Talking Points

July 03, 2026 | 12:13

Hydration Break Recap: Win Some, Lose Some

Economist

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter brings more than three decades of experience analyzing gl... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter brings more than three decades of experience analyzing gl... (Read more)

Thursday at noon marked the precise half-way mark for 2026—time flies—and it’s appropriate that the day saw a record-high close in the venerable Dow, as well as arguably the best match of the World Cup so far. After all, the key market and economic theme this year has been battling through and ultimately overcoming plenty of adversity. The MSCI All World Index finished the day with an 11.5% advance since the start of the year, almost exactly matching the previous six-month tally. Meantime, WTI dipped back close to $68, not far from its pre-war level in late February.

The conflict with Iran was clearly the new news in H1, and probably the biggest surprise of 2026 was that oil prices didn’t respond even more forcefully to the heaviest hit to global crude production… ever. With WTI never really getting far from $100 and averaging a bit less than that through the conflict, equities managed to shrug off the shock relatively quickly, and returned the focus to AI. Gasoline and diesel prices have been slower to recede, in part reflecting depleted inventories and perhaps Ukraine’s disruption of Russia’s supplies. In turn, that means headline inflation will be a bit slower to relent than the rapid-fire pullback in crude prices.

That stickiness in headline inflation will keep central banks on high alert for some time yet, and it’s why bond and currency markets have been less willing to quickly shrug off the conflict. Even as oil prices have fallen abruptly, the lingering impact of the energy shock was higher bond yields, especially at the short end. One of the biggest fixed-income moves in the first half was a 65 bp step-up in two-year U.S. Treasury yields, as the view on the Fed flipped from rate cuts to potential rate hikes. The year began with deep concerns over Fed independence—highlighted by the investigation into Jay Powell, and his fiery response. But consensus is calmer now, with Kevin Warsh’s initial comments as Chair ringing hawkish (or at least not dovish), Powell staying on as a Governor, and the Administration thwarted in its initial attempt to fire Governor Lisa Cook by this week’s Supreme Court ruling.

The shifting view on the Fed also pumped up the U.S. dollar, partially reversing its steep decline in 2025. The dollar flirted with its strongest level in almost 40 years this week against the yen at around 162 and is not far from 23-year highs versus the Canadian dollar at $1.42 (or just below 70.5 cents). Supporting the rebound in the greenback has been a solid underlying U.S. economy. While payroll growth came in light in June at 57,000, it averaged +92,000 in the first half compared with almost no net new jobs in 2025 (+10,000 per month). For overall growth, the relentless wave of AI spending, combined with a consumer backstopped by tax refunds and stock market gains, has kept GDP clicking a bit above 2%. The resilient economy, paired with headline PCE inflation above 4% and core above 3%, has the market pricing in full odds of at least one Fed rate hike by the end of the year.

Our view remains that the Fed will not hike this year, even with a rollicking equity market, a sturdy economy and above-target inflation. First, this week’s soggy jobs report and soft consumer confidence were reminders that while growth has held up well, it’s hardly overheating. More importantly, while inflation may be slow to recede, it will indeed recede if oil prices stay anywhere close to current levels. This week’s preliminary June inflation report from the Euro Area was a true leading indicator—CPI fell 0.1% m/m, slicing the yearly rate by 4 ticks to 2.8%, while core fell two ticks to 2.4%. While they will never say it, the ECB may already be having buyer’s remorse about its rate hike of just three weeks ago. San Francisco’s Fed President Daly may have put it best this week: “We don’t want to react quickly when the world is changing quickly.”

While trade and tariffs were not a big deal for much of the world in the first half of 2026—and certainly not compared with the high drama in 2025 H1—they were still a dominant factor for the Canadian economy. The long-awaited official review of the USMCA reached an eerily quiet denouement on July 1, when the U.S. declared that it would not sign a 16-year extension. While a surprise to only the starriest-eyed optimists, it leaves the deal in a limbo of annual reviews over the next 10 years. This has been our working assumption for some time in our forecasts; it’s not an ideal situation, as the uncertainty keeps a cloud over business capital spending and remains a serious threat to the auto, lumber and metals industries. Still, we count at least three reasons for some optimism on the Canadian economy when we look into the second half of 2026 and into 2027:

1) Growth seems to be recovering after the stall in the prior four quarters. Real GDP surprised on the high side in April with a 0.5% bounce, and early indications point to additional gains in May and June. This suggests that growth was close to 2% in Q2, after dipping 0.1% in the prior year (including, famously, small declines in the two previous quarters). Note that despite all the prior chatter about a technical recession, the output measure of GDP never slowed below a 0.5% growth rate on a six-month over six-month basis. And even the housing market is showing signs of bottoming out and turning around in the largest cities.

2) Major projects are gelling, highlighted by this week’s big announcement of plans for a 1 million bpd pipeline from Alberta to the southern B.C. coast. While it is still very early days, agreement on this sticky wicket is an encouraging sign of progress and could set the stage for a variety of other, less controversial, projects in coming months.

3) The domestic equity market is rolling. Yes, we know that the TSX is not particularly representative of the Canadian economy. Even so, it has acted as a very good leading indicator for growth—and it is pointing due north. The TSX has managed to churn out an 11% advance itself so far this year and was again nearing a record high by week’s end. What’s particularly noteworthy is the sustained nature of the rally. To pick but one metric, the index is up by almost 60% from two years ago, or nearly 55% adjusted for inflation. That latter increase has been topped only three times in the past 65 years—in the late 1970s commodity boom, in the late 1990s tech boom, and in the rebound from the 2009 crash (Chart 1). At the very least, the wealth effect flowing from these heavy gains should support consumer spending (and may help explain, in part, the prices some were willing to pay for said World Cup matches!).