Canadian Interest Rates

The Bank of Canada has a neutral interest rate policy although they are on record that they would consider a further decrease in rates to support the weak Canadian economy. This, combined with the Fed raising interest rates has resulted in a weakening of the Canadian dollar. As the Bank of Canada rate is 0.5%, there is not a lot of room to cut interest rates before Canada is in a sub-zero rate environment. Absent another exogenous shock to the economy, we currently do not envision the Bank of Canada raising rates over the next six months. We are more likely to hear the Bank of Canada discuss lower for longer, even in the face of the US raising rates.

As we are not forecasting a rise in Canadian interest rates, bond returns in 2016 will be similar to 2015 in the low single digit range. Upside could come from further easing by the Bank of Canada and downside would result from Canadian rates moving in tandem with rising US rates. Studies have shown that there is an 85% correlation between American and Canadian interst rates. Notwithstanding, it is unlikely that we will see the typically tight correlation between US and Canadian rates over the next year as we project differing growth characteristics of the two countries.