Gaps in policy, productivity, and performance now increasingly apparent on both sides of the border
The decision by the Bank of Canada to cut its overnight interest rate by another 50 basis points yesterday was largely expected going into the meeting. Nevertheless, it reflects an increasingly uncertain economic picture for Canada with weaker than expected GDP growth, sluggish productivity, and worsening unemployment. While not a sign of the BoC hitting the panic button just yet, this is the second 50 basis point cut in a row and an expression of worsening prospects in Canada.
Geoff Phipps, trading strategist and portfolio manager at Picton Mahoney Asset Management, looks at Canada in a global and a North American context and sees 2024 as a year of divergence between Canada and the United States. He sees significant gulfs emerging beyond just a gap between the BoC and US Fed’s policy rates. In GDP growth, productivity, and inflation there are gaps emerging cross-border that Phipps believes advisors should be paying close attention to as we head into 2025.
“If we look big picture this meeting is reflective, I think, of 2024 being a year of divergence between Canada and — in particular — the US,” Phipps says. “That’s been our firm’s view for a while and it’s probably taken a little longer to play out. In 2023 people were talking about policy divergence and its only played out materially in the last six months. And I don’t think we’re done yet.”
Playing into this policy divergence, Phipps explains, is a Canadian per-capita GDP rate that has declined for the past six quarters. Real GDP, he says, would need to grow at an average of 1.7 per cent per year for the next ten years to get Canada to its average 40-year trend. Headline GDP, too, is likely to face headwinds as curbs to immigration come into effect.
Productivity, too, has been a problem since 2019 with rates effectively flat. The BoC, Phipps says, is aware of the structural reasons for Canada’s poor productivity growth and may be pushing faster towards a neutral rate in the hopes of restimulating productivity growth. They also see CPI and core CPI numbers that are at or even occasionally below their target, offering them more cover to cut.
The statement following the cut made explicit mention of the threat of US tariffs, the proposed GST holiday, and the deteriorating value of the Canadian dollar as well. On the mention of tariffs, Phipps believes it was prudent to acknowledge the threat but notes that BoC Governor Tiff Macklem has explicitly stated that threats of tariffs will not dictate policy. As of now bond markets have not priced in the reality of a 25 per cent tariff, acknowledging the likelihood that Trump’s social media statement is a bargaining chip at worst and pure bluster at best.
While there was mention of weakness in the Canadian dollar, Phipps called attention to earlier statements made by Macklem saying there is still room for further policy divergence from the US. Phipps again thinks it was prudent to make mention of the currency without going into too much detail in the statement. More noise might have implied a level of hawkishness that the BoC does not currently feel. Moreover, given how bearish futures markets for CAD currently are, there is not much risk of any knee-jerk shifts further to the downside.
Key to his view of policy divergence will also be what the US federal reserve does next week. Phipps expects that the final FOMC meeting of 2024 will result in a 0.25 per cent cut, greeted as something of a non-event. The US remains in a ‘goldilocks’ position of modest GDP growth, and relatively controlled CPI — albeit slightly elevated.
Despite some of the weaknesses in the Canadian economy, Phipps highlights that there are still opportunities in the Canadian market. A steepening yield curve, which Phipps says is in Picton Mahoney’s base case for 2025, is positive for the banks. On the whole he and his firm expect faster monetary cycles to continue to play out. There are some calls, he says, for the US Fed to start raising rates as early as Q2 of next year. While that is not in the list of likely outcomes, Phipps highlights the idea to prepare asset managers for the idea of even more policy whiplash going forward.
In that environment, Phipps believes that more passive strategies are less well positioned. He argues that traditional asset mixes like the 60/40 lack the ability to manage shorter cycles and more challenging environments. Some degree of actively managed strategic allocations, he says, may add value.
“Traditional asset allocation has to be revisited with something that looks much different than 60/40. I think portfolios are going to need some core strategic element that has a positive performance in inflationary or stagflationary environments,” Phipps says. “And there are products and asset classes that can address that.”
