As I review client portfolios past performance over the last several years, I think we are at a point whereby an overview of the relationships between inflation, interest rates, bonds and GICs are due. Much of the analysis will be based upon the following article, “UPDATED: A timeline of Bank of Canada rate hikes.” Beginning in March 2022 until roughly March 6, 2024, the history of interest rate increases are shown as a dark bluish green line (in the chart below) for each time the Bank of Canada raised the overnight rate. The overnight rate is the interest rate the central bank sets to target monetary policy. Your personal borrowing rate will be at a slightly higher level depending upon your credit worthiness.
Now let’s step back to 2020 and discuss what happened during the start of the pandemic in Canada that I believe was the key driver of the rate hikes. “Governments around the world have spent billions this year (2020) on their response to the COVID-19 crisis — billions that, before the pandemic, many politicians said countries didn’t have or couldn’t afford.” So what happened? Inflation which we can see as the red line, on the chart, 
to the right which starts to increase in early 2000. The Bank of Canada has a target inflation rate of 2% with an upper band of 3% and a lower band of 1%. In this case, when the upper band was broken, the Bank of Canada began to act. Their primary tool is to raise interest rates, to cool the economy while trying to not overdo it so much that they cause a recession. So interest rates began rising in March 2022. Seven (7) rate hikes later Canada went from 0.25% to 4.25% in only 9 months. That is huge!!!
What’s the Investment Effect?
Bond returns are inversely proportional to interest rates, therefore there were losses in the bond portion of the portfolio in 2022. Now new GICs which have fixed maturities start benefiting from the higher rate and increase in the yield. Will this continue? Now that inflation has begun to ease, there is a possibility that rates may begin to ease by mid year 2024. Note that inflation has backed off to 2.9%, slightly below the Bank of Canada’s upper 3% target. Not quite enough for them to back off on rates yet!
So what about the Canadian Equity Market in 2022?
The S&P/TSX Composite Index posted a negative return of 8.5 per cent year-to-date to investors in 2022. See TSX in 2022: A look back at how it performed. What happened? “When the world was forced to deal with inflationary pressures, interest rates hiked dramatically and that meant a lot of volatility for the markets at large,”. A lot of volatility can be interpreted as markets going down, which they did.
Bottom Line: So for 2022, both bonds and equities experienced a negative return an thus so did Canadian’s portfolios. In fact, in many cases, the GICs became the star of the show for short term investments with mid single digit returns. Is this the new norm? In the short term yes but in the longer term it is doubtful. If/when the Bank of Canada begins to cut rates, the shine will start coming off the GICs as renewals will be at lower rates causing investors to consider alternatives. Similarity, bond yields will improve as again they are inverse the interest rates. So I hope this more clearly demonstrates why 1 year returns for 2023 are positive, whereas the 3 year returns are unusually low since they are dragged down by the year 2022 return numbers. Similarly, five year returns will be somewhat muted as the 2022 data makes its way through that timeframe.
