As businesses consider the impact of slowly rising interest rates, they have another factor to consider: the global forces that could further affect those rates.
That kind of volatility was on full display during the G7 Summit in La Malbaie, Que., this month. It ended with a series of tweets by U.S. President Donald Trump that put Canada and Prime Minister Justin Trudeau in the crosshairs – and quite likely, the entire global trade system, too.
The “external variables” that central banks use to establish key lending rates are extremely unpredictable, says Farrokh Zandi, director of International Business Designation at York University’s Schulich School of Business in Toronto.
“We don’t know when this is going to settle down,” Mr. Zandi says. Disagreements on trade policy “can create havoc for the short term, maybe the long-term.”
Ideally, the Bank of Canada and other central banks should try to avert their eyes from the volatility imposed by world leaders bickering and accusing each other of bullying and backstabbing, Mr. Zandi adds.
“They should be looking to the medium horizon, of, say, three years, when they set their policy tools to meet objectives. They ought not to be swayed by the sort of political rhetoric we’re observing these days.”
When the Bank of Canada maintained its key overnight lending rate at 1.25 per cent in its last interest-rate announcement on May 30, it cited continuing uncertainty about trade policies dampening global business investment as one of its reasons. The bank’s next announcement is scheduled for July 11.
Abroad, interest rates are slowly rising. The U.S. Federal Reserve has raised rates seven times since late 2015 and the Bank of England once, though the European central bank sees no hikes until after the summer of 2019. The Bank for International Settlements urged the world’s top central banks to keep lifting rates on Sunday but warned about the effect that escalating trade tensions between the United States and China could have on the global economy.
Interest rates have been relatively low since the 2008 financial crisis. Low rates give Canadian businesses favourable credit conditions, but with lower return on their investments, according to the Business Development Bank of Canada, a federal crown corporation.
Despite trade tensions, the global economy is robust enough to give banks a lot of wiggle room on rates, says Neville Joanes, chief investment officer at WealthBar, a robo-advisor based in British Columbia.
“We are in the midst of a prolonged equity bull run. Inflation is increasing,” he explains.
“The United States is on pace for increasing rates. However, we are seeing more resistance to that from other central banks. Unfortunately, politics seems to have exaggerated influence on capital markets these days. That’s why companies looking to expand globally are cautious.”
Companies have had a decade of opportunity to take advantage of low rates to lock in long-term borrowing, says Sean Cleary, professor of finance at the Smith School of Business at Queen’s University in Kingston, Ont.
“Now short-term rates seem to be coming up, but how far and how fast is something people are struggling with.”
Before June’s G7 dustup, the Bank of Canada had signalled strongly that it was likely to raise rates in July. “But that might be it for the year. A lot of what goes into the decision has to do with trade policy,” Mr. Cleary says.
Trade policy has become so volatile that it is difficult to determine what direction monetary policy will go. For example, if the U.S. escalates into a full-scale tariff war with Canada and other trade partners, the U.S. dollar will soar and the loonie will drop, putting pressure on the Bank of Canada to contemplate lowering rates.
“In the larger scheme of things, there is still room for central banks to reduce rates to prop up the economy, if the need should arise,” Mr. Joanes says.
With so much political uncertainty, companies can be expected to be cautious about expanding into new cross-border or global markets. With an ever-expanding list of tariff threats and the prospects of a successful NAFTA renegotiation looking dim, many companies will hold back, says Robert Mark, investment strategist with Raymond James Ltd. in Toronto.
“This is what typically happens when there is disinflation,” Mr. Mark says. But there are also targeted opportunities for global expansion, he adds.
He cites a couple of companies as examples.
“One theme I have been preaching personally is to look at ‘non-Canadian’ Canadian companies that are investing in the U.S. and globally,” Mr. Mark says. These firms are based in Canada but already do substantial business abroad, with their goods and services not affected either way by trade deals or tariff threats.
“Waste Connections Inc. is a good example,” he says. The Vaughan, Ont., company does 85 per cent of its business in the United States
Another company that can be indifferent to NAFTA is bus manufacturer New Flyer Industries Inc.
“Most of their sales are in the U.S. and supported by manufacturing that takes place there. Trump could rip up NAFTA tomorrow and they’d be fine.”