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Understanding Why Interest Rates Change

Malcolm Morrison: Interest rates have been at a historic low since the 2008 financial crisis and that has pulled some bond investors into a bit of a false sense security. John Carswell, the president of Canso Investment Council, says, the problem is that too many investors are forgetting the relationship between inflation and rising interest rates.

Malcolm Morrison: People are asking themselves because rates have been so low for so long and we’ve had false signals from central banks about when rates might start going up again and so people ask themselves, why do rates have to go up? Why can’t they just stay as they are now?

John Carswell: Well ask Zimbabwe, I have one trillion dollars Zimbabwe note on my desk and Zimbabwe doesn’t have their own currency anymore because they printed so much money that you needed a wheelbarrow load of money to buy a loaf of bread or the Germans in the vbar Republic or Argentina. When you have inflation paper money becomes worthless. So the real question is they printed a lot of money in 2009 and 10 everybody from taxi drivers, my dad, anybody I ran across, you know, “I’m buying gold coins because we know there’s going to be inflation and it’s going up.” Remember those days? Well now, people don’t believe interest rates can go up! What we do is say, “Are we paid enough to assume the risk of an investment, whether it’s a corporate
bond or equity or currency?” and I look at it and say, well, you know, the Zimbabweans ended up getting rid of their currency and everybody traded US dollars, and it took trillion…literally a trillion Zimbabwe dollars to buy a loaf of bread and nobody wanted to hold any Zimbabwe dollars. I don’t think we’re running into hyper-inflation, but if we’re going to normal levels of inflation and the Bank of Canada’s targeting two-percent inflation and what have they got for the last period since 1991 when they targeted inflation? You know, now, that’s what? Twenty Four years now? 2 percent! Plus or minus a little bit.

So if you buy a bond at two percent and the Bank of Canada’s pretty well, guarantee you that inflation is gonna be 2%, you get nothing! So that’s a zero real interest rate. So when you look at inflation at 2%, normally T-bills or something like that are 2% above inflation. So T-bills should be 4% and bonds could be 5%. Right now a ten-year bond in this country is somewhere around 1.8%. So if that bond goes up to 4-5% it’s gonna be down 10-20%.


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