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While the Bank of Canada signals its inflation fight is making progress, U.S. inflation continues to remain sticky. Andrew Kelvin, Head of Canadian and Global Rates Strategy at TD Securities, looks at the economic implications of diverging rates.
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[AUDIO LOGO]
While the Bank of Canada continues to hold the line on borrowing costs, governor Tiff Macklem says a June rate cut is, quote, "within the realm of possibilities." That said, is that the most likely path for our central bank when it comes to eventually delivering those rate cuts?
Joining us now to discuss, Andrew Kelvin, head of Canadian and global rate strategy at TD Securities. Great to have you back, as always. Great to have you here on a day like this.
Thanks for having me. It's a very interesting day. There's a lot to parse through.
Let's start parsing through it. We'll start here at home with the Bank of Canada. The statement itself, the speech itself, I'm like, I don't know. I don't feel like they're tipping their hat. And then right out of the gate in the question and answer session, Tiff Macklem says, June within the realm of possibilities. How are we supposed to read all this?
You're right. It was a really interesting contrast because the statement-- the press conference opening statement as well, they were all pretty cagey. And the MPR, I thought, was probably a little bit more-- it leaned into some of the recent positive data little bit more heavily than I would have expected. So the BOC was trying to put forward a message where they were continuing to see progress, but they wanted to keep all their options open. And then, as you said, right out the gate, first question of the press conference, he was asked if June cuts within the realm of possibilities.
And after a little bit of hemming and hawing, he said yes, which, in some respects, is a very obvious thing to say. Like, June's two months from now. June had been priced as nearly a 50/50 chance of a cut heading into this meeting. So of course, it's within the realm of possibilities.
But it's very unusual to hear a Bank of Canada governor say that. Usually when they're asked about specific meetings, specifically the next meeting, usually what they'll say is, I'm not going to comment on the next meeting. Or we'll take it meeting by meeting. Or we'll just have to look at the data.
Usually, you don't get that sort of transparent yes/no answer. So that was an interesting thing to see. Now, is it the most likely thing? We still think July. The question for the Bank of Canada is, how much evidence do they need to see to feel confident that the progress that we've made on inflation will be sustained?
They have this very subtle tweak in their forward-looking language, where previously, they talked about needing to see further and sustained progress on inflation. Now they're talking about needing to see the current progress or the realized progress on inflation sustained. So the current economic backdrop is probably consistent with the lower interest rates. They just need to be sure that this inflation backdrop will persist, that it wasn't one or two months of one-off downside surprises, because Canadian data is always a little bit volatile.
And it really becomes almost a philosophical question of, how much evidence is enough? We think they'll be more comfortable going into July if only because, given that we've been overshooting the inflation target for several years now, given where wage growth is, given where inflation expectations are, very importantly, because inflation expectations have not normalized yet, we think they'd prefer to on the side of caution.
I think they'd rather hold at 5% a little bit too long, perhaps, than cut a little bit too early, particularly with entering the spring housing market. So we still think July is more likely, but certainly the conversation should be, in our view, around a midyear start to an easing cycle. We think July, June being the second most likely.
If they do start in July, then what does the rest of the year look like? Are they on course, then, to cut at every meeting? Or is it going to simply be cut, step back, see what happens, and then decide whether they need to go again?
Historically, a one-off cut would be very rare. It's happened before. We saw it in 2016. But it would be a very rare thing. And going from what is a restrictive policy stance, going from 5% to 4.75%, and pausing would be a bit of a strange message to the market.
So when the BOC does start cutting, we do think we'll see at minimum two 25-basis point cuts in a row. And from there, it really will depend on the evolution of the data from both inflation and growth. We do expect the economy to slow down again in the middle part of this year.
Q1 data has been very strong. We don't think that will last. So we actually think we can get four 25-basis point rate cuts this year. So we do think they will get to 4% by the end of this year. But that will, as always, be just a product of how CPI performs and how the economy holds up.
Now, as Canadians, we are accustomed to the Americans, obviously, having the bigger spotlight. They sort of beat us to the punch with the big market news this morning. They came out with another inflation report. It is not moving in the direction that the markets wanted to see.
The market reaction is pretty clear on that. Does this complicate things at all for the course of where the Bank of Canada is going if the Americans, perhaps, are in a situation now, they're pushing out cuts-- pushing out cuts?
Not in the short-term. The economic reality between Canada and the US is very different. Last year, US GDP growth, on a Q4-over-Q4 basis, outpaced Canada by about 2%. And that is despite our extraordinarily strong population growth in 2023. The Bank of Canada and the Fed can diverge for periods of time, particularly around turning points.
So given that the economic realities on the ground in Canada are a little bit weaker than they are in the US, I don't think whatever the Fed happens to do will really impact the timing of the first round of BOC cuts-- not impacted by very much. We're all human.
If the Bank of Canada is on the fence between cutting in June, or cutting in July, or cutting in July, or cutting in September, the Fed can influence them, for sure. But fundamentally, when we talk about cuts in the US, we talk about a world where something has to change. Things have to soften.
In Canada, we've already seen that softening. So I do think there's a fair bit of scope for the Bank of Canada to operate independently for the first part of an easing cycle. Now, if we get down the line and the Federal Reserve stays on hold for quite a long time or is an extremely shallow easing cycle in the US, that would have impacts for the next round of rate cuts from the BOC.
Because while the BOC can get to 4 and 1/2% or 4 and 1/4% without the Fed doing anything, I think it would really be straining credibility for me to suggest that the BOC is at no point bounded by what the Federal Reserve does. So I really think that's a discussion more for 2025 rather than a current year discussion.
What do you make of all these discussions now? South of the border, based on the strength of the labor market, the inflation print we got today, that not only higher for longer-- but I think it was even a Fed speaker last week said, hey, you got to prepare yourself for the possibilities that maybe we don't even cut this year at all. Or maybe we even have to hike at some point. And I think people are like, what? This is not the mindset we had entering 2024.
No, absolutely not, although the mindset we had entering 2024 mirrored the mindset we had entering 2023--
We do it all over again.
--when rates went up. Now, I don't think that's going to happen this year. The economy is in a softer place globally than where it was entering 2023. We've made a lot more progress on inflation globally than we had entering 2023. So I don't think we're going to see a repeat.
I would also just sort of note that, unlike the Bank of Canada, where everyone tries to speak from the same script-- although the governor did acknowledge that there's a diversity of views within the room right now in governing council-- Fed speakers can say whatever their own personal views are.
Those comments from the Fed about, maybe we even see hikes, I wouldn't take that as symptomatic of something that's being discussed seriously within the Federal Reserve. Having said that, monetary policy is always sort of a funny backward-looking exercise. We have this idea of where neutral rates will be, where the sort of long-term steady state value is for overnight rates.
But you ultimately figure that out by seeing how the economy reacts to the monetary policy in place. And if US inflation doesn't moderate further from here, if US growth doesn't moderate further from here, then, yeah, that would undercut the-- it would undercut the case for, certainly, the magnitude of rate cuts that we expect. And at the end of the day, if the economy is humming along just fine, why change things?
Where's the urgency? Where's the urgency?
Exactly. So I think that's a really interesting conversation in the US that is not present to nearly the same extent in Canada. [AUDIO LOGO]
[MUSIC PLAYING]
While the Bank of Canada continues to hold the line on borrowing costs, governor Tiff Macklem says a June rate cut is, quote, "within the realm of possibilities." That said, is that the most likely path for our central bank when it comes to eventually delivering those rate cuts?
Joining us now to discuss, Andrew Kelvin, head of Canadian and global rate strategy at TD Securities. Great to have you back, as always. Great to have you here on a day like this.
Thanks for having me. It's a very interesting day. There's a lot to parse through.
Let's start parsing through it. We'll start here at home with the Bank of Canada. The statement itself, the speech itself, I'm like, I don't know. I don't feel like they're tipping their hat. And then right out of the gate in the question and answer session, Tiff Macklem says, June within the realm of possibilities. How are we supposed to read all this?
You're right. It was a really interesting contrast because the statement-- the press conference opening statement as well, they were all pretty cagey. And the MPR, I thought, was probably a little bit more-- it leaned into some of the recent positive data little bit more heavily than I would have expected. So the BOC was trying to put forward a message where they were continuing to see progress, but they wanted to keep all their options open. And then, as you said, right out the gate, first question of the press conference, he was asked if June cuts within the realm of possibilities.
And after a little bit of hemming and hawing, he said yes, which, in some respects, is a very obvious thing to say. Like, June's two months from now. June had been priced as nearly a 50/50 chance of a cut heading into this meeting. So of course, it's within the realm of possibilities.
But it's very unusual to hear a Bank of Canada governor say that. Usually when they're asked about specific meetings, specifically the next meeting, usually what they'll say is, I'm not going to comment on the next meeting. Or we'll take it meeting by meeting. Or we'll just have to look at the data.
Usually, you don't get that sort of transparent yes/no answer. So that was an interesting thing to see. Now, is it the most likely thing? We still think July. The question for the Bank of Canada is, how much evidence do they need to see to feel confident that the progress that we've made on inflation will be sustained?
They have this very subtle tweak in their forward-looking language, where previously, they talked about needing to see further and sustained progress on inflation. Now they're talking about needing to see the current progress or the realized progress on inflation sustained. So the current economic backdrop is probably consistent with the lower interest rates. They just need to be sure that this inflation backdrop will persist, that it wasn't one or two months of one-off downside surprises, because Canadian data is always a little bit volatile.
And it really becomes almost a philosophical question of, how much evidence is enough? We think they'll be more comfortable going into July if only because, given that we've been overshooting the inflation target for several years now, given where wage growth is, given where inflation expectations are, very importantly, because inflation expectations have not normalized yet, we think they'd prefer to on the side of caution.
I think they'd rather hold at 5% a little bit too long, perhaps, than cut a little bit too early, particularly with entering the spring housing market. So we still think July is more likely, but certainly the conversation should be, in our view, around a midyear start to an easing cycle. We think July, June being the second most likely.
If they do start in July, then what does the rest of the year look like? Are they on course, then, to cut at every meeting? Or is it going to simply be cut, step back, see what happens, and then decide whether they need to go again?
Historically, a one-off cut would be very rare. It's happened before. We saw it in 2016. But it would be a very rare thing. And going from what is a restrictive policy stance, going from 5% to 4.75%, and pausing would be a bit of a strange message to the market.
So when the BOC does start cutting, we do think we'll see at minimum two 25-basis point cuts in a row. And from there, it really will depend on the evolution of the data from both inflation and growth. We do expect the economy to slow down again in the middle part of this year.
Q1 data has been very strong. We don't think that will last. So we actually think we can get four 25-basis point rate cuts this year. So we do think they will get to 4% by the end of this year. But that will, as always, be just a product of how CPI performs and how the economy holds up.
Now, as Canadians, we are accustomed to the Americans, obviously, having the bigger spotlight. They sort of beat us to the punch with the big market news this morning. They came out with another inflation report. It is not moving in the direction that the markets wanted to see.
The market reaction is pretty clear on that. Does this complicate things at all for the course of where the Bank of Canada is going if the Americans, perhaps, are in a situation now, they're pushing out cuts-- pushing out cuts?
Not in the short-term. The economic reality between Canada and the US is very different. Last year, US GDP growth, on a Q4-over-Q4 basis, outpaced Canada by about 2%. And that is despite our extraordinarily strong population growth in 2023. The Bank of Canada and the Fed can diverge for periods of time, particularly around turning points.
So given that the economic realities on the ground in Canada are a little bit weaker than they are in the US, I don't think whatever the Fed happens to do will really impact the timing of the first round of BOC cuts-- not impacted by very much. We're all human.
If the Bank of Canada is on the fence between cutting in June, or cutting in July, or cutting in July, or cutting in September, the Fed can influence them, for sure. But fundamentally, when we talk about cuts in the US, we talk about a world where something has to change. Things have to soften.
In Canada, we've already seen that softening. So I do think there's a fair bit of scope for the Bank of Canada to operate independently for the first part of an easing cycle. Now, if we get down the line and the Federal Reserve stays on hold for quite a long time or is an extremely shallow easing cycle in the US, that would have impacts for the next round of rate cuts from the BOC.
Because while the BOC can get to 4 and 1/2% or 4 and 1/4% without the Fed doing anything, I think it would really be straining credibility for me to suggest that the BOC is at no point bounded by what the Federal Reserve does. So I really think that's a discussion more for 2025 rather than a current year discussion.
What do you make of all these discussions now? South of the border, based on the strength of the labor market, the inflation print we got today, that not only higher for longer-- but I think it was even a Fed speaker last week said, hey, you got to prepare yourself for the possibilities that maybe we don't even cut this year at all. Or maybe we even have to hike at some point. And I think people are like, what? This is not the mindset we had entering 2024.
No, absolutely not, although the mindset we had entering 2024 mirrored the mindset we had entering 2023--
We do it all over again.
--when rates went up. Now, I don't think that's going to happen this year. The economy is in a softer place globally than where it was entering 2023. We've made a lot more progress on inflation globally than we had entering 2023. So I don't think we're going to see a repeat.
I would also just sort of note that, unlike the Bank of Canada, where everyone tries to speak from the same script-- although the governor did acknowledge that there's a diversity of views within the room right now in governing council-- Fed speakers can say whatever their own personal views are.
Those comments from the Fed about, maybe we even see hikes, I wouldn't take that as symptomatic of something that's being discussed seriously within the Federal Reserve. Having said that, monetary policy is always sort of a funny backward-looking exercise. We have this idea of where neutral rates will be, where the sort of long-term steady state value is for overnight rates.
But you ultimately figure that out by seeing how the economy reacts to the monetary policy in place. And if US inflation doesn't moderate further from here, if US growth doesn't moderate further from here, then, yeah, that would undercut the-- it would undercut the case for, certainly, the magnitude of rate cuts that we expect. And at the end of the day, if the economy is humming along just fine, why change things?
Where's the urgency? Where's the urgency?
Exactly. So I think that's a really interesting conversation in the US that is not present to nearly the same extent in Canada. [AUDIO LOGO]
[MUSIC PLAYING]
