We heard some interesting remarks from both the Bank of Canada and the Federal Reserve this week that offer clues as to how bond and equity markets will look on a relative basis this summer. BoC Governor Tiff Maklem told the House of Commons Finance Committee Thursday that it was getting closer to the point where it could start lowering interest rates. The day before, Fed Chair J. Powell effectively took rate cuts off the table for the time being, though reaffirmed that actual rate hikes would be unlikely.

 

We are therefore set for a potential divergence in policy in the coming months, where official Canadian rates decline against a holding pattern for the U.S. In the Governor’s words, the economy has stalled, wages have stabilized, and inflation is set to further moderate in an excess supply environment. At this week’s FOMC, the label affixed to the economy was more of resiliency than weakness.  This morning’s April jobs reports reinforced this divide.

 

Maklem’s remarks echoed the results from a Bank of Canada staff analytical note released last month – “Benchmarks for assessing labour market health: 2024 update”. The main thrust of this paper was that Canada’s labour market has moved into a more balanced state and is not contributing to higher inflation. It also made note of the fact that the percentage of self-employed workers continues to fall, which I would suggest mirrors the lacklustre productivity trajectory in this country. 

 

 

As the chart shows, Canada’s national unemployment rate stands at 6.1%, which is the highest since January 2022 when it briefly popped up to 6.5%.  We have to wait until next Friday to get the April data (U.S. numbers were reported this morning), but even if the rate holds steady, this represents an increase of 1.2 percentage points from the post-pandemic low reached in the summer of 2022. A move over one percentage point in unemployment is a big deal.  The U.S. rate stands at 3.9% as of this morning – about half a percentage point above its post-pandemic low – and even that move is typically associated with the start of a significant slowing in economic growth or recession. In other words, the Canadian unemployment trajectory supports the thesis of sub-par growth going forward.

 

Ok, let’s assume that Canada moves first on rates. The Governor did remind us this week that there are limits to how far the BoC can diverge from the Fed. You know how the Canadian dollar acts when yields here get too low relative to the U.S. Still, even a marginal divergence should be good for markets, right? If we are talking short to medium-term bonds, I would say yes. Lower rates will help households and businesses, but the magnitude of interest rate relief is likely to be too small to create real stimulus. At the same time, we have not yet seen the largest impact of higher interest rates on households that will see the bulk of mortgage renewals in the coming two years.

 

In other words, Canada’s economy is still in a fragile state. The U.S. might be too if rates are left higher for too long, but if corporate revenue growth here is indeed linked to nominal GDP growth, then prospects for the broader Canadian equity market will not be up to par with the U.S. in my opinion. As I mentioned on BNN this week, that should see the TSX underperform the S&P500 over the near-term.

 

 

The above chart shows the percentage change in both the TSX and S&P500 over the past year.  While Canadian stocks have recovered from the third quarter correction of last year, the pace of gains has been sharply below the U.S.  As of today, the TSX is up about 7.5% over this period, compared with a 25% lift in the U.S. Closing this gap will be extremely difficult, especially if the Canadian economy becomes more fatigued. That doesn’t mean that there aren’t still opportunities North of the Border.

 

Given that we still expect oil and natural gas prices to remain firm, revenues in the energy patch should continue to show decent growth, while lower funding costs and a more stable employment cost picture should improve earnings. With the Trans Mountain pipeline finally completed, shipments out of Alberta are set to increase and at prices that are more favourable.

 

If we do in fact see rates decline in Canada ahead of the U.S., then this should provide a lift to interest sensitives at the margin.  In particular, Canadian telco stocks could finally see a sustained bounce after what has been an extremely dismal year.  Compared to this time last year, the capped TSX telecommunications index is down 20% compared to much more modest 2% decline in the S&P500.

 

 

Despite the fact that there is a higher probability that Canadian monetary policy shifts ahead of the U.S., I actually think there has been a risk-reward shift in U.S. market after the FOMC.  If you take almost all the rate cuts off the table, then there is less risk of there being an even more hawkish outcome than perhaps a positive surprise of those cuts coming sooner.  That was exactly what happened this morning with the U.S. jobs report, where payrolls came in weaker than expected and the unemployment rate edged higher.  Bonds rallied and fed funds futures started to imply a cut in September where only two days ago they pointed to November. This shift, in my opinion, favours U.S. stocks in a situation where there is still a ton of cash on the sidelines, and it favours high-growth segments of the market like tech.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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