No one ever thinks they’d find themselves rooting for an economic slowdown, but that’s what some investors found themselves doing earlier in the year as they longed for some relief from runaway inflation. Now, six months into 2024, how is the economic outlook shaping up, and what does it mean for markets from here?
Those were the central questions at BMO’s latest Market and Economic Outlook session with BMO’s Chief Economist Douglas Porter and Brent Joyce, Chief Investment Strategist at BMO Private Investment Counsel. The session, hosted by Patrick Bartlett, Regional President for BMO Private Wealth in the GTA, began by asking the question on many investors’ minds – when are borrowing costs going to come down in Canada and the U.S.?
What’s next for rates?
Mid-way through the year, inflation has calmed enough in most of the major developed economies to allow central banks to start trimming interest rates, explained Douglas Porter. Lower gas prices paired with smaller increases in other spending categories have helped moderate cost increases. It’s a good sign, he added, that the interest rate cuts in Canada have been in response to milder inflation rather than weaker growth. There is some speculation the Bank of Canada (BoC), which lowered rates by 25 basis points in June, could cut again in July.
“We are not yet officially calling for a rate cut at that decision date,” said Porter, although he expects the rate loosening cycle will continue gradually over the next 18 months. By the end of next year, BMO sees the BoC cutting rates by 150 basis points or 1.5 percentage points.
It’s a different story in the U.S., where inflation has been stickier largely due to the strength of the American consumer. Porter explained that Canada has higher levels of household debt than their American counterparts. “Many of us here in Canada think of the U.S. as being the more heavily indebted economy, but that’s not the case,” he said. “American consumers are actually below average when we look at it globally in terms of how much debt they have, whereas Canada is towards the higher end.”
Canadian households carrying more debt isn’t the only issue, it’s also that mortgage debt turns over faster, said Porter. Americans can lock in their mortgage rate for 30 years, whereas Canadians tend to renegotiate their rate every five years. Still, the strong U.S. consumer story is starting to shift, with retail sales growth slowing, a softening job market and lower activity in the housing market.
Given the divisions amongst the governors at the U.S. Federal Reserve over the economy, Porter said the U.S. central bank may only cut rates one or two times this year. “Our view is that the first cut could come in September,” said Porter, acknowledging it could be politically awkward timing given that it would be the last Fed meeting before the November election. “We believe that ultimately, the Fed will do what’s best for the economy, regardless of election considerations, and there are now signs that the U.S. economy is finally beginning to lose some steam.”
Market outlook
Cooling, not collapsing, was one of the messages Brent Joyce wanted to stress about the state of the economy over the last six months. While a recession in Canada and the U.S. is not completely off the table, it is looking more likely that the two economies will experience a soft landing.
Still, while Canada and the U.S. may have avoided a technical recession of two consecutive quarters of negative growth, Joyce said the fear of a recession caused companies to behave as though they were in one. Now that these countries have likely hit the bottom in terms of government spending and the housing market, Joyce believes this will start to lift corporate earnings.
Companies also tend to get more efficient during a recession, so now that we’re coming out of this challenging economic period, Joyce expects consumer demand will pick up outside of the U.S. and spur on earnings growth. Still, he’s cautious about how strong the earnings recovery might be. “This isn’t going to be the 25% or 30% earnings growth recoveries that we would have if we had an actual recession,” he said. “But it’s at least the return to normal earnings growth, perhaps slightly better, something in the 10% to 12% range.”
If this scenario plays out, equities will benefit, he explained. Bond yields, on the other hand, are starting to pull back. Even if they hold their ground here, Joyce noted they’ve already moved sharply lower over the past few months.
In December, Joyce and his team expected total returns of between 10% and 12% in Canadian equities for the year. Although the S&P/TSX is well short of that mark, he’s still standing by his forecast. For that to happen, the U.S. would have to see some market rotation away from the mega-cap technology names driving much of the market return. In anticipation of this, BMO has positioned more money with active managers who can underweight some of the more expensive areas in the market.
Still, Joyce is reluctant to rule out the hard landing scenario entirely. If markets find central banks waited too long to cut rates, that could still trigger a recession, albeit a short one. If that were to happen, he would view it as a buying opportunity. “It’s a great time to be an investor, especially a balanced one,” he said.
Loonie to dive or take flight?
With Canadian and American central banks charting divergent paths on interest rates, there were some questions at the session about whether this could weaken the loonie, which has been range-bound between 72 and 75 cents since late 2022. Porter noted that BoC Governor Tiff Macklem recently brushed off any concerns about the dollar. While there are limits to how far the BoC can drift from its U.S. counterpart, we aren’t close to that point yet.
“Our view is that the bank can cut rates independently one more time without causing serious downward pressure on the Canadian dollar,” said Porter. “If they were to push it beyond that, we think we would see a Canadian dollar dropping below 70 cents.”
A more likely scenario to play out in the coming years is that the U.S. dollar will lose some altitude as part of a cyclical move that will be triggered when the Fed starts to lower rates. “One of the reasons why the U.S. dollar has been so strong in the last couple of years has been because the U.S. economy has been exceptional,” said Porter. “The tables will turn over the next year and we’ve already begun to see those upside surprises wane in the U.S.”
Charting a path forward
Some of the questions that came up from the audience focused on the underperformance across most major markets. In response, Joyce urged investors to ignore the short-term weakness. “It’s easy to try to look for boogeymen when markets swoon for a few weeks,” he said. “We’re just having a bit of softness here.”
Another worry on investors’ minds is the upcoming U.S. presidential election in November and what that could mean for relations between Canada and the U.S. The USMCA, which is due for review in 2026, is particularly top of mind. Since the agreement was signed, both Canadian and Mexican trade surplus with the U.S. has grown. If Donald Trump gets back into office, Joyce said there is some concern that Canada and Mexico may not get a free pass. Still, he added, the fact that the agreement was negotiated by his administration could mean there will be less of a need for a major revamp, a point that was recently reiterated at the high-profile US-Canada Summit hosted by BMO and Eurasia Group.
Overall, the developing global economic picture presents a positive story for the global economy. “Some of the best news that we’ve seen is that, here in Canada and globally as well, inflation has really relented to the point where many central banks are actually comfortable with bringing down interest rates, and we got there without a full-blown recession,” said Porter. “That’s actually good news and there are certainly prospects that inflation will moderate further through the second half of this year.”
