Here's Why Your Prime-Linked Deposit Rates are Falling Today

This morning, the Bank of Canada (BoC) announced a 50 basis point cut to the overnight rate target, the benchmark rate that all Canadian fixed-income is measured against. This leaves the overnight target rate at 1.25%, down from its previous level of 1.75%. The cut was a widely expected move, and probabilities of a cut exceeded 100% in the days before the announcement, but the scale of the cut was something of a surprise. A 50 basis point cut, the Bank's first since 2009, is a dramatic change from the usually very conservative Bank of Canada.

Read the Bank of Canada's rate announcement here.

Read our previous article about the Bank of Canada here.

Historical BoC Overnight Rate

Source: Bloomberg, March 4th

COVID-19 a "material negative shock"

Reading the Bank of Canada's announcement is a great reminder that 2020 has not been a stellar year for the Canadian economy. The headline news is COVID-19, the reason "business activity in some regions has fallen sharply and supply chains have been disrupted." It's also the reason that "financial conditions" have become "less accommodative," which is a beautiful Bank of Canada euphemism for the turmoil global markets have experienced in the last week and a half.

The other news has not been helpful, either. It's easy to forget that two weeks ago, Canada's rail system was blockaded and Ontario teachers went on strike. All this adds up to stagnant economic performance, and the Bank expects the first quarter of 2020 to be weaker than expected. 

Door Open for Further Cuts

Perhaps the most informative and useful information comes at the end of the Bank's announcement. To quote the second-to-last paragraph: the "Governing Council stands ready to adjust monetary policy further if required to support economic growth and keep inflation on target."

This clearly opens the door for further cuts, should growth and economic activity continue to disappoint. The market is currently pricing in further cuts, as market-based probabilities show.

Bank of Canada Probabilities

We derive the probabilities that the Bank of Canada will cut rates from the market for Overnight Index Swaps. A value over 100% means that the market is pricing in more than one 25 basis point cut by that meeting. Below are the probabilities that rates will be cut from their current level by the Bank's next four meetings:

Meeting Date

Source: Bloomberg, March 4th

Obviously, the market is not hostile to the idea of further rate cuts from the Bank of Canada. Even before COVID-19 added a whole new dimension of risk to be considered, there were some who felt quite strongly that a Bank of Canada rate cut would be appropriate. Should economic performance continue to underwhelm, we should expect further cuts.

Cash Management in Falling-Rate Environment

In a falling-rate environment, the priority shifts from yield maximization to yield preservation. Locking in an expected higher yielding rate for a longer period of time becomes an attractive option, as we expect tomorrow's rates to be lower than today's. 

After today's announcement of cuts, we anticipate those with deposits in prime-linked accounts will receive notice that their interest rates are falling. Those with fixed-rate GICs will continue to earn the same rate of return until their deposits reach maturity. Since the rates offered for GICs often take a little longer to react to changes in the rate environment than other investments, we're recommending that our clients immediately invest in terms of 1 to 2 years. If liquidity is a concern, we recommend cashable GICs, which allow liquidity after a period of 30 or 90 days. By investing frequently and coordinating maturities in a "laddered" portfolio, investors can receive regular liquidity and competitive rates.

Contact us for our latest deposit rates or a complimentary review of your portfolio. 

Disclaimer: Canaccord Genuity Corp. is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and Canadian Investor Protection Fund (CIPF). The comments and opinions expressed in this commentary are solely the work of the Cash Management Group and Andrew Johns.