Two central banks decided to leave rates unchanged this week. One did so against a rather boring backdrop of balanced economic fundamentals, with no external pressure by the government to do anything but sit on the fence. The other also found that there was no driving factor to alter course but faced the usual all-cap tweets from the oval office and two dissenting opinions among its own board. No one expected either the Bank of Canada or the Federal Reserve to cut rates on Wednesday, but what unfolds on the economic front and in Washington will make for a more interesting background in September when they next meet.

This is the third straight meeting where the BoC has held the overnight target rate unchanged at 2.75%, whereas the Fed has maintained its key rate at 4.5% since last December as seen in the chart above. Notwithstanding that Canada has seen a faster retreat in rates over the past year, both central banks have entered a holding pattern. This stance has been criticized by some outside the Trump circle, but it is justified by the fact that economic winds are not all blowing in the same direction.

Let’s begin with inflation.  Few will argue that we haven’t made significant improvement in getting inflation under control relative to where we were a couple of years ago, let alone the immediate post-pandemic period. Canada, with a year-over-rate of 1.9%, has been below 3% since the start of 2024, while the U.S. headline rate of 2.7% is an improvement from the 3% handle seen in January of this year. That said, additional progress has been halted as demand conditions remain healthy in both countries and tariff effects begin to trickle in. Inflation measured by the implicit GDP deflator also looks to have found a floor above 2%, as the chart below shows.  Now, we can attribute some of the more subdued price increases in recent months to businesses stockpiling ahead of the anticipated tariff announcements. Those inventories have been drawn down, suggesting that new orders in the summer would come in with higher prices applied. But, with some tariffs not yet implemented or altered, this has extended the window for inventory rebuilding in some cases.

As we have discussed before, both economies are showing cracks, and it is very likely that these cracks could worsen as the full extent of Trump’s tariff tirade is realized. That said, both central banks have indicated that businesses are acting with a little more certainty as to the trade environment, misplaced or not. Deadlines get pushed out, tariffs altered, as with the case with the EU and Japan agreeing to tariffs that are substantially higher than last year, but lower than what were feared back in April. At the time of writing, we were anticipating the White House’s action on Trump’s self-imposed August 1st deadline for agreements and Mexico has just secured a 90-day pause on originally scheduled tariffs so that an agreement can be reached. Unfortunately, Trump decided in his late night musing to hit some Canadian exports with a 35% tariff.

On the surface, all of this should not inspire greater confidence nor comfort in the global economic outlook, but the hard data has not shown a material dent, at least until today.  Tuesday’s U.S. consumer confidence headline came in at 97.2 versus calls for a smaller improvement to 95, while the July ADP payroll report on Wednesday beat expectations with a 104,000 net gain in jobs. That same morning, ahead of the FOMC announcement, the advance Q2 GDP report pointed to headline real growth of 3%. True, when we strip out trade and inventories, final domestic demand growth was only 1.2%, but the 1.4% increase in consumer spending was still a decent recovery from the paltry 0.5% lift in Q1.

The problem is that U.S. non-farm payrolls came in well below expectations for July with a gain of only 73,000 and the numbers for May and June were revised down a startling 258,000. This size of a revision is rare to say the least and so far the Bureau of Labor Statistics has not given a reason for why the initial estimates were so far off.

In Canada’s case, the headwinds from tariffs have also been countered by other positive influences on the economy, like stronger than expected employment growth. As of June, total employment was up 1.7% from the same period last year and average hourly wages were running at a year-over-year pace of 3.6%. That’s far enough above inflation to support consumer spending and, as of May, retail sales were up 4.9% over the past 12 months. This shouldn’t be a major surprise, especially thinking back to the first chart. The Bank had executed more than two percentage points worth of rate cuts before it hit the pause button and given that monetary policy works with a lag, we still haven’t seen the full impact of this easing in the data.

The U.S. can’t hold claim to the same benefit, as seen in this morning’s employment report, and the one percent combined cut last year has probably already been felt in the data, but borrowing costs are not the only things that impact household spending. How people feel with respect to their financial situation overall is also a key factor in determining the ease with which pocketbooks are going to be open. And speaking of easy, the Chicago Fed’s National Financial Conditions Index is now pointing to the easiest times since November 2021, as shown in the chart below.

This index is derived from conditions in equity markets, but also the bond market, money market and shadow banking areas. It is calculated weekly, and the interpretation is that the more negative the number is, the easier conditions are. As for money markets, or short-term interest rates, there has been no net contribution to conditions, since the Fed has not lowered rates. Likewise, bond yields have tracked along a fairly narrow range since the start of the year.  The 10-year U.S. treasury yield started off near 4.8%, fell briefly below 4% in April and is now hovering near 4.4%. However, with stock markets hitting new record highs on strong earnings and a more “relaxed” feeling among investors regarding the trade story, this has been enough to push the needle on overall conditions.

The Fed is correct in pointing out, in response to questions of why policy rates are still at restricted levels, that if they were truly restrictive, we should not be seeing the economic conditions that we observe. Nor should corporate borrowing spreads over government yields be as narrow, and the stock market shouldn’t necessarily be trading at multiples that are above average.

As much as the policy verdicts were as anticipated and justified by fundamentals, the thing that did stand out was that two members of the FOMC dissented against the majority decision to hold rates.  Governor Christopher Waller and Vice Chair for Supervision Michelle Bowman both voted in favour of a quarter-point rate cut, making this the first time since December 1993 that two members of the FOMC went against the herd. It’s worth noting that since 2000, we have seen only five dissenting votes at an FOMC meeting and that is including this week. Back in the Volcker and Greenspan, dissenters were more common but as Fed credibility around inflation control built, so did the near unanimity of voting.

It is perhaps no surprise that the two Trump appointees would be out there supporting the president’s push for lower rates and Waller has been viewed as a potential replacement for J. Powell when his term ends next year (assuming he doesn’t step down or Trump finds a way to fire him beforehand. Now, back at the December 1993 meeting, Governors Wayne Angell and Lawrence voted in favour of a half-point hike in rates on inflation concerns.

Some analysts have indicated that these dissenting views ended up being proven right, excess demand in the U.S. started to fuel increasing pressures on prices, ultimately leading the Fed to double the Fed funds target to 6% by early 1995. Similarly, some believe that Waller and Bowman might have also been correct in their vote this week. Perhaps, but there is less data supporting the call for lower rates today than there was supporting tightening back then. We still expect the Fed will bring rates down, potentially as early as September, but only if inflation continues to cool and the economy weakens. That will potentially help markets in 2026, but we have a lot more uncertainty to get through between now and then.

In the hiatus before the September BoC and Fed meetings, with earnings season drawing to a close in the coming weeks, attention will shift back to what Trump does and how his policies to date are shaping the environment for the rest of the year. Our view is that even with the stellar results delivered by tech and other sectors, the overall market still looks overvalued. Taking some money off the table now as we head into August is a prudent strategy in our opinion.

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

Andrew Pyle