When you take a look at the Financial institution of Canada’s coverage fee over the previous couple of years, the route has been clear. The primary 25 foundation level, or 0.25%, minimize got here on September 4, 2024, bringing the speed right down to 4.25%. That was adopted by a collection of further 0.50% and 0.25% cuts.
After a short pause from April to July 2025, easing resumed once more in September and October 2025, ultimately pushing the coverage fee right 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. When you’re a house owner with a variable-rate mortgage, that doubtless appears like reduction. Decrease borrowing prices imply smaller curiosity funds.
When 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 broaden. Economies contract. Inflation rises and falls.
When 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 stated, for extra energetic buyers, falling charges do have implications. Specifically, they have an effect on mounted earnings exchange-traded funds (ETFs) in several methods relying on what these ETFs truly 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 give attention to is length. ZFL at the moment has a weighted common length of about 16.9 years.
Period measures how delicate a bond portfolio is to modifications 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 greater coupons. Older bonds that have been issued at decrease charges turn into much less engaging by comparability. As a way to compete, their costs should fall in order that their yield, which is the coupon divided by the bond’s market value, adjusts upward to match prevailing charges.
When rates of interest fall, older bonds with greater coupons turn into extra precious. Buyers bid up their costs as a result of their mounted funds now look engaging relative to newly issued bonds at decrease charges. The longer the length, the extra pronounced this value motion tends to be.
You possibly can 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 slicing to assist a slowing economic system, the other dynamic may play out.
Potential losers from a rate-cutting cycle
On the flip aspect, some ETFs turn into much less engaging as charges fall. A very good instance is the BMO Cash Market Fund (TSX:ZMMK).
ZMMK holds very short-term, high-quality mounted earnings devices. These embody treasury payments, bankers’ acceptances, and business paper, all with maturities beneath three hundred and sixty five days and a median maturity of lower than 90 days.
This construction makes ZMMK a preferred 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 value tends to be very secure 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 usually yield across the Financial institution of Canada’s coverage fee, typically barely greater as a consequence of publicity to high-quality company paper.
When the coverage fee 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 fee cuts proceed, that yield will doubtless fall additional.
Because of this, some buyers might rotate out of cash market ETFs and into higher-yielding property resembling dividend shares or actual property funding trusts looking for earnings.