A continued decline in inflationary pressures, coupled with ongoing signs of a cooling Canadian economy, prompted the Bank of Canada to make its third consecutive interest rate cut this week. It’s widely expected that the U.S. Federal Reserve will initiate its first rate cut at its next meeting later this month. Today, we discuss the state of the Canadian economy and reflect on the Canadian equity market’s performance so far this year.

Canada's inflation rate has steadily declined this year to 2.5% year-over-year in July, marking its lowest level since March 2021. The economy grew at an annualized rate of 2.3% in the second quarter, however, roughly 80% was driven by increased government spending. For the fifth consecutive quarter, per-capita growth declined, unable to keep pace with Canada’s population growth.

The Canadian labour market also offers a mixed picture. While the unemployment rate held steady at 6.4% in July, it has risen almost one percent from the same time last year. However, this uptick is more a reflection of slower hiring than widespread job losses.

Canadian households continue to grapple with mortgage refinancings. Many homeowners secured ultra-low mortgage rates during the pandemic and are now seeing their fixed-rate terms expire, with a considerable number of renewals still on the horizon. RBC Economics has estimated that approximately 25% of all existing mortgages will reset in 2025, and a third will follow in 2026. While a decline in interest rates can help, some analysts predict mortgage payments could rise between 20% to 40% depending on the extent of rate cuts, creating a drag on consumer spending as households grapple with higher borrowing costs.

Despite a relatively weak economy, Canadian equities have performed well, with the market up over 12% year-to-date. This underscores the point that stock markets can sometimes reflect a different picture than the economic reality. Markets tend to be forward looking, with prices reflecting expectations of the future trajectory of company earnings. In contrast, economic data tells us what has already happened.

The Canadian stock market’s strength this year can be partially attributed to the anticipation of rate cuts by the BoC, which should eventually provide relief to both Canadian consumers and businesses. This has helped the performance of rate-sensitive sectors like Financials, Consumer, Utilities, and Real Estate. The market has also been buoyed by strong performance across other sectors like Materials and Energy.

We consider Canada’s stock market to be fairly valued, meaning it is neither expensive nor cheap. The performance of the stock market is encouraging as it has come in the face of economic challenges that may persist for some time to come. Nevertheless, the rate cuts that are well under way should eventually serve as an offset to the hikes implemented just a few years ago and potentially lead to a more durable period of growth at some point in the future.

Thanks for tuning in and see you in two weeks.