Managing director at BMO GAM explains what Macklem might do, and how the dollar and the market might react
The Bank of Canada (BoC) will make its final interest rate announcement of the year tomorrow amidst a challenging economic backdrop. Chief among Governor Tiff Macklem’s concerns will likely be the jobless numbers at a post-pandemic high, and the deteriorating value of the Canadian dollar. With so many headwinds, and generally lower than or on-target CPI prints, the consensus going into tomorrow’s meeting is not whether the BoC will cut, but how much they will cut by.
Bipan Rai believes that the BoC will cut by a full 50 basis points tomorrow. The managing director and head of ETF/structured solutions strategy at BMO GAM explained that the growth issues impacting Canada now are enough to justify another ‘jumbo’ cut. Rai outlined how the jobless numbers might weigh on the BoC’s outlook as well as what their concerns about a weakening Canadian dollar could mean for any future rate cut path.
“I do think it that [unemployment] is a meaningful signal to the Bank of Canada that it needs to expedite its move back towards neutral policy right now with with the overnight rate potentially moving to three and a quarter,” Rai says. “You're getting towards the upper end of the neutral policy rate range, as the bank Canada sees it, but it probably needs to dip a little bit closer towards the midpoint at a faster clip.”
Those jobless numbers, Rai explained, are less a sign of mass layoffs and rapid economic deterioration as they are of higher participation rates. The economy added jobs, but a higher participation rate showed that the Canadian economy is now less able to absorb new workers, pointing to a slowdown. GDP growth in Q3 and Q4 has also underperformed the BoC’s expectations, all of which points to downside risk and the need for the BoC to move closer to a neutral rate.
One of the other key concerns for the BoC now, though, is the performance of the Canadian Dollar, which has weakened considerably against the US dollar since the start of Q4. While the stimulatory effect of a weakening CAD may begin to be felt in the medium-term, Rai believes it shouldn’t prevent the BoC from cutting by 50 basis points tomorrow. Moreover, he believes the action of a jumbo cut itself is already priced into the value of the Canadian dollar.
That doesn’t mean tomorrow might not impact currency markets’ view of CAD. Language in either the official communication or Macklem’s press conference could result in a swing in the value of the currency. The threat of US tariffs, too, could impact the place of the Canadian dollar on futures markets, though Rai says there is so much bearishness priced into CAD right now that it would take a significant realization of that tariff threat to meaningfully drive CAD down further.
At the meeting itself, Rai is watching for a few key pieces of language or potential changes to standard BoC procedure. If the BoC changes the guidance that it offers in the final paragraph of its statement that could point to the path for future interest rate decisions. He’s also watching for any mention of the weakness in the Canadian Dollar as well as any comments on that the looming HST holiday might mean for the Canadian economy.
As of now, the overnight index spot market has a 0.46 per cent cut priced in, which is effectively a full bet on a 50 basis point cut. If the BoC only cuts by 25 basis points, Rai says that would indicate a lack of concern about Q4 economic performance on the part of the bank. He says that a smaller cut would be a potential tailwind for the Canadian dollar and should prompt a significant rally in CAD.
Nevertheless, Rai believes we will get a 50 basis point cut tomorrow. If that happens, he emphasizes the importance of context and clarity when asset managers explain the cut to their clients and stakeholders.
“A non standardized cut does not portend to an imminent recession here in Canada, because I think that's the first place that a lot retail investors would look towards,” Rai says. “This is merely the bank Canada speeding up the move towards neutral policy settings, given the fact that incoming data hasn't really suggested that growth is really tracking in line with what they would have expected it to be right now.”
