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This transcript has been generated using machine learning technology. While this technology was trained with CIBC terminology, it may contain errors.
Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.
Katherine Judge: Welcome to the Eyes on the Economy podcast. I&#8217;m Katherine Judge, Executive Director and Senior Economist at CIBC. And today I&#8217;m joined by our Chief Economist, Avery Shenfeld. We&#8217;re recording this on Monday, May 25th, which I wanted to note in case the events in the Middle East shift, which could quickly change market perceptions because our focus of today&#8217;s podcast is on the implications of the conflict in Iran and interest rate policies in the US and Canada. So Avery, let&#8217;s start with what futures markets are pricing in in terms of interest rate policy for the Fed and Bank of Canada to the end of the year and how does that compare to CIBC&#8217;s forecast?
Avery Shenfeld: Well, as of this morning, the market was pricing in about one quarter point hike from the Federal Reserve and about one and a half quarter point hikes from the Bank of Canada. And there&#8217;s been consistency here in the sense that at every point in time, while both markets are responding to events, the market has tended to price in more hiking and perhaps earlier hiking from the Bank of Canada than the Fed.
That&#8217;s in contrast to our forecast where we don&#8217;t have either central bank actually hiking from here to the end of the year. We had actually thought that the Fed might actually squeeze in a rate cut before the end of the year. That&#8217;s looking less likely day to day now that we get constant delays by a week or two already from when we thought this conflict would end. But we don&#8217;t have either central bank hiking and we don&#8217;t think the Bank of Canada has a greater proclivity to hike than the Fed at this point.
Katherine Judge: So let&#8217;s say we have a scenario where oil prices stay elevated or even go higher. Which central bank would have more to fear impacts and what factors are you looking at to play into that conclusion?
Avery Shenfeld: So our view is that in contrast to what the market has done, in scenarios where oil prices stay elevated for longer or even go a bit higher, we see the Fed as having a greater reason to actually end up hiking rates than the Bank of Canada, at least in 2026. And the simplest explanation is that the Canadian economy is not nearly in as good a position as the US.
The Bank of Canada, for example, reminds investors that the Canadian economy is operating with excess slack or excess capacity or a negative output gap. The U.S. economy is sitting at full employment. The CBO estimate of the output gap is actually slightly positive. And if you look, that&#8217;s consistent with what we see in indicators of inflation and inflation pressures. So prior to the war, Canadian core inflation, based on the Bank of Canada&#8217;s core measures, and we averaged four of them together because they broadened it from the two official ones, was running at around 2%, and in fact is still sitting at 2% on that core measure. U.S. core inflation never really got much below three and has heated up earlier. And underneath those inflation differences are in fact forces that, again, relate to the degree of slack in the economy.
We have seen a sharper deceleration in unit labor costs in Canada than in the US. And that&#8217;s even the fact that the US has better productivity growth because what&#8217;s happened is that Canada&#8217;s wage inflation, and we&#8217;re using the quarterly measures of compensation here, which are, at least for Canada, much more accurately than some of the monthly numbers. Those are much tamer in Canada than the US, which is what you would expect given the 6.9% unemployment rate in Canada, which even if you translate that into the US methodology, because there are some differences, is still miles above where US unemployment is at 4.3%. And we&#8217;ve got even that&#8217;s on the cost side, so labor costs, but also on the consumer spending power and the ability for consumers to just pay more for gasoline and everything else.
That too suggests that Canada is much less inflation prone because real per capita income growth in Canada has decelerated, in fact, is actually down year over year and still positive in the US. So American households do have more spending power than Canadian households overall. So on all these traditional measures that you would look at to see not only current inflation being lower in terms of core measures, but the economy&#8217;s capacity to generate inflation due to consumer spending power and what&#8217;s happening to business costs. All of those suggest that Canada is going to be less inflation prone than the U.S. and therefore the Bank of Canada should be much more patient in terms of thinking about raising rates.
Katherine Judge: Now, what about areas where the US has less of an inflation risk in Canada? Are there any of those that you can highlight?
Avery Shenfeld: Well, we obviously looked far and wide to see if we could find anything where the U.S. is looking tamer than Canada on inflation. And the one area where we see that is in rent inflation. Now, we have issues with the ways that both the U.S. and Canada measure rent inflation. And particularly in Canada, the CPI measure for rent seems subject to wild fluctuations from month to month that suggests it&#8217;s not a particularly reliable measure based on a small sample size and the way they have to adjust it for changes in the mix of apartments being monitored. In both countries, we have other leading indicators of rent inflation from asking rents that we think provides leading indicator or directional indicator of where rent inflation is going. And on that score, actually, things look tamer in Canada, where asking rents in major cities are in fact falling quite notably.
They may be easing a little bit in the US, but they&#8217;re really under some downward pressure in Canada. right now, the CPI for rent in the US is tamer than the one in Canada, but it wouldn&#8217;t surprise me if Canada catches up to the disinflation we&#8217;ve seen in rents in the US.
Katherine Judge: Great, so we&#8217;ve covered 2026 pretty thoroughly. What about 2027? Where do you see policy rates going in both the US and Canada?
Avery Shenfeld: Well, we do think that the Federal Reserve will at some point go back to their earlier inclination, which was to actually think that there&#8217;s a little bit more room for them to cut interest rates. Now, obviously, we need an end to the blockade in oil so that oil-induced inflation comes down. We also need the Trump administration to not add further tariffs because one of the reasons inflation stayed sticky on the high side over the past year was the pass-through of some of that tariff inflation, which would drop out of the numbers in 2027 in terms of year-over-year inflation if tariffs don&#8217;t go any higher. And if all those ifs come true, we think the Fed does have room to ease rates about a half a percent in 2027 if the economy actually shows it needs it by seeing a little bit of upward pressure unemployment, which is again in our forecast. In Canada&#8217;s case, we don&#8217;t see the Bank of Canada really moving until mid-year at the earliest. There is a possibility that the Bank of Canada takes rates up towards neutral by the end of the year, which in their estimate is $275. But again, there&#8217;s a lot of ifs in that forecast. We need a favorable outcome, for example, on those trade talks, which so far haven&#8217;t really even got started between Canada and the U.S. So we need at least some tariff relief and certainly no new tariff barriers added to Canada.
And we also need some of the capital spending that the federal and provincial governments are trying to induce both directly from the government and also from the private sector. We need some of those big projects to actually get launched with shovels in the ground in 2027 to generate a lift to growth. So we could see the Fed cutting in the first half of next year in the Bank of Canada, sort of cutting hiking rather in the latter half of 2027. But for now, that&#8217;s all distant forecast with a lot of ifs.
And I think for now, our message is to focus on this year where we don&#8217;t have either central bank likely to move in contrast to the market&#8217;s pricing for at least some upside risks to policy rates.
Katherine Judge: Thanks Avery, we&#8217;ll wrap this up here. So for those listeners that are interested in seeing a more detailed take, we posted an article by Avery and Andrew Grantham on CIBC&#8217;s economics website last week on this topic. So thank you for joining us for this edition of Eyes on the Economy and until next time we&#8217;ll be keeping our eyes on the economy and calling it as we see it.
Disclaimer: The information and data contained herein has been obtained or derived from sources believed to be reliable, without independent verification by CIBC Capital Markets and, to the extent that such information and data is based on sources outside CIBC Capital Markets, we do not represent or warrant that any such information or data is accurate, adequate or complete. Notwithstanding anything to the contrary herein, CIBC World Markets Inc. (and/or any affiliate thereof) shall not assume any responsibility or liability of any nature in connection with any of the contents of this communication. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice. CIBC Capital Markets is a trademark brand name under which different legal entities provide different services under this umbrella brand. Products and/or services offered through CIBC Capital Markets include products and/or services offered by the Canadian Imperial Bank of Commerce and various of its subsidiaries. For more information about these legal entities, and about the products and services offered by CIBC Capital Markets, please visit www.cibccm.com. Speakers on this podcasts are not Research Analysts and this communication is not the product of any CIBC World Markets Inc. Research Department nor should it be construed as a Research Report. Speakers on this podcast do not have any actual, implied or apparent authority to act on behalf of any issuer mentioned. The commentary and opinions expressed herein are solely those of the individual(s), except where the speaker expressly states them to be the opinions of CIBC World Markets Inc. Speakers may provide short-term trading views or ideas on issuers, securities, commodities, currencies or other financial instruments but investors should not expect continuing analysis, views or discussion relating to these instruments discussed herein. Any information provided herein is not intended to represent an adequate basis for investors to make an informed investment decision and is subject to change without notice. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice.

Inflation fears: Bank of Canada vs. the Fed

CIBC Economics

Avery Shenfeld

Managing Director and Chief Economist

CIBC Capital Markets

Katherine Judge

Senior economist

CIBC

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