Following the Jackson Hole conference and U.S. Federal Reserve Chair Jerome Powell’s speech, the Federal Open Market Committee (FOMC) is closer to cutting rates.
But the committee is still divided on timing and needs to see more data. A weakening labour market will make them more aggressive, but the inflation outlook uncertainty, driven by tariffs and immigration policy, will likely keep the pace slow.
However, the market was already pricing in the equivalent of 5-25 basis point rate cuts by the end of 2026. It only added a slightly higher probability that the rate cut will come in September after the speech. So, while the equity market read it as bullish, the bond market did not see it as much.
While U.S. President Donald Trump wants a strong stock market to be sure, what they really need is lower inflation pressure giving the FOMC the cover it needs to cut rates.
The real catalyst for them meeting the market expectations in 2026 is a weakening labour market or the narrowly believed outlook that tariffs are only a temporary shock to inflation.
Cutting rates because inflation is falling is bullish for assets – cutting rates because the labour market is losing jobs is NOT!
The Canadian economy has been structurally weaker over the past year with softer inflation, growth and labour markets giving the Bank of Canada more room to cut rates.
Looking forward, the bank is only expected to cut rates 25 basis points over the next year. The FOMC will narrow the 175-basis point gap to less than 100 basis points.
Historically, we should see the Canadian dollar appreciate versus the U.S. dollar, but I’m not sure that our economy justifies it just yet.
Should we see the Canadian dollar move back towards 1.4285 (70 U.S. cents), hedging long term exposure would make sense.
As rates in Canada and the U.S. converge, the cost of hedging comes down. Keep this strategy on the front burner.
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