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How will rising U.S. rates impact your clients?

A Fed Funds rate hike is coming and it could impact Canadian portfolios.


Date: October 29,2015

Numerous United States Federal Reserve meetings have come and gone without an interest rate hike, but most financial experts say that an increase is coming, and it could happen as soon as December.

While Canada’s overnight rate will likely stay low for longer than in the U.S., when it comes to economics, what happens down south tends to have a big impact here.

According to Jurrien Timmer, director of global macro at Fidelity Investments, advisors do need to be mindful of rising U.S. rates, but the uptick isn’t going to derail global markets like some expect.

“It’s not going to take us into a bear market,” he says. “It’s not a game-changer.”

Watch America and emerging markets

Naturally, the biggest impact of a Fed Funds rate hike will be felt in America, and in particular with U.S. stocks. For the last few years, equities have done well because rates have been so low, says Mr. Timmer. It’s unlikely markets will climb as quickly in a higher-rate environment.

“The ride that comes with growth without inflation and with a good underpinning of central-bank liquidity is over,” says Mr. Timmer. But, he adds, there’s no reason to panic. Earnings growth should stay positive, and that will continue to keep markets in the black.

Things get more complicated outside of the United States. A higher interest rate generally leads to a stronger U.S. dollar, and that can have a negative impact on emerging markets like China.

In China, the renminbi is loosely pegged to the U.S. dollar, so when the greenback rises, so does the Red Giant’s currency, and that makes its export market less competitive compared to other nations.

China did try to devalue its currency over the last couple of months in anticipation of these effects, says Mr. Timmer, and “that created a wave of deflation that really started to affect our market as well.”

Pay attention to asset allocation

What does all this mean for Canadian investors? In some ways, a rate hike could result in more global opportunities, says Mr. Timmer.

“The world is their oyster in a way,” he explains. “They can go [invest] outside of Canada and not be penalized for it through negative currency translation.”

At the same time, advisors will need to pay attention to how markets react and adjust their clients’ asset allocation accordingly.

“If a rate rise in the U.S. is a negative for emerging markets, that may tell you that emerging markets and commodities are not yet the place to go,” says Mr. Timmer. “But I wouldn’t think that there are implications for investing in equities or bonds [in general].”

Of course, some sectors are interest-rate sensitive, like real estate investment trusts and utilities. And while a hike may be priced into some of these stocks, there could be further losses ahead.

“As rate jitters have come up, those sectors have taken the brunt of the selling,” says Mr. Timmer.

Consider non-correlated assets

Advisors who want to do more to ensure that clients’ portfolios continue to perform in the face of a rate hike can get creative with alternative asset classes, says Scott Plaskett, senior financial planner and CEO of Ironshield Financial Planning.

Generally, a balanced portfolio will have a significant portion of its assets in fixed-income securities, he says, which could fall in value as yields rise.

He suggests taking a closer look at asset classes that can provide a portfolio with a higher yield, but at a similar level of risk as bonds. This includes infrastructure stocks, which tend to be less correlated to the average stock, or funds or equities that invest in commercial real estate.

“If there’s a stock market crash or a bond market correction from interest rates rising, these asset classes [may] not be affected [as] much.”

As long as advisors stay on top of what’s happening in global markets, it shouldn’t be too difficult to prepare clients for the coming rate hike. Ultimately, a rate increase suggests that the U.S. economy is growing and, with our economy so intertwined with America’s, that’s good news for Canada, says Mr. Timmer.

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