Understanding GIC Rates in an Interest Rate Hike Environment

For all the GIC loving investors out there, this interest rate hike environment is certainly what you have all been patiently waiting for, as crazy as that sounds…you know who you are and what I mean. Over the past decade we have been in a historically low interest rate environment and the average nominal returns on GIC’s have been between 1.40-2.28 per cent. You were hard pressed to ever find a return that paid more than 2.5 percent for a 5-year term. But some of you are noticing one key discrepancy when shopping today’s rates. The yields offered on shorter terms (1 -2 years) are all paying more than 5 percent, but the longer terms (3-5 years) are paying less than 5 percent leaving many of you scratching your heads saying “wait a minute, shouldn’t I be getting paid more, not less, to lock my money up for a longer time period, what’s the catch here!”

The answer to that is, you’re not crazy and normally that would be the case.

The Inverted Yield Curve

Investing your capital for a longer period of time carries more risk and because of that the exchange to you the investor, is you would then typically earn a premium for doing so. Graphically speaking, if you were to plot the yields of 1–5-year GICs, the line would slope gradually up and to the right.

Which makes logical sense.

However, just like all the topics we dissect in our newsletters and in meetings there is more to the explanation and the answer once again starts with, these are not normal times. Right now, if we look at these rates on a graph they slope downward, meaning the lowest yields are paid for longer maturity periods. In the industry this is what’s called an inverted yield curve, which is especially pronounced in the bond market right now.

As of last week, Government of Canada bonds maturing in one year were yielding 4.39 percent. Three-year bonds were yielding 3.56 percent, and five-year bonds just 3.05 percent. (Source: The Globe & Mail December 2022)

Interpreting the Inverted Yield Curve

With the Bank of Canada raising the rates again another half percent, many of you might find yourself thinking “okay I can endure this for the long-term gain…but how long is the short-term pain going to last?” An inverted yield curve is often said to signal an economic slowdown. These are all indicators that the policy is working.

To further strengthen this point, the reason we are seeing higher short-term rates being offered than the expected longer-term rates signal that interest rates will fall as the economy slows and the central bank wrestles inflation to the ground. That’s why you’re getting a lower, not higher, yield if you lock in a GIC for four or five years compared to a one-to-three-year GIC.

Strategic GIC Investing

For those wanting to invest in GIC’s right now to take advantage of the risk-free return you could build a ladder of GICs. For example, you could invest equal amounts of your money in GICs with maturities ranging from one to five years. When the one-year GIC matures, roll the proceeds into a new five-year GIC, and so on. By staggering your maturities, you’ll avoid having all of your GICs coming due at the same time, possibly when interest rates are very low.
 
Having said all that, we have not changed our tune about investing in the market. If you can’t stomach any risk at all, or have a short-term goal like buying a house in the next year or two then parking your cash in a GIC makes a lot of sense. But if you are investing for the long run, you will likely pay dearly – in the form of higher taxes and lost capital growth – for the “safety” that GICs provide. You’ve heard the expression, “no pain, no gain,” right? If you can endure the “pain” the stock market occasionally dishes out, you’ll likely be rewarded with some very nice gains over the long run.