Markets are betting the Bank of Canada will cut at each of its remaining interest rate decisions this year as the labour market in the United States looks to be loosening faster than expected.

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Bank of Canada seen cutting interest rates faster after weak U.S. jobs data Back to video

The U.S. interest rate decisions unexpectedly rose to 4.3 per cent on Friday, leading markets to price deeper cuts from the Federal Reserve in 2024. Some analysts, including at Citigroup and JP Morgan, are now expecting two half-percentage point bouts of easing from the Federal Reserve at its next two meetings.

Though Governor Tiff Macklem insists the Bank of Canada sets policy independently, he can more comfortably lower borrowing costs if the country’s biggest trading partner is about to join the global trend of cutting interest rates.

The two countries’ economies are deeply intertwined, and more weakness in the U.S. is likely to trickle through to Canada. That also allows Macklem to keep normalizing borrowing costs without worrying about moving too far ahead of the Fed and risking consequences for the loonie.

“If the U.S. economy is rolling over and the Federal Reserve is cutting, that gives the Bank of Canada a green light to keep going and push toward neutral,” Benjamin Reitzes, rates and macro strategist at Bank of Montreal, said by email.

Canadian bonds rallied after the U.S. data was released, and yields on Canadian government five-year notes fell 13 basis points to 2.89 per cent just before 3 p.m. in Ottawa, the lowest level since May 2023. Traders in overnight swaps are fully pricing three more rate cuts this year, upping bets that Canada’s central bank will ease at each of its upcoming meetings.

In mid-July, economists in a Bloomberg survey expected the central bank to cut its key policy rate from the current 4.5 per cent to 3 per cent by the end of next year.

But after the release of the U.S. data Friday, Bank of Montreal’s Doug Porter wrote to investors that his bank now sees Macklem cutting the policy rate at each of the next four meetings, bringing it to 3.5 per cent by January and ultimately to 3 per cent by mid-2025. “That means the bank will arrive at the presumed end point more than half a year earlier than expected,” he said.

In June, the Bank of Canada led the Group of Seven countries into easing, and cut rates for a second consecutive meeting in July as evidence of cooling inflation mounted. Macklem’s decision to launch into cuts ahead of the Fed sparked currency worries amid expectations that Bank of Canada and the Federal Reserve’s interest rate policies would diverge.

For now, those concerns are looking increasingly to be in the rearview mirror as the spread between U.S. and Canada rates narrows and the countries’ outlooks realign.

“Even though they’ve said we’re not close to limits of divergence, it has to give the Bank of Canada a bit of comfort knowing that the Fed is going to be right behind them,” Taylor Schleich, a rates strategist with National Bank of Canada, said by email.

But Friday’s global bond rally also has the potential to add to Canada’s upside inflation risks. The vast majority of fixed mortgages in Canada have terms of five years or less, and their rates are likely to soon move lower if yields continue to fall. That puts the risk of a sharp rebound in the country’s housing market back on the table after the Bank of Canada had faded the possibility of surging home prices complicating the inflation picture in July.

The Bank of Canada also released a June survey of economists on Friday that showed just how quickly the outlook has changed — the median expectation for 5-year yields was 3.28 per cent by the end of 2024.

Canada’s unemployment rate — which is calculated differently than in the US — rose to 6.4 per cent in June, and is up 1.4 percentage points since the beginning of 2023. Statistics Canada releases July data for the Labor Force Survey next Friday, and economists expect the jobless rate to rise again to rise to 6.5 per cent.

“The weaker U.S. data should pass through into the BoC’s thought process,” Andrew Kelvin, head of Canadian and global rates strategy at Toronto-Dominion Bank’s securities division, said by email.

Bloomberg.com