By Michael O’Neill

Who knew Bank of Canada Governor Tiff Macklem was a Frank Sinatra fan? The BoC cut the overnight rate by 25 bps to 4.75% and became the first G-7 central bank to ease policy following the post-pandemic rate hike spiral.

It wasn’t much of a surprise. A host of weak economic reports, particularly sluggish Q1 GDP data, combined with falling inflation, ticked all the boxes that the BoC said needed to be ticked before rates could be lowered. Still, about 20% of economists and analysts believed the BoC would not move in June. The expected the cut at the July 2024 meeting, after policymakers had time to digest the latest Business Outlook Survey and the updated economic forecasts in the  Monetary Policy Report.

Many pundits suggested that the BoC would need to wait and follow the Fed’s lead, but the Governor dismissed that notion out of hand. He told the House of Commons finance committee at the beginning of May that, “Our interest rates in Canada don’t need to be the same as the U.S. rate or global rates. But there is a limit to how far they can diverge. We’re not close to that limit.”

You just know Mr. Macklem is feeling pretty good about himself as it was rumored (by me) that he walked to the press conference podium quietly singing:

“Yes, there were times, I’m sure you knew
When I bit off more than I could chew
But through it all, when there was doubt
I ate it up and spit it out
I faced it all, and I stood tall
And did it my way” (Frank Sinatra)

More Dovish than Hawkish
Traders saw the statement as more dovish than hawkish because of its focus on falling inflation rates. The press conference statement noted that “the 3-month rates of core inflation slowed from about 3½% in December to under 2% in March and April. It also pointed out that the proportion of CPI components increasing faster than 3% is now close to its historical average, suggesting price increases are no longer unusually broad-based.”

The kicker was, “If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate.”

Smoke and Mirrors

The BoC policymakers will have you believe that the decision to cut rates was “Made in Canada,” and solely based on domestic data. But was it?

It is certainly looks like the Governing Council was reacting to the sharp fall in US Treasury yields in the past week. Recent soft US economic data, including the June 5 ADP employment change report, led traders to speculate that the first Fed cut would be in September (55% chance). The data fueled a plunge in the 10-year Treasury yield from 4.64% on May 29 to 4.348% on June 5. The 2-year yield fell to 4.75% from 5.00%.

Loonie Losing Luster
The Canadian dollar (Loonie) faces several challenges that could dampen its value. Here are the main factors contributing to its potential decline:

  • Interest Rate Differentials: A significant influence on the Loonie is the CAD/US interest rate differential. The 10-year yield gap has widened to -90.2, favoring the US, only slightly improved from the record -91.1 seen in April 2024.
  • Economic Growth Disparities:
    • Canada’s economy is projected to grow only 1.5% in 2024, compared to 2.4% in the US.
    • Most of Canada’s growth is expected to stem from Federal government spending, rather than improvements in productivity.
    • The Fraser Institute highlights that since mid-2019, Canada has faced one of the longest and deepest declines in real GDP per person since 1985.
  • Foreign Investment Declines:
    • Investment in Canada’s oil sector has significantly decreased due to the federal government’s shift from fossil fuels to renewable energy.
    • This policy change has deterred investment in the world’s third-largest proven oil reserves, previously a key support for the Canadian dollar.
  • Fiscal Policy Impacts:
    • According to the Canadian Taxpayers Federation, as of June 5, 2024, Canada’s Federal debt stands at $1.228 trillion, equating to $31,039 per person.
    • The tax rate on capital gains exceeding $250,000 has increased from 50% to 66.7%, which may discourage investment in new businesses and increase government tax revenues.

While Macklem is crooning “My Way,” the Loonie is on a “Highway to Hell.”