The U.S. Federal Reserve raised interest rates this week for the first time since 2023, bringing its target range to 3.75% to 4.00%.
For Canadian investors, that raises a natural question. Are borrowing costs set to rise here as well? The increase came just two weeks after the Bank of Canada held its policy rate at 2.25%.
Fortunately, the Bank of Canada sets Canadian monetary policy independently. Still, both economies are deeply connected, and the Fed’s decision can affect the Canadian dollar, bond yields, stock valuations, and companies with U.S. exposure.
Why the U.S. Federal Reserve’s decision impacts Canada
Let’s start with some boundaries. The Federal Reserve doesn’t set Canadian mortgage rates. But the decisions made by the Fed can influence the wider financial environment where Canadian banks, businesses, and investors operate.
Higher U.S. rates can strengthen the U.S. dollar and weaken the loonie. That can make imported goods more expensive. It can also push bond yields higher, which gives investors more incentive to hold fixed-income investments instead of dividend stocks.
There’s also the trading relationship. The U.S. is Canada’s largest trading partner despite the ongoing trade war. If higher rates slow borrowing and investment in the U.S., some of that weakness could cross the border.
These three Canadian stocks show how differently the effects can appear.
TD feels the impact through its U.S. banking business
Toronto-Dominion Bank (TSX: TD) is one of Canada’s big bank stocks. It also has a large U.S. network that stretches from Maine to Florida. This gives TD direct exposure to lending and deposits in the U.S. market.
In the most recent quarter, TD’s U.S. segment reported net income of $1.07 billion, reflecting a 41% improvement over the prior year.
As a result, TD has one of the most direct connections to the U.S. Federal Reserve’s decision to raise rates.
For a bank, the impact is mixed. On one hand, higher interest rates mean that TD can charge borrowers more and potentially earn more. But that increase can also lead to reduced demand for loans as consumers feel less inclined to borrow at higher rates.
Higher rates create a mixed picture for Fortis
Another, less-obvious area affected by the U.S. Federal Reserve’s decision is utility stocks such as Fortis (TSX: FTS).
Higher bond yields can pressure utility stocks in several ways.
Utilities like Fortis are often purchased for their stable and growing dividends. When bond yields rise, income-seeking investors typically rotate out of utilities and into fixed-income investments.
Additionally, utilities are capital-intensive businesses that are dependent on borrowing to fund improvements. Fortis finances its projects through a mix of cash flow and debt. When rates increase, the cost of borrowing those funds also increases.
That being said, Fortis does have a currency advantage. Nearly two-thirds of the company’s regulated earnings come from its U.S. and Caribbean-based utilities. A stronger U.S. dollar can increase the Canadian dollar value of those earnings.
A stronger U.S. dollar can raise Dollarama’s costs
Another company that’s impacted by the U.S. Federal Reserve interest rate hike is Dollarama (TSX: DOL). And with Dollarama, the currency effect runs in the opposite direction.
Dollarama purchases most of its merchandise in U.S. dollars. An interest rate hike that strengthens the greenback makes those products more expensive when translated back into loonies.
Dollarama can delay or reduce the impact of currency moves by hedging most of its U.S. dollar merchandise purchases. The company can also adjust its pricing, product sizes, and merchandise mix to protect margins. Dollarama last used that flexibility in 2022 when it introduced the $5 price point.
What this means for Canadian investors
The Fed’s rate increase won’t push Canadian interest rates higher automatically. Still, it can affect TD’s banking operations, the value of Fortis’s U.S. earnings, and Dollarama’s merchandise costs.
