Rate cuts have begun in Canada – when will the U.S. follow suit?

The world seems to be shifting from a time of rate hiking to a time of rate cutting and emerging market central banks have been headed downward for a while now.

We now have a handful of developed world central banks that are easing, including the Bank of Canada, with a number of others seemingly yet to come. And it makes sense that this pivot is happening. We do see inflation becoming less high. That's the main motivator. We know that interest rates are still quite restrictive, so there's a desire to remove the pain associated with that.

But it's likely to be quite slow. Historically, central banks cut rates very quickly, but that's normally because they're confronting a recession. That doesn't seem to be the case right now. The way up this time was very fast and that was to deal with this inflation emergency. Inflation is not coming off as quickly as it came on.

Again, it should be a slower journey and very dependent on the path for inflation and growth. Certainly we have forecasts and we think it's reasonable to think the Bank of Canada can cut rates perhaps a few more times over the span of 2024. We think the Fed starts a little bit later. And there's an interesting gap that's opening up here between the two central banks.

And it makes sense. The Canadian economy is weaker, Canadian inflation is lower. Canadians in general are more interest rate sensitive. Canada should be cutting rates first and seemingly is. But we think there's the window for the U.S. also to begin reducing rates perhaps in the fall. It's a little bit tricky from a timing perspective with an election that's approaching and so on, but I would think they can deliver perhaps a cut, maybe a little bit more and ultimately have the bulk of the world's developed economies on this downward path.

And the big question we ask ourselves as economists is where are they going? What's the end point? The honest answer is we don't know. It's all dependent on the economy and other things. And it is somewhat of a changed world relative to before the pandemic. And we're guessing as to what a neutral rate might be, where they're targeting the end point.

But to the extent we make a guess, we think something like a two to three and a half percent range is a good one. Really the story here is one in which there should be room for multiple percentage points of easing over the next few years. And that should make the debt burden for the average person quite a lot less.

Will the growing U.S. deficit stifle economic growth?

We’re in a very unusual position right now, which is that economies are growing and yet there are just massive public deficits out there in the U.S. among the leaders in that regard. Not unique though. There are quite a range of countries that are running pretty big deficits right now. And really that just says that governments are spending more than they can sustainably spend. And particularly at a time when interest rates are rising, that becomes more painful to service that debt. One of the more flashy talking points recently has been that U.S. public debt servicing costs are on their way to exceeding the military budget. You're spending a lot of money paying interest when you might be spending on other more critical things. This isn't really a focus right now even for markets.

Right now, markets are focused on can the economy keep growing, does inflation come down? How much rate cutting can we actually get? But I think when you look beyond those near-term issues, fiscal austerity and the need for smaller deficits is going to be pretty central to the medium term. Over the next two to five years, I would think that becomes more of a priority.

The U.S. is a bit of a special case to the extent it's the world's reserve currency. It gets away with a lot that other countries maybe don't. It's an open question just how much the U.S. specifically manages to fix this, particularly with two presidential candidates who don't seem to be really prioritizing balanced budgets or prioritizing the deficit whatsoever.

But in general, I think it's a good guess that there should be some fiscal austerity in the U.S. It's a very strong prediction that we can expect fiscal austerity in a range of other countries and it's going to be a headwind on economic growth slowing things down with maybe some of the less well behaving countries punished in terms of a bigger risk premium in the bond market.

How will the result of the U.S. election influence the markets and economy?

The U.S. election is getting awfully close. It's in November of this year and we know who the candidates are. It looks like it's a reprise of the 2020 election. It's Biden versus Trump, of course. One is the current president, one is the prior president.

We have a bit of a track record and a bit of a sense what each one is about. It looks like it's a really close race right now. We track betting markets and probability markets and certainly polls as well. And they say it's close. Either could win at this juncture. Maybe Trump is a hair in front, but it's very close.

Either candidate is quite conceivable. Obviously, their platforms and policies potentially matter quite a lot for the economy and for markets. And, you know, when we look at this, we first take things with a grain of salt because we know that politicians always campaign in poetry, they govern in prose. The reality is there will probably be a divided Congress coming out of this.

That limits what any president can actually achieve. And we need to keep that in mind. Nevertheless, as we pass through some of the proposals, these are very tentative thoughts and these may yet change. But from a stock market perspective, you could argue that the stock market might be more favourable toward the Trump platform. He's proposing corporate tax cuts, which stock markets love.

He's proposing deregulation, which they're also very fond of. That might be the positive stock market side. From an economic standpoint – and recognizing the stock market isn't the economy and vice versa – I think you might make the opposite comment tentatively. Trump is proposing tariffs, which hurt growth. Trump is proposing less immigration, which perhaps hurts growth and so possibly happier stock market and a slightly weaker economy if he were to win, possibly the reverse if we were to get the other outcome.

But let's keep in mind that there's a lot of uncertainty still. The divided Congress is key here because a lot of these aspirations won't be delivered if that's how things play out. And critically, there is one really common point here that both candidates are very similar on, which is neither seems to be paying particular attention to the overall fiscal position of the U.S. budget.

That would argue that if these deficits keep running, that's support for the economy regardless of who wins the election. Economists would say maybe that's the single most important consideration.

Will China’s economic growth rebound?

The Chinese economy matters enormously. It consumes half of the world's base metals, among other things. It's an economy that we're watching really quite closely and it needs to be tracked, whether you're investing directly in it or not.

Certainly most of the headlines about China these days revolve around housing market woes. Those are very real. Chinese housing market was a driver of growth. Now it is a source of profound weakness. We do see lower Chinese home prices and falling home sales and struggling builders and so on. I do want to say Chinese policymakers are doing something about that, or at least starting to do something about that.

They have cut rates and cut mortgage rates and they've eased buying requirements. And they have most recently created a program to absorb some of the excess unsold inventory that builders have constructed. They are doing things to try to stabilize this market. I think we're some distance off from it being stabilized. I don't have any expectation of a housing boom in the foreseeable future in China. But I do think focusing just on housing may mislead a little bit because we can say that even though the Chinese consumers are cautious and they're very much tied up in housing and housing wealth is a big driver of household wealth.

We can say that Chinese retail sales are rising contrary perhaps to the public imagination. So consumers are spending. We're actually seeing quite strong industrial production right now and pretty good export growth and so on. And so when you tally that up, China is on track for more than 5% growth this year. So the Chinese economy is growing. It's not a disaster.

I think the Chinese stock market may be starting to recognize that there is maybe some upside here. But looking I guess beyond that, I would say I get a lot of questions as to whether we can trust the Chinese numbers. Are they really growing at 5%? The answer is, well, it's hard to say with precision, but we do run three alternative indicators of Chinese economic activity.

They're about the same right now. So they would say that it's not obvious China's numbers are greatly different. You know, China isn't secretly stagnating. China probably is growing by something like 5% right now. Looking to the long term, just briefly on China, I would say China probably does decelerate somewhat from here. We are penciling in 3 to 4% growth as a long-term norm in a time of diminishing demographics, at time of frictions with the U.S., given the lack of support from housing, it makes sense the Chinese economy slows somewhat further. But that's not a bad growth rate in an absolute sense.

It beats the developed world. At a minimum, China is even at that sort of growth rate on track to generate about a quarter of global growth. So it's going to matter a lot. It is still an economic power.

What are the forces affecting Canada’s housing market?

Well, certainly in a time of higher interest rates and rates are still high, even as central banks start to ease or to think about easing, there is a lot of pressure on the housing market.

Of course, we've seen real weakness in recent years and I'm not sure we're fully through that. In fact, the way I would put it in a Canadian context is there is one big powerful support for housing. And if you want to be an optimist on the housing outlook, you would point, of course, to population growth driven by immigration growth.

It's just unprecedented. And there is a shortage of housing and there is a lot of demand for housing. And you can argue that perhaps housing should therefore soar. We're a bit more skeptical, though, just because we do still know that affordability is extremely poor because of those high rates, but not just because of that, because home prices also have gone up an awful lot in recent years and indeed over the last few decades.

The affordability we still think is maybe the stronger force. We know that Canadians are set to roll mortgages over the next few years in a way that significantly increases those monthly payments. That would be inconsistent with a housing market boom, at least on the price side. We're looking for roughly flat home prices over the next few years at a minimum, underperforming the normal rate of growth.

When we look regionally, certainly there is some variation and know the biggest markets may be most limited. Alberta has its own special story to the extent it didn't fully partake in some of the earlier strength. And so it may well enjoy more strength, but in general it should be a subdued period on the price side, not totally inconsistent with the experience from the 1990s, which was the last housing bust.

And you had an intense drop initially and then just a period of stagnation in which allowed incomes to catch up and interest rates to settle and those sorts of things. That's really what we're looking for here. I will step away from prices for a moment. And just to speak about construction activity on the residential side. There is a housing shortage.

Governments are doing some things to try to induce additional supply. It's coming slowly, though, because it's still very expensive financing for builders. It's still hard for them to find people with expertise in the trades. We're not expecting fireworks there in the next few years. But I think over the remainder of the decade, you would expect construction activity to pick up in a pretty robust way.