Markets anticipate rate cuts in Canada and the U.S.
Markets showed notable strength this week, with the S&P 500 Index surpassing its previous peak in February. Banks led gains, with industry analysts suggesting that, as long as there’s no recession, it’s “game on” for equities. The rally was driven by the belief the U.S. Federal Reserve (the Fed) will soon begin cutting interest rates. Weaker economic data — including a downward revision to U.S. gross domestic product (GDP) growth and the poorest consumer spending figures since the COVID-19 pandemic — strengthened the case for monetary easing, which has drawn retail investors back into equity markets.
The bond market moved in tandem with equities, as Treasury yields and the U.S. dollar both declined. Traders are now pricing in a high probability of two or possibly three rate cuts by year-end, with the first anticipated as early as September. However, this contrasts sharply with the Fed’s official stance. Nearly a dozen Fed officials (including Chair Jerome Powell) have emphasized a cautious, data-driven approach. While some hinted at a potential rate adjustment in the fall, their tone suggests a timeline far more conservative than markets currently expect.
In Canada, the economic outlook is more complex. The Bank of Canada (BoC) is navigating a challenging environment, working to navigate sluggish economic conditions while managing risks of tariff-induced inflation. Weaker employment data, easing wage pressure and less inflation from tariffs than expected in the spring justify further rate cuts. The BoC may consider two additional 25-basis-point (a quarter of one percent) cuts this year, bringing the policy rate to 2.25% from its current 2.75%. This backdrop highlights the difficulty of offsetting economic drag from global trade tensions. While regions like Alberta benefit from population growth and a resurgent energy sector, these bright spots are unlikely to fully counteract broader economic headwinds, particularly in the eastern provinces, where tariffs on steel and aluminum continue to exert pressure.
Meanwhile, U.S.-Japan trade talks are reaching a critical juncture, with President Trump’s reciprocal tariffs set to kick in on July 9. Japan’s chief negotiator, Ryosei Akazawa, is heading to Washington for further discussions, with auto tariffs being the primary sticking point. Akazawa has signalled a willingness to extend negotiations if necessary, adhering to the principle that “nothing is agreed upon until everything is agreed upon,” a sentiment shared by many nations.
Looking ahead, the upcoming U.S. inflation report will be a key test of whether market expectations are justified or if the Fed’s patience will ultimately prevail. A clear divergence remains between market optimism for imminent U.S. rate cuts and the Fed’s patient, data-driven stance.
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