After a brief pause from April to July 2025, the easing resumed in September and October 2025, ultimately lowering the policy rate to 2.25%. Since then, the Bank has remained stable, with breaks in December 2025 and again in early 2026.
But when you zoom out, the broader trend is unmistakable. Rates have fallen significantly below their peak. If you’re a homeowner with an adjustable-rate mortgage, you probably feel like relief. Lower financing costs mean smaller interest payments.
However, if you are an investor, you may be wondering how to reposition your portfolio. My answer is simple. Don’t. The interest rate goes up. Interest rates are going down. Economies are expanding. Economies are shrinking. Inflation rises and falls.
When you build a diversified long-term portfolio, these cycles are part of the process. Trying to tactically trade every policy change often causes more harm than benefit.
That said, falling interest rates do have consequences for more active investors. In particular, they impact fixed-income exchange-traded funds (ETFs) in different ways, depending on what those ETFs actually hold. Here’s what I think about it.
Potential winners of a rate cut cycle
One ETF that could gain tailwinds during a rate-cutting cycle is the BMO Long Federal Bond Index ETF (TSX:ZFL).
This fund tracks an index of Canadian government bonds with a term of 10 years or longer. While that sounds simple, the most important number to focus on is duration. ZFL currently has a weighted average maturity of approximately 16.9 years.
Duration measures how sensitive a bond portfolio is to changes in interest rates. The longer the term, the more the price will move when the rate changes.
When interest rates rise, newly issued bonds with higher coupons come onto the market. Older bonds issued at lower interest rates become less attractive in comparison. To compete, their prices must fall so that their yield, that is, the coupon divided by the market price of the bond, adjusts upwards to prevailing interest rates.
When interest rates fall, older bonds with higher coupons become more valuable. Investors are bidding up because their fixed payments now look attractive compared to newly issued bonds at lower interest rates. The longer the term, the clearer this price movement can be.
You can see this clearly in the history of ZFL. In 2022, when interest rates rose rapidly in response to post-pandemic inflation, the ZFL fell 24.1% in one calendar year. But if the Bank of Canada continues to cut spending to support a slowing economy, the opposite dynamic could emerge.
Potential losers from a rate cut cycle
On the other hand, some ETFs become less attractive as interest rates fall. A good example is the BMO Money Market Fund (TSX:ZMMK).
ZMMK holds high quality, very short term fixed income instruments. These include Treasury bills, bankers’ acceptances, and commercial paper, all with maturities of less than 365 days and average maturities of less than 90 days.
This structure makes ZMMK a popular option to park cash and earn some returns at the same time, without tying up money in a guaranteed investment certificate (GIC). It is not insured like a GIC, but its price tends to be very stable compared to traditional bond ETFs.
The trade-off is that returns closely follow the prevailing short-term interest rate environment. Money market ETFs typically provide returns around the Bank of Canada’s policy rate, sometimes slightly higher due to exposure to high-quality corporate paper.
When the policy interest rate was above 4%, ZMMK’s return was also more than 4%. Today it posts an annualized distribution return of about 2.4%. If interest rate cuts continue, interest rates will likely fall further.
As a result, some investors looking for income from money market ETFs may turn to higher-yielding assets, such as dividend stocks or real estate investment trusts.
#falling #interest #rates #Canadian #investors