Threat of tariffs overhang Bank of Canada and Federal Reserve interest rate decisions
Canadian investors might have ended the day yesterday with little more clarity on the state of North American monetary policy than they woke up with. Despite a Bank of Canada cut of 25 basis points, and the decision to hold interest rates steady by the US Federal Reserve, the core macroeconomic question remains unanswered. We can only hear that answer from one person, President Donald Trump.
CI Global Asset Management’s economist Neil Shankar explained why these meetings haven’t given investors some of the clarity they were seeking. He explained the role that the threat of US tariffs played in both meetings and highlighted what we have learned and how advisors can still offer reassurance to their clients despite some of the uncertainty we see now.
“I think Canadian investors certainly need to wait for more details from the Trump administration as it relates to some of the potential tariff threats that have been proposed, particularly as it relates to the scale, the breadth, the timing, the duration of these tariffs that are still looming,” Shankar says. “So unfortunately, we got some clarity on how the Bank of Canada is thinking about this, how the Fed is thinking about this, but I think there still remains more questions than answers, given the uncertainty around these threatened tariffs.”
The threat of tariffs was explicitly addressed by Bank of Cananda Governor Tiff Macklem following the BoC’s decision to cut its overnight rate. Macklem stated that his goal is now to get Canada onto as solid of an economic footing as possible ahead of any potential tariffs. Shankar notes that the tariff threat was not the only factor in Macklem’s decision, with a CPI number sitting below two per cent and an economy in excess supply. Nevertheless, it was an explicit factor for the Bank of Canada.
Fed Chair Jerome Powell, conversely, was more cagey in addressing the threat of tariffs. He told reporters in his press conference yesterday that the range of possible outcomes was too broad for him to comment on. Shankar notes, however, that the Fed’s summary of economic projections released after the December FOMC meeting saw a majority of participants revised the inflation risk in their core inflation forecast to the upside. He sees this as a more implicit acknowledgement of some of the possibly inflationary impacts of Donald Trump’s policy goals.
The future path of interest rate policy decisions for both central banks, Shankar says, will depend on the scale, breadth, timing, and duration of Trump’s tariffs. Moreover, he notes that explicit carve-outs for certain sectors and goods might make a major difference. Shankar highlights the scenario of 25 per cent blanket tariffs included in the Bank of Canada’s monetary policy report. In that scenario, which included in-kind retaliatory tariffs from Canada, they expect a 2.5 per cent hit to Canadian GDP in the first year and some upward pressure on inflation.
Yesterday's meetings also leave the Bank of Canada and the Fed more than one full per centage point apart. Policy divergence had already impacted the value of the Canadian dollar, which was further hit by the threat of tariffs. Favourable developments on the tariff front, Shankar says, might even result in some upside for CAD despite the policy divergence.
Nevertheless, advisors and their clients are now facing the overhang of uncertainty and the threat of economic devastation from possible US tariffs. While that overhangs it may be challenging for advisors to present the positives to their clients, but Shankar argues that there are positives to be found and that focusing on them might help offset some of the fears now present.
“There's certainly a lot of risk on the horizon. But underneath that we're actually fairly optimistic about the Canadian economy, outside of this huge risk of tariffs,” says Shankar. “Canada has eased aggressively since June, we've had 200 basis points of monetary policy easing over the past seven months. Even as the Bank of Canada highlighted today, you are starting to see an improvement in underlying economic activity. Consumption data has been relatively firm. The labour market is showing some signs of strength in Canada and we have the potential for a more business-friendly government. All of these things improve the medium-term outlook for Canada. If we do get a more favourable outcome on the tariff front, we actually can paint a relatively optimistic picture for the Canadian economy and that's something that I would also communicate to clients.”
