In this week’s economic update, we are focusing on the expectations for further interest rate cuts in both the U.S. and Canada. We are also exploring the potential impacts from recent and upcoming political developments in both nations.
We are also sharing the most recent episode of #MacroMemo, where RBC’s Chief Economist Eric Lascelles is exploring these topics to further detail – the incoming U.S. President’s agenda, the moderation of economies, and the slipping of the Canadian dollar.
Economic Update
The stock markets closed out a strong year on a quieter note as investors began to re-calibrate their expectations for future interest rate cuts by the U.S. Federal Reserve. This shift in expectations led to a rise in government bond yields that continued in recent weeks. Below, we provide updates on recent developments in Canada and the United States.
Reduced rate cuts expected for 2025 from Federal Reserve
The Federal Reserve cut interest rates at its mid-December meeting, as widely expected, despite inflation showing signs of being sticky. However, Fed Chair Jerome Powell struck a different tone on future rate cuts, stating that it will likely be appropriate “to slow the pace of further adjustments,” while acknowledging that the risks of economic weakness and inflation are relatively balanced. Policymakers’ projections revealed that they now expect to cut rates by only 0.5% in 2025—half of what was previously anticipated—and raised their inflation forecast for the year.
Bank of Canada also looking to moderate future cuts
Closer to home, the Bank of Canada (BoC) also signaled the potential for a more restrained approach to interest rate cuts going forward. Markets currently expect 0.50% to 0.75% worth of rate reductions this year. However, it would not be terribly surprising if the BoC feels compelled to go further to avoid the risk of undershooting its 2% inflation target. The Canadian economy has been relatively lacklustre, with expectations this may continue near-term, which has contributed to lower Canadian bond yields than in the U.S. The Canadian dollar has suffered as a result because global funds tend to flow towards higher-yielding currencies, thereby strengthening their value relative to lower-yielding ones.
Trudeau resignation could complicate tariff negotiations
Meanwhile, Canadian Prime Minister Justin Trudeau announced his resignation. This was somewhat expected following months of poor polling, recent exits of key officials within the Cabinet, and mounting calls for his departure. Nevertheless, his exit introduces significant political uncertainty at a time when the country is dealing with the threat of tariffs from the incoming U.S. administration. Trudeau will remain in office until his successor is selected, with Parliament suspended until late March. Although the Canadian government retains the power to impose counter-tariffs on the U.S. without legislative approval, the leadership void could complicate negotiations. This uncertainty is also weighing on the Canadian dollar.
Long-term view critical in the face of recent political developments
Recent developments in Canada may not inspire a lot of confidence in investors. But it is worth noting that the Canadian equity market may not depend as much on political or economic developments at home as it once did. After all, Canadian equities were up nearly 20% last year despite the fractures that already existed domestically. Instead, other factors, such as falling interest rates and declining inflation, have arguably been more important. In addition, U.S. growth has benefited many of the Canadian businesses that have become increasingly tied to activity south of the border over the years. Therefore, in our view, it’s important not to get too swayed by developments at home.
Summary
Overall, we expect some continued pessimism about Canada and its near-term economic prospects. But interest rates may continue to move lower, which may drive some anticipation of better economic and earnings growth later this year. Meanwhile, sentiment is nearly the opposite when it comes to the U.S. The consensus view is for continued economic expansion, the emergence of regulatory and tax tailwinds, and for limited additional rate cuts. Investors should remain mindful that these expectations – positive for the U.S. and less so for Canada – are already reflected in current market valuations. It’s the potential for a change in the outlook, for better or worse, that will likely drive market movements. As always, we are constantly and proactively monitoring the markets as part of our investment strategy, and we remain confident in our portfolio management approach.
#MacroMemo – Change and more change: updates from Eric Lascelles
In the latest episode of #MacroMemo, RBC’s Chief Economist Eric Lascelles dives into many of the most recent forces shaping the economic outlook. These include President-elect Trump’s agenda (tariffs, tax cuts, and more), Prime Minister Trudeau’s announcement that he’s stepping down, the signals of a moderating economy, and the expected slowing of future rate cuts.
You can watch the full episode (or read the transcript) by clicking here.
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.