Canada Will Eclipse the U.S. with Rate Cuts

Starting in June, Canada will move first to cut rates and the cost of borrowing will decline by more than the US in 2024. 

In addition to yesterday’s stronger than expected US inflation report, employment figures released last Friday in Canada and the US shed additional light on two very different realities. While the US is showing signs of heating up, possibly giving rise to a resurgence in inflation, Canada’s economy continues to drift lower.

The US added 303,000 jobs during March, well ahead of the 200,000 gain that was forecasted by economists. This contributed to their unemployment rate falling 10 basis points to 3.8%.

On the inflation front, US price growth (excluding food and energy, which are removed because of their volatility), exceeded economist estimates in January (+3.9% year-over-year), February (+3.8%), and now March (+3.8%) as well.

Economists thought we would add 25,000 jobs in March, yet we lost 2,200 positions. Our unemployment rate ticked up from 5.8% in February to 6.1% last month. Sure, monthly numbers can be lumpy, but the direction is negative.

Inflation is cooling faster in Canada than south of the border. In fact, February’s core inflation reading was the lowest in more than 2 years. Compared to 2023, core inflation rose 3.4% in January and 3.2% in February, underwhelming economist estimates both times.

Let’s not forget the inflation target for each respective central bank. The US Federal Reserve targets a 2% inflation rate while the Bank of Canada aims to keep inflation at the 2% midpoint of its 1 to 3 per cent target range.

Pierre Trudeau once compared Canada’s relationship to the United States as sleeping next to an elephant. This time, however, the elephant in the room is domestic.

Three-quarters of Canada’s mortgage borrowers have a fixed rate. Now that four years have passed since the pandemic started when many borrowed or refinanced at ultra low interest rates unseen in an entire generation, our mortgage market will face a flurry of renewals in 2025 and 2026 at significantly higher interest rates.

14% of all outstanding Canadian home loans will renew in 2024, followed by another 24% in 2025 and 35% in 2026. According to the Bank of Canada, borrowers with a five-year, fixed rate mortgage maturing in 2025 and 2026 will pay about 20% more to their lender upon renewal. For most people, that translates into an additional $400 per month, which will surely slow down consumer spending in the years to come. After all, about 60% of the economy is the consumer.

By contrast, the most common mortgage in the US is a 30-year fixed rate loan.

We expect the Bank of Canada to cut rates three times in 2024. Irrespective of the US’s monetary policy, Canada will begin its rate-cutting cycle in June because domestic inflation is weakening, our employment market is declining, and there are a large volume of fixed rate mortgages that will renew at significantly higher interest rates over the next 2 years.

While this will lead to a lower Canadian dollar relative to the US greenback, we also expect the dividend-paying Canadian stocks to attract more attention from income-seeking Canadians as GIC rates decline.