50 Shares of Easing... Happy Holidays!

 

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North American markets continued their unrelenting march to record highs this week with all major benchmarks posting gains on the week. We had a flurry of inflation and economic data this week on both sides of the border. Most important for Canadians was the Bank of Canada’s interest rate decision on Wednesday.

The BoC cut its key overnight rate 50 basis points to 3.25%, as largely expected and its fifth consecutive trim for a cumulative 175 bps of rate relief. The Bank thus retains the crown of most aggressive rate-cutter in the world (no other G10 central bank has cut by more than 125 bps, and the Fed is at 75 bps so far). However, even with the meaty cut, the Canadian dollar actually found a footing after the announcement (gave it all back on Friday, and then some), as the Bank clearly signalled that the pace of cuts will cool markedly in coming meetings, assuming the economy provides no major surprises. While we would not go so far as to say the tone was hawkish, the Opening Statement for the Press Conference was quite direct that "we anticipate a more gradual approach to monetary policy.” No kidding.

A few key quotes from the Statements, and cutting to the chase, because these are the most important:

• "The Governing Council has reduced the policy rate substantially since June, and those cuts will be working their way through the economy. Going forward, we will be evaluating the need for further reductions in the policy rate one decision at a time. In other words, with the policy rate now substantially lower, we anticipate a more gradual approach to monetary policy if the economy evolves broadly as expected. Our decisions will be guided by incoming information and our assessment of the implications for the inflation outlook." (Emphasis ours.) At 3.25%, the Bank has brought down the overnight rate to the top end of what they view as the range of neutral (2.25%-to-3.25%), and they got there in lightning speed (six months). Now they can stand back and assess how the economy is handling that big easing, and also wait to see how the tariff threats play out.
• On immigration changes: "The most significant of these is reduced immigration targets, which suggest GDP growth next year will be lower than we forecast in October. The effects of lower population growth on the inflation outlook will likely be more muted because reduced immigration dampens both demand and supply in the economy." The bottom line for the BoC is yes slower population may chill growth, but the inflation impact is mixed, so no obvious effect on policy.
• On trade: " In addition, the economic outlook is clouded by the possibility of new tariffs on Canadian exports to the United States. No one knows how this will play out in the months ahead—whether tariffs will be imposed, whether exemptions get agreed, or whether retaliatory measures will be put in place. This is a major new uncertainty." Our read is that the combination of the spike in the unemployment rate to 6.8% and the dark cloud of trade uncertainty prompted the Bank to supersize its rate cut today, to front-load support for the economy. Any concerns over a weaker Canadian dollar were brushed aside, especially since a currency depreciation will be the inevitable response to U.S. tariffs in any event.

Bottom Line: In the short space of six months, the Bank has driven the overnight rate from a highly restrictive 5% level right down to the top end of their estimate of neutral rates at 3.25%. Now, the BoC has directly signalled that the pace of cuts will slow, perhaps dramatically—the Bank even noted that it will now "evaluate the need for further reductions". Ultimately, given the slack in the economy, and the cloud over the trade outlook, we look for some further small rate trims of the 25 bp variety in 2025, bringing the overnight rate down to 2.50% before mid-year (i.e., at the lower end of neutral). As the Bank notes, the major wildcard is what unfolds on the tariff front, and how Canada responds; suffice it to say, rates are going lower still if broad U.S. tariffs are imposed on Canada.

Source: BMO Economics EconoFACTS: BoC Policy Announcement ... -50 bps to 3.25%

Meanwhile, our final note of 2024 wouldn’t be complete without a note on inflation… On Wednesday we had US CPI inflation for November that was uncomfortably warm even though it was in-line with the consensus forecast. Prices increased 0.3% month-on-month -- the fastest monthly pace since April. U.S. consumer inflation year-on-year increased by another tenth of a percentage point to 2.7% from 2.6% in October and a low of 2.4% in September. The inflation rate from a year ago was the fastest since July. We saw an unfavorable pickup in commodities (+0.5%), food/beverages (+0.4%, eggs are up 40% this year?!), gasoline (+0.6%), and motor vehicles (new +0.6%, used 2.0%) prices last month that kept inflation elevated even as we saw some marginal improvement in services (+0.3%) and housing (+0.3%) inflation.

Source: BMO Economics EconoFACTS: U.S. Consumer Prices (November)

Bottom Line: Despite stubborn persistence in the headline and core CPI inflation data, Wednesday’s report likely won't preclude the Federal Reserve from one more quarter point rate cut before the end of the year. Some members of the Fed Committee will likely take solace in the improvement in services and housing inflation. With that said, the Fed will need to see more improvement on the inflation front in the months ahead, if its plan for a steady pace of additional rate cuts next year is to be fulfilled.

Source: BMO Economics EconoFACTS: U.S. Consumer Prices (November)

As we head into year-end and the holiday season, investors have many reasons to cheer. The stock markets in the U.S. and Canada have been making record highs. Perhaps most importantly - and underpinning the solid financial markets - is that the U.S. and Canadian economies continue to grow at or above trend, with no signs of recession on the horizon. Why?

We know the backbone of the economy is the consumer, which drives about 70% of U.S. GDP and about 55% of Canadian GDP. Of course, consumers have faced challenges over the past year in elevated inflation readings and higher interest rates, which have pressured both spending and borrowing. Nonetheless, data continues to point to healthy rates of consumption. Meanwhile the labour market has been resilient and a source of strength, namely in the US.

The U.S. unemployment rate ticked higher last month, from 4.1% to 4.2%, but remains comfortably below long-term average unemployment rates of around 5.7%. Similarly, in Canada the labour report for the month of November was overall okay. The total jobs added were about 51,000, above forecasts of 25,000. And the unemployment rate, while it did tick higher to 6.8% remains below the long-term average of around 8.0%. In our view, the labour market in both economies continue to normalize after a period of outsized strength after the pandemic in 2020.

Overall, the fundamental backdrop for financial markets remains intact, and the U.S. and Canadian economies appear poised to achieve the elusive "soft landing" (modest slowdown but still growing at or above trend). As we look toward 2025, we would expect consumers to be supported further by lower interest rates and wage growth that exceeds inflation rates.

Despite potential policy uncertainty and market volatility ahead, we continue to believe that pullbacks can offer opportunities for investors, especially because we don't see an economic downturn in the near-term-horizon.

This concludes our weekly commentaries for 2024. We will pick things up again in 2025. We wish you all a Merry Christmas, Happy Holidays, and a fantastic New Year!

 

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