Transitory. Data dependent. Cloud of uncertainty. All terms that have been utilized by central banks during periods where the future path of economic growth and inflation were so in question that the best decision at the time was to stand pat. The last time the world appeared as nuts as it does now was back during the pandemic. Ironic then that the five largest central banks held their respective policy meetings in the same week for the first time since 2021. With the Iran war now heading into its fourth week, it’s no surprise that central bank officials sounded as confused and uncertain as everyone else and very much guarded in terms of laying out the direction of policy. Should interest rates be lowered because of the possible negative economic shock from the war, or should they be raised to ward off higher inflation coming from elevated energy prices and supply chain disruption. Talk about being stuck between Iran and a hard place (thanks Ally for this devilishly good title!)

 

Before I get into the specific details from the Bank of Canada and Federal Reserve meetings, let’s first appreciate exactly the dilemma faced by both. It’s safe to say that we dodged a bullet from Trump’s tariff circus in 2025, not only in the North American economy not being turned upside down, but in consumer prices not shooting higher and reversing the progress made on inflation since 2022. A soft landing looked likely during the second half, which would have allowed official rates to be cut further over the course of 2026.  No recession and a nice dose of additional stimulus for equities and bonds.

 

But then, labour market conditions started to weaken, partly reinforcing fears of job replacement by artificial intelligence (AI). Even though Trump’s tax cuts and refund cheques were coming online, could it be that stalled growth in employment would lead to slower or negative consumption growth, necessitating even more rate cuts this year? Fast forward to this week and the concerns over the jobs market are the same, if not worse; but inflation worries have intensified over the near term as well for the reasons we have discussed over the past couple of weeks.

 

The problem is that central banks are deciding on a course of action, knowing full well that whatever they do or don’t do will affect the macro economic landscape with a lag. If the Iran war turns out to be protracted, not only will oil prices possibly climb towards $150/barrel, but companies might be forced to start passing along cost increases. That could be the price of an airline ticket, the price of a loaf of bread because of degraded wheat production, or the price of a semiconductor because helium prices are higher.

 

In terms of the balance of risks between weaker growth and higher inflation, the scale has tipped recently towards the latter, at least in terms of how the market sees things. The chart below shows the current Federal Reserve fed funds target and implied expectations by the market of where that rate will be over the next several months and quarters. This is derived from actual futures contracts that expire on those dates in the future. By subtracting the price of that futures contract from 100, we get the implied fed funds rate.

 

 

As you can see, investors are pricing in a decline in the fed funds rate from the current level of 3.75% (which was left unchanged at Wednesday’s FOMC) to around 3.5% by the end of this year and then down towards 3% by the end of next year. In other words, a couple of quarter-point rate cuts over this period. Compare that to the blue line which shows implied expectations just one month ago, where three cuts were being priced in by the end of the year. Bottom line, investors still see a downward path for rates in the United States. But if inflation concerns were to increase either because middle east tensions are persistent or because business and consumer inflation expectations move higher, that path could shift direction.

 

This was clearly evident in the messaging by the Bank of Canada this week. By all accounts, Canada was well on the way to setting the groundwork for additional monetary easing this year. After continuing to cut rates through to the fourth quarter of last year, the Bank’s overnight target rate of 2.25% looked pretty close to neutral; however, inflation dipped down below 2% and then February gave us a much larger than expected drop in employment. Market participants saw the Bank trimming rates further to insulate the Canadian economy from sliding further and even Governor Macklem commented this week that an argument for cutting rates could have been made had it not been for the war with Iran.

 

 

The above chart shows the implied Bank of Canada rate curves today versus a month ago and you can see the pivot in expectations towards the possibility of rate hikes into 2027. Again, it’s important to note that these are simply implied rates from the pricing of futures contracts and are not an actual forecast of where rates are heading. That said, Macklem said that the Bank “will look through the war’s immediate impact on inflation, but if energy prices stay high, we will not let their effects broaden and become persistent inflation.”

 

This messaging was echoed even by the Bank of England and the ECB. Both central banks voted on Thursday to leave their respective official rates unchanged – 3.75% for the BoE and 2% for the ECB. Yet the comments from both meetings were also aligned in terms of wasting no time to tighten monetary policy should inflation rise in response to higher energy prices. In response, markets have begun to price in rate hikes for both the BoE and ECB by the end of the year as they work to bring inflation back down towards the 2% target.

 

There is a word is missing from all of the remarks made by the G5 central banks this week. Oh yes, “transitory”. This is almost a forbidden term among central bankers after the criticism of 2021-2022 when they were viewed as being too late to tighten policy to prevent the melt-up in inflation. No one wants to repeat that experience, which is why we had the hawkish leaning this week. Some have drawn parallels between what is happening now with the pandemic, but that is a flawed comparison. The shock of six years was a demand destruction event. Prices fell initially because of that and central bankers threw everything but the kitchen sink at it (rate cuts and quantitative easing). Even crude oil prices turned negative for a short period of time. Generally, prices of things, services and stocks fell until the market “cleared”.

 

What we are witnessing today is a supply destruction event and the difference is that prices will have to rise for the market to ultimately clear. This is certainly true of oil and it’s interesting to note that as much as the rise in crude oil futures prices has been incredible, with Brent breaking above $110/barrel, they are still well below the spot (cash) prices for crude in Saudi Arabia, which are closer to $150. And, as I mentioned earlier, other commodities and products are seeing rapid price increases. So, we have a war with no apparent off-ramp and an already significant dent in the region’s energy infrastructure. On Thursday, an Iranian attack on Qatar’s LNG facility wiped out 17% of its production capability for up to five years. The chart below shows the spot price of LNG – Asia, which jumped above US$22/million BTU this week, which is the highest in three years. It has been worse, but with increased production from areas outside of the middle east, this might be contained. Still, it is going to show up in prices.

 

 

The continued gradual success on inflation has been halted and now folks are worried about rising interest rates, but despite the shifting in central bank language and market expectations of where rates are heading, let’s not forget that higher energy and goods prices can act like a tax hike. And tax hikes shrink the ability of households and businesses to spend, which can lead to weaker economic growth or outright contraction.

 

I raise this point because central bankers are thinking about this as well. While the commentaries might have sounded hawkish this week, you have to know that the economists behind the scenes are running their models at full tilt to assess what could potentially happen in terms of demand destruction from this event. Indeed, this is almost a perfect storm, and it would be naïve to dismiss recession calls for 2026, whether for individual countries or regions.

 

The weakening pattern in employment has been attributed to AI substitution and also the crowding out effect of massive amounts of capital being diverted to building out the AI infrastructure, thus leaving less room for growing or even maintaining staff levels. Now, add to that the cost pressures companies are going to face from energy and supply shortages. This will squeeze margins and again likely prompt a scaling back of jobs. Where we once thought lower interest rates would stimulate economic activity this year, we now face the possibility of higher rates, both short-term and long-term, thanks to even stronger odds of fiscal deterioration.

 

During the initial weeks of the Iran war, Ally and I have counseled against kneejerk selling of risk assets, though we have maintained a slightly defensive allocation coming into this year. The longer this drags on, however, the less this is about guessing off-ramp scenarios and more about the traditional analysis of recessions can do to equities and commodities. In an ironic sense, the more protracted this becomes the easier it is to decide on the next tactical positioning in the portfolio. A shrinking of the economy won’t just see a few sectors fall (as we have seen with software companies) but a more general correction. At the same time, a recession would eventually force central banks to abandon their current stance of fighting inflation with higher rates and become the calvary, riding to the rescue with rate cuts. That will favour bonds and even the long end of the curve, which we have so far been minimizing exposure.

 

If there is one consoling factor coming out of this week for retail investors is that their confusion of where this whole thing is going is shared by central bankers, businesses and politicians. Yes, Iran is a different kettle of fish than Venezuela and Trump has served up the ghost pepper taco we discussed back in January. There may be a need to become more defensive in the coming weeks, but there are also going to be opportunities. Central banks found themselves wedged between Iran and hard place this week. That doesn’t mean we have to.

 

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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