Canadian Bond Yields Decline. Bloomberg
Market expectations are rising that the Bank of Canada will cut interest rates at each of its remaining meetings this year, influenced by signs that the U.S. labour market is weakening faster than anticipated.
On Friday, the U.S. unemployment rate unexpectedly climbed to 4.3%, prompting markets to forecast deeper cuts from the Federal Reserve in 2024. Analysts from Citigroup and JP Morgan are now predicting two half-percentage point reductions by the Federal Reserve at its next meetings.
While Bank of Canada Governor Tiff Macklem maintains that the bank’s policy is set independently, the potential rate cuts by the Federal Reserve provide a supportive backdrop for lowering borrowing costs in Canada. Since the economies of the U.S. and Canada are closely linked, economic weakness in the U.S. is expected to impact Canada as well. This interconnectedness allows Macklem to lower rates without risking significant divergence from U.S. monetary policy, which could negatively impact the Canadian dollar.
“If the U.S. economy is rolling over and the Federal Reserve is cutting, that gives the Bank of Canada a green light to keep going and push toward neutral,” Benjamin Reitzes, rates and macro strategist at the Bank of Montreal, said.
Following the U.S. data release, Canadian bonds saw a rally, with yields on five-year government notes dropping 13 basis points to 2.89%, their lowest since May 2023. Traders are now fully pricing in three more rate cuts this year, betting that Canada’s central bank will ease at each upcoming meeting.
In a mid-July survey, economists predicted the central bank would reduce its key policy rate from the current 4.5% to 3% by the end of next year. However, Doug Porter from the Bank of Montreal now expects Macklem to cut rates at each of the next four meetings, bringing the policy rate down to 3.5% by January and ultimately to 3% by mid-2025. “That means the bank will arrive at the presumed endpoint more than half a year earlier than expected,” Porter said.
In June, the Bank of Canada led the Group of Seven countries by cutting rates for the second consecutive meeting in July as evidence of cooling inflation emerged. Macklem’s decision to cut rates ahead of the Fed had initially sparked concerns about currency stability. However, as the gap between U.S. and Canadian rates narrows, these concerns have eased.
“Even though they’ve said we’re not close to limits of divergence, it has to give the Bank of Canada a bit of comfort knowing that the Fed is going to be right behind them,” Taylor Schleich, a rates strategist at National Bank of Canada, said.
Despite the global bond rally potentially increasing Canada’s upside inflation risks, the majority of fixed mortgages in Canada have terms of five years or less. If yields continue to fall, mortgage rates are likely to decrease, possibly revitalizing the housing market, which the Bank of Canada had previously downplayed as a significant inflation factor.
The Bank of Canada also released a June survey showing the median expectation for five-year yields was 3.28% by the end of 2024. Canada’s unemployment rate, calculated differently from the U.S., rose to 6.4% in June, up 1.4 percentage points since early 2023. Statistics Canada is expected to release July data soon, with economists predicting the jobless rate to increase to 6.5%.
“The weaker U.S. data should pass through into the BoC’s thought process,” Andrew Kelvin, head of Canadian and global rates strategy at Toronto-Dominion Bank’s securities division, said.
