Money markets on Wednesday not only priced in higher odds for a rate cut in the U.S. later this month – but did so for Canada as well.
Data Wednesday showed U.S. job openings falling to a 10-month low in July and there were more unemployed people than positions available for the first time since the COVID-19 pandemic. The so-called JOLTS report provided further evidence that the Federal Reserve would cut interest rates this month to help support the economy.
Meanwhile, a series of commentaries from Federal Reserve officials on Wednesday were widely interpreted as being dovish.
Fed Governor Christopher Waller repeated his call for an interest-rate cut in September given the weakening of the labour market, and said that how fast the central bank cuts after that will depend on what happens next in the economy.
Atlanta Fed president Raphael Bostic said high inflation remains the U.S. central bank’s main risk, though growing signs of a weaker labour market still likely warrant a single 25-basis point cut this year.
And Minneapolis Fed leader Neel Kashkari said with the neutral Fed funds rate around 3 per cent, “that suggests that interest rates have some room to come down gently over the next couple of years.”
U.S. rate futures now are pricing in a 96 per cent chance of a 25-basis point cut at the end of the Federal Reserve two-day policy meeting on Sept. 17, according to CME Group’s FedWatch tool. That was at 92 per cent late on Tuesday.
The Bank of Canada’s next rate decision will be on that same day. The direction of the Federal Reserve’s key lending rate often has significant influence on Canadian monetary policy – and that appeared to be the case on Wednesday.
Implied interest rate probabilities in overnight swaps markets now suggest a 62-per-cent chance of a 25 basis point cut on Sep. 17, according to LSEG data. That’s up from nearly even odds on Tuesday, and up from 40 per cent before the release of unexpectedly weak Canadian GDP figures on Friday.
“It feels like a follow-the-Fed trade as the meeting pricing for September 17th has increased of late in both cases,” Derek Holt, vice-president and head of Capital Markets Economics at Scotiabank, said in an email to the Globe.
“The elimination of Canada’s reciprocal tariffs except for metals and autos lessons tariff pass through risk into Canadian prices, but that was relatively small to begin with,” he added.
Here’s how implied probabilities of future interest rate moves stood in swaps markets at 3:30 pm ET Wednesday. The current overnight rate is 2.75 per cent. While the bank moves in quarter-point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves. As shown, markets have now fully priced in a Bank of Canada rate cut by the end of October.
Economists often stray from traders’ thinking on the likelihood of future rate moves.
Mr. Holt, for one, thinks markets may be a bit too quick to believe the Bank of Canada will have more room to cut if the Fed eases.
“The BoC outlook is distinct in many ways and so I’m not sure I buy the follow-the-Fed argument. On the dovish side, Canada has slack, the U.S. doesn’t, but that’s why the BoC embarked on more aggressive easing than the Fed. The BoC’s policy rate is much lower. Fiscal stimulus in a fall budget could be material whereas it’s minor in the U.S. BBB [Big Beautiful Budget Bill]. Wage growth has stronger supports in Canada that could last for years as resets from collective bargaining agreements 3-4 years ago push through. The Canadian interest sensitive sectors are responding and with further adjustment ahead in lagging fashion to bigger prior easing in Canada. Supply chain cost pressures are significant with terrible productivity and the highest inventory-to-sales since the 1990s, which is a risk to growth but also cost pass through,” he said.
He added that the BoC outlook is “somewhat on tenterhooks” given volatile trade headlines.
“If tariffs are swept away and a deal emerges, then a modestly disinflationary demand shock ebbs and the BoC would likely upgrade growth and hold fire. That could come out of negotiations or the Supreme Court’s ultimate decision [on tariffs] and I think it would be wrong for the BoC to try and judge the outcome at this stage.”
Both Canada and the U.S. are due to release employment reports for August on Friday, and they will be key to where interest rates go from here. Economists forecast that Canada’s economy added 10,000 jobs and the unemployment rate edged up to 7% from 6.9%.
“It is probably the biggest jobs number we’ve seen in recent times coming out of both sides of the border,” said Allan Small, senior investment advisor of the Allan Small Financial Group with iA Private Wealth. “I think a bad number in Canada solidifies a cut here.”
With files from Reuters