Should you take a look at the Financial institution of Canada’s coverage charge over the previous couple of years, the route has been clear. The primary 25 foundation level, or 0.25%, reduce got here on September 4, 2024, bringing the speed all the way down to 4.25%. That was adopted by a collection of further 0.50% and 0.25% cuts.
After a quick pause from April to July 2025, easing resumed once more in September and October 2025, ultimately pushing the coverage charge all the way down to 2.25%. Since then, the Financial institution has held regular, together with pauses in December 2025 and once more in early 2026.
However zoom out, and the broader development is unmistakable. Charges have moved materially decrease from their peak. Should you’re a house owner with a variable-rate mortgage, that probably seems like aid. Decrease borrowing prices imply smaller curiosity funds.
Should you’re an investor, although, you may be questioning how you can reposition your portfolio. My reply is easy. Don’t. Rates of interest go up. Rates of interest go down. Economies develop. Economies contract. Inflation rises and falls.
Should you’re constructing a diversified, long-term portfolio, these cycles are a part of the method. Making an attempt to tactically commerce each coverage shift usually creates extra hurt than profit.
That mentioned, for extra energetic buyers, falling charges do have implications. Particularly, they have an effect on fastened revenue exchange-traded funds (ETFs) in several methods relying on what these ETFs really maintain. Right here’s how I give it some thought.
Potential winners from a rate-cutting cycle
One ETF that will see tailwinds throughout a rate-cutting cycle is the BMO Lengthy Federal Bond Index ETF (TSX:ZFL).
This fund tracks an index of Authorities of Canada bonds with maturities of 10 years or longer. Whereas that sounds easy, the important thing quantity to deal with is length. ZFL presently has a weighted common length of about 16.9 years.
Length measures how delicate a bond portfolio is to adjustments in rates of interest. The upper the length, the extra the value will transfer when charges change.
When rates of interest rise, newly issued bonds come to market with larger coupons. Older bonds that have been issued at decrease charges grow to be much less engaging by comparability. With a view to compete, their costs should fall in order that their yield, which is the coupon divided by the bond’s market worth, adjusts upward to match prevailing charges.
When rates of interest fall, older bonds with larger coupons grow to be extra precious. Traders bid up their costs as a result of their fastened funds now look engaging relative to newly issued bonds at decrease charges. The longer the length, the extra pronounced this worth motion tends to be.
You’ll be able to see this clearly in ZFL’s historical past. In 2022, when charges rose quickly in response to post-pandemic inflation, ZFL fell 24.1% in a single calendar 12 months. But when the Financial institution of Canada continues chopping to assist a slowing economic system, the other dynamic might play out.
Potential losers from a rate-cutting cycle
On the flip facet, some ETFs grow to be much less engaging as charges fall. A superb instance is the BMO Cash Market Fund (TSX:ZMMK).
ZMMK holds very short-term, high-quality fastened revenue devices. These embody treasury payments, bankers’ acceptances, and industrial paper, all with maturities below twelve months and a mean maturity of lower than 90 days.
This construction makes ZMMK a well-liked choice for parking money whereas incomes some yield, with out locking funds right into a assured funding certificates (GIC). It isn’t insured like a GIC, however its worth tends to be very steady in comparison with conventional bond ETFs.
The trade-off is that its yield carefully tracks the prevailing short-term rate of interest setting. Cash market ETFs sometimes yield across the Financial institution of Canada’s coverage charge, generally barely larger on account of publicity to high-quality company paper.
When the coverage charge was above 4%, ZMMK’s yield was over 4% as nicely. In the present day, it’s posting an annualized distribution yield of about 2.4%. If charge cuts proceed, that yield will probably fall additional.
Because of this, some buyers could rotate out of cash market ETFs and into higher-yielding belongings corresponding to dividend shares or actual property funding trusts in the hunt for revenue.
