We are all familiar with the phrase “like a bull in a china shop”. Now, let’s swap the china shop for a jewelry store and at the back of the shop, behind the counter, sits a person working on a watch. It’s fully intact, except for the removed bezel as the technician meticulously adjusts the jewel, escapement and balance wheel. If done right, this watch is going to keep ticking. But then the bull enters the shop, sending showcases flying and dust in the air. At one point it starts snorting at the watch technician and pounds its hooves into the marble floor. What was already a complex procedure has now been made even more difficult by the presence of the bull. Welcome to what it’s like being the Governor of the Bank of Canada or the Federal Reserve Chairman today, except that the watch is the economy and the bull…well you know who he is.

 

Enter Wednesday which, coincidentally, was the first policy statement of the year for both central banks. And there were no real surprises on both fronts. Market participants expected a quarter point rate cut from the BoC and no change from the Fed.  That’s what we got, though with some interesting nuances in the messaging.

 

 

The Bank of Canada announced a 25-basis point reduction in its policy interest rate, bringing it to 3%. This marks the sixth consecutive rate cut, aimed at stimulating economic activity. Governor Tiff Macklem highlighted that inflation has stabilized around the 2% target, and previous rate cuts have begun to boost household spending and overall economic growth. However, he emphasized significant uncertainty due to potential U.S. tariffs on Canadian exports, which could disrupt the Canadian economy. The Bank is preparing for various scenarios and plans to assist the economy in adjusting to potential trade conflicts.

 

The Federal Reserve opted to maintain its current policy interest rate, keeping it within the target range of 4.25% to 4.5%. Chair Jerome Powell acknowledged the solid performance of the U.S. labor market and a recent moderation in inflation. He noted that while the economy remains resilient, the Fed is closely monitoring potential inflationary pressures stemming from proposed fiscal policies, including tariffs and tax cuts, under President Donald Trump’s administration. The Fed aims to balance supporting economic growth with its mandate to control inflation and will adjust its policy stance as necessary based on incoming economic data.

 

These were the highlights from the actual press statements released at the time of the rate decision announcements but, as always, the meat was in the press conferences. Or the difference in cuts of meat, for that matter – specifically with respect to the tariffs. In the case of the Bank of Canada, Governor Tiff Macklem stated that if the U.S. were to impose the tariffs announced during the Trump campaign and in recent weeks, the resiliency of Canada’s economy would be tested. In addition, the revised economic projections tabled by the Bank this week contain a lower degree of confidence because of the uncertainty over U.S. trade policy.

 

 

As much as the gap between policy rates has widened, the move lower in Canadian government bonds yields contrasts with the stickiness in U.S. treasury and reflects the greater vulnerability of the Canadian economy. The above chart shows the comparison of 2-year yields while the one below shows the relative movements in 10-year yields. This week we saw Canadian 2-year yields reach their lowest levels since 2022, while the U.S. counterpart is about 1-1/2 percentage points above their comparable 2022 mark. The 10-year Canadian yield has seen a moderate upward trend since last September, but nowhere near the correction in U.S. long yields.

 

 

What we can glean from policy statement and comments made at the press conference is that the Bank is prepared to deliver additional rate cuts if tariffs unfold and the downside risks to the economy outweigh the risks of higher inflation from the tariffs. At 3%, the Bank’s overnight rate is now within what most consider the estimated range of where the neutral rate should be (2.25% to 3.25%). Even if tariffs are not imposed, or they end up being less aggressive than telegraphed by the demander-in-chief, there is still room for rates to come down a smidge as long as inflation holds below 2%. A full-blown recession could see rates dip below the 2.25% level though that would likely send the Canadian dollar down to levels against the U.S. dollar not seen since the 1990s.

 

For Chair J Powell, there was limited airtime given to tariffs. In fact, the actual policy statement contained no reference to them and during the press conference, Powell mentioned the word only six times. For that matter, the topic of immigration and Trump’s proposed mass deportations of illegals never came up in the statement and was mentioned just four times in the Q&A. While the Fed is working on what-if scenarios in the background, it is not going to provide guidance on possible responses to hypotheticals. As Powell said, “I want to avoid commenting, even indirectly on the conduct of tariffs. It’s not our job…”

 

Ditto on the questions regarding Trump’s continued calls for lower rates. The timing is not lost on anyone that barely a week after the inauguration and a speech jammed with all of Trump’s promises and commandments, the Fed chose to hold the line on rates. Yesterday, we got the advance estimate on U.S. Q4 GDP and growth came in at 2.3%. This was slightly below calls for 2.6%, however, personal consumption growth was a full percent above consensus at 4.2%.

 

 

Initial jobless claims also came in hotter than expected, with a decline to 207,000 applications. Where they had trended higher during the first half of last year, reflecting the weakening in labour force conditions, claims have been trending lower since October and are approaching the lows seen at the end of 2023. This is revealing a concerning asymmetry for the Fed. When rates went from zero to 5.5%, all that happened to claims is that they rose from a low of 166,000 to a high of 264,000. The Fed has only cut rates by 1% since last summer and initial claims have tumbled from 258,000 last September to 201,000 in the first week of January. If the Fed needed just one piece of information to justify pausing on rate cuts or even suspending them indefinitely, that’s it. What Trump does with that (other than labeling the claims data fake) is anyone’s guess, but investors need to factor a plateau in rates into their positioning.

 

Both central banks are navigating uncertainties related to potential U.S. policy changes, particularly concerning trade, and are prepared to adjust their monetary policies to maintain economic stability. Given the higher sensitivity to trade in Canada than the U.S. (case in point, the U.S. ranks 169^th out of 171 countries in terms of total trade as a share of GDP), we can expect a more rapid response by the Bank of Canada to disruptions. Considering that conditions were actually fairly conducive to stable growth, lower inflation and lower rates coming into 2025, I’m sure both Macklem and Powell would have preferred no disruptions at all.

 

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

Andrew Pyle

 

 

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