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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: Hello. In the past two days, we&#8217;ve seen three major economic events in North America. I&#8217;m Katherine Judge, Executive Director and Senior Economist at CIBC, and I&#8217;m joined by our Chief Economist, Avery Shenfeld, to talk about what market participants should be taking away from what we&#8217;ve heard from the Canadian government in its mid-year fiscal update and from the two interest rate announcements from the Fed and the Bank of Canada recently.
So let&#8217;s start with the mid-year update. Does what Ottawa announced have any significant impacts to our macro forecast or on Bank of Canada policy expectations this year?
Avery Shenfeld: Well, there was some fiscal stimulus in this mid-year update, but the vast majority of that had actually already been announced and it would have been factored into people&#8217;s expectations for Canada. So, the two biggest items that actually stimulate growth, one is the enhanced GST credit, which they call the grocery rebate or something like that. That was announced some months ago and more recently they did announce the removal of the excise tax on gasoline and diesel, but that&#8217;s really only cushioning a piece of the blow from the elevated gasoline and diesel prices. really a reduction of a drag rather than stimulus. So I don&#8217;t think any of that really that matters much for economic growth ahead or really for the bond market too because we did have the government really not change its bond issuance requirements for this year. They cut the bills issuance. That does relate to the prior year&#8217;s deficit being lower, so creating a little bit of an overall borrowing requirement. But when we look out over the next few years, there&#8217;s really nothing here that could be thought of as either a lot of new stimulus or on the other hand, a lot of fiscal restraint that we didn&#8217;t expect that would reduce bond supply and push interest rates lower.
Katherine Judge: And there was also an announcement of a sovereign wealth fund being created. So do you see this as having a material impact on capital spending on major projects? And where is the funding going to come for this?
Avery Shenfeld: Well, in terms of this announcement, what it does underscore is, how serious the government is about its intention of getting capital spending, which has been a lagging part of the Canadian economy and perhaps a reason for its weak productivity, getting that moving at a much more rapid clip than we&#8217;d seen in the past decade. So underscoring that as a priority for the government with any announcement, we see as a positive.
Whether this particular mechanism actually does the trick for that is a little difficult to tell because we don&#8217;t have the precise mandate, the precise way that this will be actually choosing projects. And there is actually a little bit of a conflict here in some sense, because in one sense, they say it&#8217;s arm&#8217;s length and we&#8217;re going to bring in, allow private sector investors to join in, which makes it sound like it&#8217;s just another for-profit entity that may have the same retire requirements for return on capital that private funds would have already had looking at Canadian projects. So is it just another player in the capital market that might already be reasonably funded? Or alternatively, is it going to be, which they also suggest, aimed at particular projects seen in the national interest and therefore perhaps advancing capital in a way that the private sector might not be willing to do on projects that perhaps the government sees as having positive externalities for the economy as a whole, rather than a fully capital market equilibrium return on investment that a private sector investor would look at. So unclear, I would say, at this point. And the history of these sorts of funds, if you go back to when, for example, the government first launched its infrastructure bank, is that this also takes time to get going. You need to create a board, you need to hire executives and so on. They need to start receiving applications for projects. And so it isn&#8217;t really clear whether today we&#8217;re looking at a more accelerated timetable for an acceleration of capital spending in Canada. But again, on the positive side, it does say that the government is again, trying to indicate the seriousness of its efforts to get that part of the economy moving.
Katherine Judge: So what other details would we need to see in order to tell if this is going to work or not?
Avery Shenfeld: Well, you did say for one that we need to see where the capital is actually coming from for this or the funding. It may well be that the government decides to sell other federal assets. we don&#8217;t create a new borrowing program. We sell things like airports that are already built in effect and standing there and which could provide a reasonable return on investment to a private sector investor like a pension fund that wants a long lived asset like an airport. The government takes its money out of that.
Of course, it will lose the future returns. It would have received on that. So it&#8217;s not free money, but then it just devotes that to this project. But if they&#8217;re looking to sell assets to raise the money, then of course, we have to, again, wait for that process to go through. So that&#8217;s not instantaneous. So we&#8217;ll have to see those details. And we really then have to see the precise investment mandate that this fund gets.
and its ability therefore to lever up projects where there would be an issue with raising capital from the private sector because in our view, the biggest impediment really hasn&#8217;t been the availability of funds. There are lots of international and domestic organizations that would invest in a project with a good rate of return, whether that was a pipeline or an LNG facility.
The real issue is having the economic climate, the regulatory climate, and so on that makes those projects profitable and gives them an adequate return and removes some of the risk that a private sector investor faces in getting all the approvals done on a timely basis. So it really is only one piece of a very big puzzle in getting this going, and we really need to see what those other pieces look like to see whether this will work or not.
Katherine Judge: So moving on to the Bank of Canada decision, it was interpreted by markets as being more hawkish than expected. Can you explain that market reaction and what is your view on whether rate hikes in 2026 are more on the table today versus prior to the announcement?
Avery Shenfeld: I think a lot of that market reaction had to do with something else that was happening on the very same day, which was markets were digesting the news that Donald Trump was warning of a more protracted stalemate within the negotiations with Iran, a larger embargo on Iranian shipments. Therefore, the counterpart to that would be a larger effort by Iran to keep traffic out of the Strait of Hormuz for other oil exporters. We saw a big run up in oil prices, not only overnight and in the early morning hours, but right through while the Bank of Canada was talking about its outlook. The problem is that that then put a very sharp focus on what the governor had to say about how the Bank of Canada would respond if oil prices not only shot up, but stayed high. When he mentioned, as he did a couple of times and was mentioned in the text, that there could be more than one hike, in other words, some consecutive hikes, if that outcome was what we ended up seeing, then the market was looking at that and being worried about it. But that said, in terms of our own view, we actually took comfort for several other things that the Bank of Canada said. One was that they didn&#8217;t see as particularly likely that this one-time shock in oil prices would spill over into core inflation. And they highlighted the slack in the economy as a reason why there might be not that same transmission. And in fact, contrasted that with what happened in the post-COVID recovery when a shock from the, in this case, the war in Ukraine to both energy and grain prices did help trigger a broader inflation. So the Bank Canada is not thinking that that&#8217;s going to happen very soon. And the Bank of Canada sees the underlying inflation is still pretty contained, so they&#8217;re giving themselves the benefit of time to see how this war unfolds. In our view, while we&#8217;re a bit disappointed, like markets are, in seeing this stalemate arise, and we&#8217;re now sort of drifting a couple of weeks past when we thought this war might have ended and traffic in the Strait start to resume. The reality is I don&#8217;t think the Bank of Canada&#8217;s finger is on the rate hike trigger. If we were to get, for example, an opening of the Straits of Hormuz even in June or July, at that point, yes, inflation will be higher than the bank had forecast and the outlook for the balance of the year would be higher than they forecast, but they&#8217;d still be able to see into 2027, a return to tamer energy prices, tamer headline inflation, and because their view is that that&#8217;s not going to easily, this little episode or bigger episode perhaps, is going to extend into broader inflation, I think they&#8217;re willing to sit still. Remember that they did highlight two-way risks to interest rates, the risk that an unfavorable outcome to trade talks would force them to ease further.
And since that news on both the trade talks and the war will start to come through over the course of the summer, my view is that, and our view is that they&#8217;re going to wait for that information rather than jump the gun. And our expectation is that the war news will be favorable enough that they won&#8217;t end up hiking in 2026. So I understand the market&#8217;s jitteriness over this latest bump up in energy prices and the warning or shot across the bow from the Bank of Canada that if it continued and spread, they might have to respond. But I ultimately don&#8217;t see the Bank of Canada as responding in 2026 and really waiting until 2027 when even we hope the economy will be on a sounder footing to start taking rates, maybe up a couple of hikes back to neutral.
Katherine Judge: And we also had the Fed decision recently. They also held rates steady, but there were some new descents around the language. Does that impact your call on where we see rates headed for the Fed this year?
Avery Shenfeld: Well, not so much the direct wording of this statement because the reality is we fully understand why the Fed said that. But what has perhaps changed our call is why the Fed made that wording change. So a few of the members of the FOMC essentially voted for a subtle wording change that would have removed the reference to further moves, which implied moves in the same direction that they were already going, which was down, and have a more neutral language that didn&#8217;t say up or down. So no one was talking about raising rates right away, but some of the members of the FOMC are now not sure that there will be a rate cut or that there couldn&#8217;t even be a rate hike down the road. So it&#8217;s not so much that they said that, it&#8217;s what they were responding to.
And what they&#8217;re responding to is the same thing that markets were responding to when they judged the Bank of Canada, which is the escalation in energy prices in recent days and the increasing evidence that perhaps it&#8217;s going to take longer to get that Strait of Hormuz problem unstuck and to get the oil-induced inflation to go the other way. And in that kind of context, I think it&#8217;s fair to suggest that our existing call which was for the Fed to deliver a quarter point cut in September and again in December, might be just a bit too soon to have enough evidence that inflation is again abating. We&#8217;ve also had one other development as well, which was that the last employment report still showed the U.S. unemployment rate at 4.3%. That&#8217;s basically at full employment. So there&#8217;s no particular urgency for the Fed to actually help the economy with a rate cut the way there might be for the Bank of Canada looking at Canadian unemployment. So all of that suggests that September might be too early for a reasonable scenario for the Fed to deliver the first of the cuts that we had forecast. I think we&#8217;re inclined to start thinking about December as the earliest we could get a quarter point cut. And we may well see two cuts from the Fed, one in December and one, say, early in 2027. We will have a new dovish Fed chair.
But more importantly, if the war has ended and inflation is coming down, we could be looking at an economy where, given where interest rates are, which is still on the high side of where we think neutral is, there might be room to take rates to roughly neutral, which would be a couple of quarter point cuts. So it&#8217;s a delay. It&#8217;s not driving a stake into the prospects for rate cuts.
But the longer this war impasse persists, the more we&#8217;ll have to think about the right timing for a first cut. And as of now, perhaps December looks more likely than our earlier call for September.
Katherine Judge: Okay, thanks Avery, we&#8217;ll wrap it up here. Thanks for tuning in to this edition of CIBC&#8217;s economics podcast. 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.

Navigating economic shifts: Canadian fiscal update and central bank decisions

CIBC Economics

Avery Shenfeld

Managing Director and Chief Economist

CIBC Capital Markets

Katherine Judge

Senior economist

CIBC

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