We continue to look for no change in Federal Reserve or Bank of Canada policy rates this year, although the risk of rate cuts has risen on both sides of the border.
On January 29, the FOMC kept the fed funds target range unchanged (1.50%-to-1.75%) for the second consecutive meeting. There was a subtle, but significant, change in the press release. In discussing why the current stance of monetary policy was appropriate, the statement said that this would lead to inflation “returning to”, as opposed to remaining “near”, the symmetric 2% target. When asked about this in the presser, Chair Powell said it was to avoid any misinterpretation that the FOMC was somehow comfortable with a slight undershoot of 2%. With the results of the review of the monetary policy framework scheduled for midyear, this also potentially signals that the Fed is becoming increasingly impatient with the chronic (and asymmetric) failure to hit the target. Headline and core PCE inflation were both up 1.6% y/y in December.
Powell also repeated (for the third consecutive meeting) that it would take a “material reassessment of our outlook” to trigger another rate cut; an assessment, in turn, that would likely be brought about by on-the-ground underperformance or a meaningful deterioration in the risks surrounding the outlook. While our attention has tended to focus on economic growth underperforming, it now seems that inflation misses are more important than before. Meanwhile, on the risk front, the semi-annual Monetary Policy Report to Congress (released February 7) said: “Downside risks to the economic outlook seem to have receded somewhat in the latter part of 2019. Labor market conditions and economic growth in the United States have been resilient to the global headwinds in 2019, and conflicts over trade policy diminished somewhat toward the end of the year. Economic growth abroad also shows signs of stabilizing, though the coronavirus outbreak presents a more recent risk.”
The impact of the coronavirus plus Boeing’s suspension of 737 MAX production should temporarily push real GDP growth well below potential in 2020Q1. As the economy subsequently rebounds from both factors (the risks being that the former is larger and the latter is longer), and China starts buying more U.S. goods and services as part of the trade deal (the risk being that this is delayed), GDP growth should run the rest of the year at or slightly above potential. This, along with an expected mild up-drift in core PCE inflation, should keep the Fed on the sidelines. But it’s obvious where the net risk lies.
On January 22, the Bank of Canada kept the policy rate unchanged at 1.75%, where it has been since October 2018. The tone of the announcement and MPR was more dovish than expected. Tellingly, the Bank dropped the word “appropriate” when describing the current policy stance. The key passage was that the “Governing Council will be watching closely to see if the recent slowdown in growth is more persistent than forecast. In assessing incoming data, the Bank will be paying particular attention to developments in consumer spending, the housing market, and business investment.” The Bank is waiting to see if the slowdown persists. It’s assumed to reflect temporary factors such as “strikes, poor weather, and inventory adjustments [a pipeline shutdown]” along with the potential that “global economic conditions have been affecting Canada’s economy to a greater extent than was predicted.”
The Bank kept an eye on retail sales softness and broader consumer caution, and the other eye on the on-target inflation trends and the rebounding housing market. The latter looks like it might have been the ultimate deciding factor. In a subsequent speech, and in reference to last October’s similar contemplation of a rate cut, Deputy Governor Beaudry said: “Given the state of the financial vulnerabilities in Canada, we judged the risk of reigniting the acceleration of house price expectations and the buildup of debt was too high—and that could make attaining our inflation target harder in the long run.”
Since the policy announcement, January releases showed continued advances in housing (at least in some major centres), decent job growth that was all full-time and sporting some wage acceleration, and even a rebound in consumer confidence. This likely lessened any building urgency to ease, despite concerns over the impact of the coronavirus. Nevertheless, until it is clear that growth has fully shaken off Q4’s paltry performance (and we think it will, with growth at 2.0% through H1), the Bank’s going to keep its finger close to the easing trigger (with housing acting as a safety lock).
With central bank rate cuts priced in by the autumn on both sides on the border, and our base call for stand-pat policies and resumption of slight-above-potential growth, we look for bond yields to rise modestly this year. We expect the Canadian dollar to appreciate slightly over the next 12 months, but remain range-bound.