July 2024: Rate Easing Cycle Kicks off in Canada, with U.S. to Follow Soon
Quarterly Asset Allocation
As we settle into summer, we are relieved to have started into an interest rate easing cycle, at least in Canada, as the Bank of Canada (BoC) finally has enough confidence that inflation is on a sustainable path back to its 2% target level. Overall, we anticipate another three rate cuts in the four remaining meetings before the end of the year, allowing us to end the year with a 4.00% policy rate. (Note that our Canadian Fixed Income committee member more conservatively leans towards only two rate cuts by the end of 2024.) While this will take a little pressure off consumers and businesses, it will still leave many upcoming mortgage renewals to face higher rates than when they last renewed, and still result in pressure on a still fragile economy. We expect policy rate cuts to continue into 2025, reaching 3.00% around mid-year.
We have a lot of confidence that the Federal Reserve (Fed) in the U.S. will similarly join the rate cutting party before the end of the year, but opinions vary as to whether the Fed will start easing in September, or wait until as late as December. Our U.S. Economics team is forecasting the first U.S. rate cut in November, two days after the election, with another in December, to end the year with a Fed funds rate of 5.00%. The easing should keep U.S. GDP near trend at 2.1% in 2024 and 2.0% in 2025, but the differential in policy rates between the two countries is likely to put some downward pressure on the Canadian dollar against the U.S. dollar, and for the most part, we wouldn’t be surprised to see the Canadian dollar depreciate slightly from the US$0.73 level currently to a US$0.71-0.72 range, with the risk of getting closer to US$0.70 if the Fed delays rate cuts to the end of the year, or even pushes into 2025 while the BoC continues easing.
The easing of rates was a relief, especially as we continue to see signs that the Canadian economy is weak, and perhaps weakening further. Despite a slight uptick in inflation in May, we expect the overall trend on inflation to be down and for the BoC to continue easing, providing some relief to the soft economy. We are not expecting any kind of (significant) recession, but we are seeing signs from consumer confidence, business intentions, declining productivity, and a growing unemployment rate, that keep us cautious, yet optimistic that continuing rate cuts will keep economic growth just mildly positive. By contrast, the U.S. economy, which has been remarkably resilient, continues to achieve good growth, although we similarly see softening as the higher interest rate environment has been more gradually adding pressure to the U.S. consumer. Still, we are looking for a soft landing in the U.S., with modestly stronger growth than in Canada.
Key Takeaways:
- U.S. Economy: Economic activity in the U.S. has remained relatively strong since the recovery from the pandemic recession, even as the Federal Reserve has kept its foot on the brake. However, we are starting to see some signs of weakness as the “long and variable lags” of monetary policy continue to put downward pressure on both consumption and investment. The variations in employment measures also show a cooling labour market. Inflation, as measured by the PCE Price Index, is very close to target as we begin the second half of 2024. Given these warning signs pointing to slower economic growth, our U.S. economists think the Fed should move ahead sooner rather than later with several rate cuts to accommodate this lower economic growth before other sectors of economic activity start to falter under the pressure of high interest rates.
- Canadian Economy: We believe Canada’s economy is likely to achieve a soft landing with inflation under control. During this rate easing cycle, even though GDP growth may continue to slow and the unemployment rate may continue to rise, we do not anticipate dramatic impacts. Our biggest concern related to negative impacts on GDP is the wave of mortgage renewals at significantly higher rates than the expiring terms, which would increase consumer debt burden and negatively impact spending. However, future rate cuts should help moderate this pressure. We see the risk of significant layoffs as low at this time, but the labour market will likely continue to soften as workforce (population) growth outpaces job creation.