Happy New Year! We hope you’ve enjoyed the holiday season.
In this week’s economic update, we examine the expected timing and degree of interest rate cuts in 2024. We will unpack the factors influencing interest rate policy in both the U.S. and Canada, and how inflation will play a key factor in any potential cuts.
We are also sharing a short video from RBC’s Global Asset Management featuring their Chief Economist Eric Lascelles, where he speaks to the positive and negative economic impacts that could steer us towards a full recession or a soft landing.
Lastly, we are sharing details around Tax-Free Savings Accounts and the changes made to this year’s contribution limits.
Economic Update
Market action in the first few weeks of the year has been relatively muted, contrasting with the strong gains witnessed towards the end of last year. This moderation can be attributed to a string of slightly stronger global economic data, prompting investors to reassess their expectations for interest rate cuts. We expect the timing and degree of rate cuts to be one of the biggest debates this year.
U.S. Interest Rates remaining steady, but expectations for cuts in 2024
The Federal Reserve, the central bank in the U.S., decided to hold interest rates steady at its most recent meeting in December. During its post-meeting press conference, Chairman Jerome Powell suggested that the Fed has been faced with three big questions over the past few years: how fast to raise rates, how high to raise them, and the timing and size of cuts. While the first two questions were its predominant focus until recently, the question of rate cuts is now coming into view. The Fed’s December meeting revealed that, on average, policy makers expect to cut interest rates by nearly 0.75% in 2024 and expect the pace of inflation to slow to 2.4% (from over 3.0% today) and the unemployment rate to rise modestly, to 4.1% (from 3.7%).
BoC expected to follow a similar path to the U.S., potentially sooner
Unlike the Federal Reserve, the Bank of Canada does not provide explicit future rate projections. But investors expect Canada’s central bank to similarly pivot towards interest rate cuts. The market is pricing in close to 1.4% in rate cuts by both the Bank of Canada and the Federal Reserve this year, with the latter expected to cut as early as March and the former as early as April.
Despite the market’s expectations, there are reasons to believe that the Bank of Canada may act sooner and more swiftly than its U.S. counterpart, given its earlier start to rate hikes and Canada’s heightened sensitivity to interest rates due to higher household debt and shorter mortgage terms. Moreover, the Canadian economy has shown early signs of strain from the impact of higher rates with more sluggish GDP growth, weaker consumer spending, and dwindling job gains.
Inflation rates to largely impact decisions are rate cuts
The two factors that should ultimately determine the timing and degree of interest rate cuts are inflation and employment trends. Last year saw a steady decline in the pace of inflation in both Canada and the United States, but some pressures remain. One example is the cost of shelter, which makes up the largest weight within the Consumer Price Index in both countries. It includes categories such as rent and mortgage interest costs, both of which have shown few signs of abating, particularly in Canada. Furthermore, the downward trajectory of inflation has started to flatten after a relatively sharp decline through the first half of the past year. December’s U.S. inflation data, released this past week, even showed a modest uptick. We believe that policymakers at the Bank of Canada and the U.S. Federal Reserve will aim to get inflation sustainably under 3.0% before considering any rate cuts.
The Federal Reserve is also focused on employment as part of its dual mandate. While there has been a moderation in job growth, it is hard to argue that the employment backdrop in the U.S. requires any support from the central bank. A more meaningful deterioration in the U.S. job market may be required before the Fed considers any move to reduce rates.
Summary
Investors will remain hyper-focused on inflation and employment trends this year, as they try to gauge when central banks may take action and cut interest rates. We foresee this fueling swings in the markets in both directions as investors re-calibrate their expectations. Nevertheless, this year should mark a notable shift in the environment as central banks transition to a more accommodating policy. That has historically proven to be a more constructive backdrop for investors.
Are we headed for a full recession or a soft landing?
In the latest Macro Memo, RBC Global Asset Management’s Chief Economist Eric Lascelles talks about his view on soft or hard landing recession scenarios and how the relative probabilities of the two are shifting.
This includes discussing recent economic developments, supply chain, global central bank policies, and upcoming macro and political events – all of which contribute towards the debate on the likelihood of different recession possibilities.
Click below to watch this short video update and learn more about why Eric believes that the likelihood of a soft-landing has increased.
TFSAs – what’s changed for 2024?
Your Tax-Free Savings Account (TFSA) can be a powerful and tax-efficient tool when investing for short-term and long-term goals. The TFSA contribution limit has increased to $7,000 in 2024, up from $6,500 in 2023. If you’re interested in learning more, you can click the link below for more detail.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.
