example of a growth company that heavily relies on debt is marijuana company, Canopy Growth Corp ($WEED). They can be more sensitive to rate hikes. An example of a growth company with lots of free cash flow is digital payments company, Block Inc ($SQ). They may not shake as much in response to rate hikes.
The good thing about rising rates
The main advantage of rising interest rates is the opportunity it yields.
As a long-term investor, if a company dips significantly due to rising interest rates, but has positive cash flow and not a lot of debt (or they can easily cover their debt), they will likely trend back up in the long run.
This is mostly true in the technology sector because a lot of growth companies rely on debt for their growth, so the entire sector can potentially dip. However, companies with positive cash flow can be really attractive at these times.
What do I do with this information
First, don’t panic when you see headlines about rising interest rates.
Second, look for opportunities. Find companies with strong fundamentals, but their stock price is dipping anyway, mostly because of fear. These companies have a better chance at a quick recovery.
Third, stay educated. Knowledge is profit in the stock market.
Fourth, find a community of investors that you can rub shoulders with. You can learn from each others’ mistakes.
That’s all for now.
Happy trading,
Your fellow Stock Hackers,
🍒Cherry & Erwin
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