Talking Points

July 17, 2026 | 12:39

Monetary Policy’s Odd Odyssey

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)

This is an unusual time for markets, with a reasonable debate for both sides on whether the next move by central banks will be to hike or cut interest rates. Certainly, markets are leaning to at least one hike by the Fed and perhaps half of one by the Bank of Canada by the end of 2026, but there’s not much conviction. All it would take to wash away those hawkish views could be a serious crack in energy prices, and/or the equity market. On the flip side, of course, is that all it would take to ratify those views would be a renewed ratcheting up in fuel costs, perhaps alongside ongoing strength in equity markets. Naturally, just to add to the haze, fuel prices did jump this week as the ceasefire ceased, but the highest-flying portions of the market took a big step down—both the Philadelphia semiconductor index and the KOSPI entered bear markets—undercutting equities more broadly. Thus, even amid the upswing in oil prices, 2-year Treasury yields fell slightly for the week.

Also somewhat trimming the chances of Fed rate hikes was a pair of friendly U.S. inflation readings for June. True, the more recent pop in energy prices renders these results for last month as already a bit past their “best before” date. But even beyond the flashy headline drops in CPI and PPI, June core prices were much milder than expected, turning the volume down on arguably the best reason for the Fed to consider hiking. Core CPI was flat—technically, down 0.02%—only the second time that such a tame result has happened in the past 15 years, aside from the madness of spring 2020. This shaved the annual underlying inflation rate to a non-threatening 2.6%, with both the 3- and 6-month trends the same or milder. While the June PCE price index will likely come in warmer, upcoming revisions in that series—alongside Fed Chair Warsh’s comments that he doesn’t fully trust any of the official inflation gauges—have somewhat clouded its reputation as the go-to inflation reading.

Chair Warsh’s semi-annual testimony to Congress provided some heat, but not a lot of new light, on the rate outlook. He reiterated that the Fed had “no tolerance” for high inflation, just a day after Governor Waller had flatly stated that the Fed may need to hike soon if near-term inflation came in hot. Let’s just say that the June CPI/PPI threw some icy water on the heated rhetoric. Even with the back-up in oil prices to well above $80, the odds of a hike at the July 29 FOMC meeting have shriveled. Still, looking later into this year, markets are not giving up on the prospect of some tightening, and are pricing in higher-for-longer. For example, real long-term Treasury yields keep climbing and, at around 2.4% for 10s and nearly 2.9% for 30s, are at their highest since 2008. Recall, that both were in negative terrain barely four years ago.

Beyond concerns about the latest flare-up in oil, arguably the bigger concern for policymakers is the inflationary impact of the boom in AI spending. The semi-official view there has shifted notably in the past six months, as even Warsh allowed that the demand side surge is first going to pressure inflation higher before the supply side productivity gains come riding to the rescue. (There is an eerie parallel there in the debate around the boom/bust in Canada’s population growth, as many eventually came to recognize that the demand lever gets pulled first and harder.) The very recent deep wobble in chip stocks likely doesn’t change the outlook for near-term inflation, as spending plans among the large tech companies are, if anything, ratcheting even higher for 2027. And while the PPI may have been tame last month, what caught our eye was the eye-popping yearly price increases in computers (9.7%), communication equipment (12.7%), and electronic components & accessories (27.6%), all running at their fastest pace in decades of data.

Pulling these many strings together, the snap-back in fuel prices will heighten the Fed’s deepening, and likely more important, concerns about the inflationary impact of the AI buildout. Adding to the mix, the U.S. consumer remains remarkably resilient. While retail sales cooled to a 0.2% gain in June, the ex-gas station reading was a solid +0.7%, leaving them up a sturdy 5.7% y/y. So, while the latest tame inflation prints are certainly welcome, it may require a series of such good results as well as cooler oil prices and equity markets to stay out of the grips of Cyclops (rate hikes), let alone to make it back to Ithaca (rate cuts).

The main focus for Canadian markets in the coming week will be the June CPI on Monday morning. (Aside: StatCan has apparently decided this year that their star attraction—the Consumer Price Index—should be highlighted first thing on Mondays, to set the tone for the week. Previously, Mondays had been a bit of a data dead zone, for many economies, but it seems that Canada’s CPI has now stepped into that void.) Much like its U.S. counterpart, the headline result will be flattered by a 10% drop in gasoline prices, which should trim overall prices by a few ticks, shaving annual inflation to perhaps a snick below 3% (versus 3.5% stateside). Core has been notably cooler than U.S. trends at right around 2%, largely due to very soft shelter costs—a major turnaround from the story of just a few years ago, when population growth was juicing rents and home prices.

The Bank of Canada is expecting inflation to fall further in coming months, with this week’s Monetary Policy Report looking for headline CPI to cool to 2.4% by Q4, with core at 2.0%. The Bank readily allowed that these forecasts were compiled prior to the latest bounce in oil, to about $10 higher than their working assumptions. Accordingly, we are at least a couple ticks higher in our call and, given the renewed U.S./Iran tensions—and lack of an obvious off-ramp—the risks seem skewed to the upside. Gasoline prices have already moved well above June’s average in recent days, so Monday’s inflation reading will land with a fat asterisk of being stale.

Thus, even with the Bank carefully toeing a neutral line and clearly having a very high threshold for rate moves in either direction, markets continue to doggedly price in moderate odds of a rate hike before the end of the year. Not to fully rehash the many reasons why that seems unwise, rates are in neutral terrain, with core inflation basically now on target, the jobless rate is still higher than neutral, housing is struggling to break out of a four-year funk, and trade relations with the U.S. remain unresolved. Finally, even the Canadian dollar is clouding the case for hikes, as it firmed another 1% this week right to the $1.40 mark (71.4 cents US), even as other currencies are broadly flat versus the greenback. While no one will mistake the loonie for a robust currency, its fledgling recovery slightly dims the case for hikes.