With another meeting being held by the U.S. federal reserve, markets are once again bracing themselves for higher interest rates south of the border, which many are hoping will act to balance the economy in the long run. Canadian investors, just like their U.S. counterparts, are looking for ways to turn a profit from this move upwards.
The reason that higher rates act as a brake pedal to economic growth is because the higher costs to borrow money results in a larger burden by the borrower to service the debt over time. Companies need more profitable projects that meet higher hurdle rates to justify borrowing money. Many spenders may re-consider their habits as they are able to receive a higher amount of interest income for every dollar saved, which may lead to more people saving money instead of spending it.
With higher rates seeming like a sure thing for the United States, Canadian investors seeking a lower-risk approach to benefiting from this hike may want to position themselves in companies such as Toronto-Dominion Bank (TSX: TD)(NYSE: TD), which, as the second-largest Canadian bank, has more branches south of the border than in the snowy, white north.
As rates increase, the Toronto-based bank should be able to increase the rates on variable rate loans and lines of credit to customers, leading to higher revenues for the bank, while consumers pay a higher cost to borrow money and, of course, take longer to pay it off. With the potential to receive higher interest payments in U.S. dollars, investors buying shares of this financial juggernaut in Canadian dollars may also reap the rewards from a lower Canadian dollar.
For those seeking direct exposure, American International Group Inc. (NYSE: AIG) is one of the biggest insurance companies with a market capitalization of US$53 billion. It is in prime position to benefit from higher interest rates. Over the past year, the company has undertaken a massive share-buyback initiative, shrinking the size of the company’s footprint by close to 9.7%, as the excess capital available to management was used to reduce the number of shares outstanding.
Had a massive share buyback not been undertaken, the company would have even more capital at its disposal to deploy in other income-generating endeavours. Essentially, every insurance company is responsible for investing the premiums they receive in a way that makes the cash flows available on short notice. The money is most often invested in fixed-rate investments, which offer a relatively low rate of return. With higher interest rates on the horizon, American International Group stands to reap a significant amount of upside, as its large capital base will bring in significantly higher amounts of interest income.
