North American Outlook

November 07, 2024 | 17:06

Trump: The Sequel

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Key Summary

A potential Republican sweep suggests upside risks for U.S. growth and the greenback, but also increased pressure on inflation and interest rates and more uncertainty about trade protectionism
We nudged up our U.S. growth forecast for next year, but any further changes await more clarity on which party controls the House and on the timing and details of actual policy proposals
We have not changed our outlook for Canada's economy, except to note that the range of uncertainty around it has risen
A more obvious implication of the election is that, while the Fed is still set to ease policy further, interest rates are likely to end up higher than previously expected

United States

Investors have voted on the likely outcome of Donald Trump's return to the Oval Office and a possible Republican sweep of Congress, and the verdict is that they anticipate more good things than bad for the economy. Share prices have blasted higher, with the S&P 500 testing 6,000, while already-tight credit spreads have narrowed further, all in anticipation of the economic benefits of lower taxes and lighter regulations. We nudged up our 2025 GDP growth outlook by a couple of tenths to 2.2% as a result. However, we are hesitant to move further until we have greater clarity on the timing and details of the new policies (control of the House will matter here), with the largest lift from tax cuts possibly occurring in 2026. We also want to see how financial conditions unfold. Surging equity values are great for household wealth, but spending could get dinged by higher bond yields amid concern that stronger growth, larger budget deficits and increased tariffs will cause a resurgence in inflation. Reflecting this risk, we raised our outlook for both short- and long-term U.S. interest rates by 50 bps, though we still expect a downward trend to prevail next year.

Not that the economy needs more stimulus. Apart from slowing job growth and sagging home sales, the economy shows few signs of 'landing', or settling down to a sustainable long-run rate of about 2%. Real GDP growth remained strong in the third quarter, at 2.8% annualized, close to Q2's pace. The mighty consumer led the way with a 3.7% increase in spending, the fastest in over a year. Assisting were businesses, governments (notably for defense spending) and exports. The largest drag stemmed from a surge in imports ahead of the (short-lived) ports strike. Hurricanes and other strikes (notably at Boeing) could slow GDP growth to 2.0% in the fourth quarter.

Slower job growth has loosened the labour market. Nonfarm payroll gains downshifted to an average 115,000 in the five months to October from 225,000 in the first five months of the year, partly due to bad weather and labour strife. At 4.1%, the jobless rate is up from the cycle low of 3.4% and could inch up to 4.3% next year, putting it a tick above the Fed's estimate of 'neutral' but still about one percentage point below the three-decade mean.

A cooler labour market is calming the inflation waters. With cheaper gasoline chipping in, inflation has resumed a downward course in recent months after stalling earlier in the year. On a year-over-year basis, the Fed's preferred measure—the price index for personal expenditures—is only slightly above the 2.0% target. While core inflation is proving to be stickier—at 2.7% y/y for three straight months—it should resume declining in the new year once base effects turn friendlier. Increased tariffs are a threat, but their impact could be partly neutralized by a stronger dollar and price cuts by foreign producers. For this reason, we have not changed our inflation call.

With the inflation target within reach, the Fed is more "attentive to the risks to both sides of its dual mandate". The goal now is to recalibrate policy to prevent the jobless rate from rising further. This was the main motivation for kicking off the easing cycle with an outsized 50-bp chop in September. However, given ongoing resilience in the economy and potentially more stimulative fiscal policies, policymakers settled on a smaller 25-bp reduction on November 7. We expect five more quarter-point rate cuts totaling 125 bps by late 2025, taking the fed funds target range to 3.25%-to-3.50%, or at the upper end of neutral and 50 bps higher than previously thought for the terminal rate.

After plumbing 15-month lows of 3.6% in September, the 10-year Treasury yield has quickly backed up to four-month highs of 4.3% due to stronger economic growth and the 'Trump trade', as investors priced in larger budget deficits and the risk of inflation-fanning tariffs. We still expect the 10-year rate to decline in the year ahead as the Fed eases policy, but to land at 3.9% by late 2025, 50 bps higher than expected previously.

Canada

The U.S. election results are both good and bad for Canada's economy. Stronger growth for the biggest foreign buyer of your products is always a good thing, but potential tariffs could blunt said exports. Moreover, uncertainty about the USMCA review could undermine business investment. For now, we have made no changes to the outlook for Canadian growth or interest rates.

Lacking momentum, the economy could use a boost from stronger U.S. demand. Recent monthly GDP data suggest growth slowed to 1.3% annualized in the third quarter from 2% in the first half of the year. Growth looks to run at 1.1% for all of 2024, a small step down from last year’s tepid performance. The impact of past rate hikes, notably via mortgage resets, continues to curb consumer spending. While auto sales remain healthy and even sped up this year, households have cut back on discretionary purchases. With shoppers on a tighter budget, business spending contracted in the past year. Despite lower mortgage rates, the housing market remains constrained by high prices in some regions and a softer job market.

Employment moderated to a still-decent growth rate of 1.5% y/y in September. Despite limited layoffs, market conditions have weakened considerably, with job openings returning to pre-pandemic levels and the jobless rate climbing about one percentage point in the past year to 6.5%. We estimate that more than half of its increase since late 2022 is due to torrid population growth. A further rise to around 7% is likely by early next year before the economy picks up and immigration curbs kick in.

As interest rates fall and global demand firms, GDP growth should strengthen moderately to 1.8% in 2025, close to the past-decade norm. The upturn should be led by consumers given their heightened sensitivity to interest-rate changes. However, the federal government’s plan to slash immigration targets (for both temporary and permanent residents) could see the population stand still or even contract slightly for two years, implying some downside risk to growth. (It's worth noting that Donald Trump's pledge to deport millions of undocumented migrants could make it harder for the Canadian government to reach its target if many migrants set their sights on crossing the U.S.-Canada border.) The 180-degree shift in immigration policy attempts to correct for the unsustainable inflows of the past two years, which juiced population growth to a more than six-decade high. Still, given the historically low correlation between annual changes in the population and real GDP, we are hesitant to mark down our economic outlook. Lower interest rates should support a pickup in per-capita consumer spending growth, which will also lift business spending.

A few sectors such as housing will take the brunt of immigration curbs. Existing home sales have stabilized but remain depressed as buyers await further rate relief. Resales rose almost 7% y/y in September but are still below normal. Preliminary figures from several major cities suggest an even larger pickup in October, no doubt juiced by the Bank of Canada's stepped-up rate cut. Most markets remain balanced, but sellers still call the shots in much of the Prairie Provinces and Atlantic Canada amid decent affordability and migrant inflows. By contrast, buyers in Toronto and Vancouver carry more sway due to limited affordability and a glut of unsold condos in the former region. Nationwide, benchmark home prices have bottomed after falling 14% from their peak. A few affordable cities, however, including Montreal, Calgary, and Moncton, are still probing new highs. The housing market is expected to recover only modestly in the year ahead in response to lower mortgage rates and new insured mortgage rules that will support lower monthly payments and down payments, especially for many first-time buyers. But the recovery will be held back by weaker immigration and still-challenging affordability in B.C. and Ontario. Prices are expected to trend modestly higher, allowing incomes to slowly catch up to the high valuations in some regions. Housing starts look to decline from earlier elevated levels in response to weaker population growth and high condo inventories, especially in Toronto. Rent growth will continue to moderate as vacancy rates edge higher, keeping inflation on low simmer.

With help from cheaper fuel, consumer price inflation fell to 1.6% in September, though key core measures are still running a little above 2%. As a result, the Bank of Canada is now fully committed to promoting stronger growth to stop the jobless rate from rising further and inflation from staying below target. After cutting policy rates by 125 bps since June—the most aggressive move among major central banks in that timeframe—an additional 125 bps of rate relief is anticipated by June 2025. This would take the policy rate down to more stimulative levels of 2.5%. We expect all the moves to be of the quarter-point variety, though another 50-bps chop can't be ruled out in December. Until the economy shows signs of sustaining faster momentum, the risk will remain tilted toward even deeper rate cuts, though the Bank may need to tread carefully if the currency remains under pressure.

At around 72 cents US, the Canadian dollar is flirting with two-decade lows against the mighty greenback. Its biggest challenge is the wide gap in interest rates between the two countries, reflecting the large difference in economic performance, with the U.S. growing more than twice as fast as Canada in the past year. The currency has also been held back by long-standing competitiveness issues, such as sagging productivity and rising unit labour costs. Facing uncertainty ahead of the 2026 review of the USMCA and possible tariffs on exports to the U.S., we expect the currency to remain depressed for a while, before appreciating toward 74 cents US by late 2025 as the greenback succumbs to Fed policy easing through next year.