With the Bank of Canada and Bay Street economists expecting economic growth to improve and normalize in 2025, investors are focusing on the speed and strength of the recovery. However, the latest economic data could be signalling trouble ahead for the economy if the Bank of Canada maintains a restrictive monetary policy for much longer.
On Tuesday, Canadian real GDP increased by a modest 0.2 per cent in February, and real GDP growth in January was revised down to 0.5 per cent from 0.6 per cent previously. Furthermore, based on Statistics Canada’s preliminary estimate of no change in GDP expected in March, growth is clearly decelerating and may have stalled.
The Globe and Mail spoke with TD’s chief economist Beata Caranci, who shared her views on the economy, interest rate cuts and implications for bond and stock markets.
Rate cut expectations keep getting pushed out. Yet, CPI median and CPI-trim are both near 3 per cent. The unemployment rate topped 6 per cent in March. These economic data points seem to warrant a rate cut. Why do you think the Bank of Canada will not reduce rates until the second half of this year? What further evidence does the Bank of Canada need to see?
I think they’re a little gun shy because they’re worried probably with what they’re seeing in the U.S. In the U.S., they had several months of good data and then the next three months it went in the other direction. They definitely don’t want to have to do a U-turn. They’re clearly leaning on the side of waiting until it’s beyond a shadow of a doubt.
Now, the one thing you could point to in their defense is that they’ve got the 1 to 3 per cent range, but they really are targeting that mid-point and those annual rates on headline and those core metrics are still at the top end of the range. I think they’re hoping these metrics can edge down a little more and reaffirm the direction is downwards and that would give them more comfort.
You have the first rate cut by the Bank of Canada in July?
Quite frankly, it could be June or July, you’re splitting hairs at that point. It’s really about do they need to see one or two more inflation reports that are favourable. To your question, how much evidence do they need to see? They haven’t been able to tell us that. They’re just telling us that we like what we see.
You’re forecasting 100 basis points of cuts this year, and 175 basis points of cuts next year with the overnight rate falling to 2.25 per cent at the end of 2025. Are you forecasting 25 basis points of cuts at each meeting?
Typically, once the central bank starts to cut, they generally don’t go with the start and stop process because it can be confusing and create volatility in the bond market and the currency markets. Once you start, you want to continue on an even and predictable path. This is another reason why they could be delaying it.
Recently, Fed Chair Powell indicated that interest rates are likely to remain higher for longer. What is the probability that we don’t see any rate cuts this year in the U.S. or perhaps just one, especially with the U.S. election coming in November?
I think it’s a high probability that we only get one, maybe two cuts out of the Fed due to persistently elevated inflation. They will openly state that they’re not going to design monetary policy around an election, but at the end of the day, they also don’t want to run interference by creating chatter around their decision to cut rates. So, if they could do it in advance, meaning no later than September, that would be ideal. But, if it doesn’t look feasible with the inflation and jobs data, then it makes the most likely timing for a cut in December, which does go to your point that we only get the one rate cut for this year. Keep in mind, there’s nothing stopping them from one rate cut that could be 50 basis points if they wanted to, there’s no rule requiring them to start with 25 basis points. They just need a signal to markets to avoid financial volatility and be consistent with their messaging and intent for future meetings.
Are you concerned with inflation reigniting with the rising price of oil, the Canadian dollar depreciating making imports more expensive, lower interest rates potentially increasing consumer spending and housing activity. Do you see inflation ticking back up as a potential risk?
Yes.
So, a couple of things. One, the Bank of Canada’s, Tiff Macklem, is putting an emphasis on the core measures when he’s speaking, particularly more so in the last few public appearances. They’re already aware that the headline inflation measure could get lifted for a couple of reasons. For instance, carbon taxes come into play and higher oil prices due to geopolitical factors. If it doesn’t filter more broadly into other prices, then they’re not going to be as worried, and I think that’s partly why we’re hearing ongoing reference to core metrics.
To your other point, yes, lower interest rates could reaccelerate inflation by unleashing consumer and housing demand by more than expected. That would definitely be an area of concern. That’s why within our forecast, we’re just doing 25 basis point moves, and maybe they have to even go slower. They have, in the past, moved interest rates at every other meeting. So instead of the usual six-week interval between meetings, you’ve got 12 weeks to observe more data points on inflation and jobs to better gauge dynamics. If they feel they’re starting to fall behind, they could then speed up the pace. Basically, there’s a lot of options in front of them.
They’re going to be worried about any quick recalibration in housing and consumer demand. The one thing that Canadian households have that the U.S. doesn’t have is a higher amount of excess deposits that were not spent after the pandemic. The U.S. drew this down quickly, which is why they have higher consumption profiles than us. We’ve presumed that Canadians are anticipating or are worried about upcoming debt costs, so they’re keeping the powder dry. But, by keeping the powder dry, it also means that when interest rates fall, households may feel more confident in turning those savings into spending patterns that cause the economy to rebound very quickly.
Of all the key economic indicators you monitor are there some that are more worrisome to you than others? Perhaps not moving in the right direction or maybe they don’t have as much momentum as you would expect?
I’m really surprised how resilient and strong the job vacancies rate has been in the U.S. Although employer demand for workers has eased, it seems to have leveled out at a rate that’s still high relative to pre-pandemic. You need the demand for workers to come down a lot more for the job market to slacken and take pressure off of inflation through the consumption cycle. The only other way to square the circle is to have productivity growth provide a stronger offset. That is exactly what’s been happening in the U.S., but now that story is starting to fade or come into question. So, the inflation risks are actually starting to worsen again. The trend in the last three months shows reacceleration of U.S. inflation, and this may not be the end of it. That’s where I’m most concerned on thinking of what it could mean for Canada and the degree to which it could limit the central bank from cutting interest rates.
Many commodity prices are significantly higher than TD’s assumptions for the first quarter, such as gold, oil, silver, and copper. Do you believe your estimates are too low or do you think the other way that maybe some commodity prices are inflated and fall back to your forecast?
A couple of things to keep in mind is when we forecast commodities, we’re doing an average for the quarter. You have to think through the whole quarter and there’s a lot of volatility related to commodities. That’s one thing to keep in mind.
The other factor is that the views on the global economy have certainly shifted in the last couple of months. Geopolitical risks have definitely worsened. I think what you’re partly seeing is an element of risk pricing happening in commodities, which has put them a little bit higher in combination with the fact that the global economy is continuing to show this resilience, maybe some even pricing of China coming into a bit of strength as we move through the year. So, there’s quite a few dynamics but they’re all pushing in the same direction right now.
You expect home prices to rise 1.2 per cent year-over-year in 2024 and 4.3 per cent year-over-year in 2025. However, if rate cuts keep getting delayed and mortgages are renewed at much higher rates next year could home prices be vulnerable with some homeowners forced to sell or investors deciding to sell if the economics are not as attractive?
That’s why we have a low single-digit growth profile on housing prices.
I’m more worried about the other side of the risk. Prices could pop more than we expect. If you saw the Bank of Canada’s survey, the Canadian Survey of Consumer Expectations, there was a rising share of people indicating their intention to buy a home in the next 12 months. So, there’s pent-up demand and we’ve had a weak market for over a year. We may be underestimating the degree to which people show a willingness to jump into the market the minute they see interest rates loosen.
We have a housing affordability crisis and need to increase housing supply. Why do you have relatively stable housing starts over the next two years in your forecast? Why don’t you see a pick-up in housing starts?
There’s a few things, one is that in Canada, we do a very good job of not really starting to build condominiums until you’ve met a threshold on presales, 70 to 80 per cent to get the financing. What we’ve seen over the last couple of years is presales have been quite low. Therefore, you’re not going to get the follow through on the construction because they haven’t done the presales that create the construction. It’s largely a function of the higher interest rates, in particular, that soaked up a lot of demand last year. So now you have developers who if they intended to start next year, they might be intending now to start in two- or three-years time, whenever those numbers start to come back in. So that’s one factor.
The other factor is going back to our mechanics of Canada, we need to have more supply. But at the same time, we haven’t demonstrated in our own history that we can sustain high supply above 280,000, 290,000, 300,000, we can hit it on a certain month, but we don’t sustain it, which speaks to: Are there enough construction workers? Does the construction industry have opportunities to be more productive, which is why you saw in the budget things like prefab homes and the manufacturing of homes to get that productivity going because the way that things are being done now, it’s just not going to get us there.
Where are you an outlier versus consensus and why do you hold that perspective?
I would say we deviate with the Bank of Canada that has a more optimistic view on Canada’s growth trajectory than we do, especially for next year. They’re just above 2 per cent on their forecast and we’re at about 1.5 per cent. Part of the reason is because we’re still mindful of the leverage risks and the rollover risks that are happening even as the Bank of Canada is expected to be cutting rates. They are also far more optimistic than us on near-term potential GDP growth, which means they view there’s more slack in the economy than us. If they’re right, it means inflation dynamics might be pressured down at a faster rate and create more incentive to cut interest rates this year.
What does the current economic environment suggest for fixed income or equities?
We will see what happens on the interest rate cycle because the minute central banks start to cut, in particular, the Fed, that usually starts to become more supportive to equities. And obviously, bond prices go up.
But I feel like right now we’re in that pocket where everybody’s trying to judge not just which direction, but the magnitude of interest rate moves that we’ll end up seeing. So there’s a little more volatility, but arguably equities have had a really good run, so it would not be surprising if you start to see a pullback or reset - if we do get it.
The other factor, which we have no idea how it’s going to play out, is the U.S. elections. It’s not clear to me how markets will interpret a Biden versus a Trump win and how Congress breaks down with Republican versus Democrats. So that’s going to be quite material. Republicans are more business friendly in terms of wanting to cut corporate taxes and hold personal income taxes steady. A more growth friendly policy would normally be positive for equities. But we also know that the U.S. debt escalation is getting into a quite a vital stage, so markets may expect more from governments than just tax cuts. They might expect initiatives that balance the books. So, we have a big unknown policy-factor out there facing financial markets. We’ll have to see how that plays out at the end of this year, and into next year.
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