Central banks diverged, as cloud giants split the market
Why did the Bank of Canada increase its interest rate?
On Wednesday, the Bank of Canada (BoC) raised its policy rate a quarter of a percentage point to 2.5%, its first increase since July 2023. Markets had priced it in, so the reaction was muted, with two-year bond yields up by only a couple of hundredths of a percentage point, and the loonie little changed.
Core inflation (inflation minus food and energy) sits near 2%, unemployment has hovered around 6.5% for months, and the BoC itself still sees excess supply in the economy. Those look like conditions for holding the interest rate. However, the BoC hiked anyway, because its new forecast changed the picture. Headline inflation (which includes food and energy) is expected to run at around 3% through much of 2027, rising to about 3.5% by year-end, and to only return close to 2% by mid-2028. The stated goal is to reduce the risk that high energy prices spread to everything else. That makes this an insurance hike. Canadian gross domestic product growth gave the BoC some room for keeping rates lower, with forecasts raised to 1% this year and 2% for 2027 and 2028, as exports held up better than feared on strong U.S. demand and higher energy output. Bank of Canada Governor Tiff Macklem left the door open to the possibility of more hikes but promised to proceed carefully. The U.S. Federal Reserve helped with this position, as you'll see below. The next decision on rates will be on December 9.
Why did the U.S. Federal Reserve hold its interest rate?
A few hours later, the U.S. Federal Reserve (the Fed) held its rate at 3.75-4%. The vote was 10-2, with Governor Lisa Cook and Cleveland Federal Reserve President Beth Hammack preferring a hike. The statement said more information will help the committee set the stance needed for a timely return to 2% inflation. Fed Chair Kevin Warsh again refused to offer forward guidance, saying he only believes in it during a crisis. He said growth has strengthened, insisted politics played no role in his decision (six days before the U.S. mid-term elections) and announced that the Fed will hold fewer rate-setting meetings starting next year. Markets read it as a pause with a lean toward potential rate increases in the future. The Fed’s December meeting, when new projections will be available, remains likely to result in a hike.
The irony of the day is hard to miss. For months the set-up was a Fed leaning toward hikes and a Bank of Canada with room to wait before making a decision. On Wednesday, Ottawa moved and Washington paused. Each central bank followed its own forecast, and Canada’s now shows inflation to be stickier than was expected in July.
Why did Microsoft and Alphabet get different market reactions?
Microsoft and Alphabet both reported their quarterly earnings on Wednesday evening, and both showed accelerating cloud demand. Microsoft’s Azure grew by 48% to $33.2 billion, ahead of the company’s forecast of its future financial performance. Google Cloud grew by 103% to $30.7 billion, with $11.1 billion of operating income. The reactions were split; Microsoft’s stock rose after the market closed, while Alphabet’s share price dropped sharply.
The difference was the cost. Microsoft spent $45.2 billion on capital expenditure and still generated $18.6 billion of free cash flow. Alphabet spent $51.4 billion, more than double a year ago, and burned $9.1 billion in cash, its second straight quarter of negative free cash flow. It held its 2026 capital expenditure range at between $195-$205 billion and said 2027 spending will increase significantly. Alphabet’s Search and YouTube ad revenue was lower than expected.
This is the grading system the market has applied since the summer. Growth gets you in the door, and funding decides the reaction. Microsoft pays for its AI growth from operations. Alphabet is funding growth that keeps getting bigger with money its operations are not yet producing. That made it the fastest grower in the room but with the weakest reaction from the markets, for the second quarter running.
What market data is due next week?
The U.S. mid-term elections will take place on Tuesday, November 3. We still wonder about the likely market reactions, depending on the outcome, but we shall see. We’ll also have interesting jobs data on both sides of the border later in the week.
Listen to the latest podcast from the IG Investment Strategy Team for further insights.
