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The Bank of Canada’s three lending-rate cuts since June are expected to spur consumer spending and bring relief to borrowers across the country. For the Big Six banks, however, the anticipated cut by the U.S. Federal Reserve this week might prove more consequential.
Why we’re fixed on the Fed
U.S. Federal Reserve chair Jerome Powell is expected to make a cut to the bank's benchmark lending rate for the first time in four years on Wednesday.Evelyn Hockstein/Reuters
First, a quick recap:
A cut is coming. All that’s left to predict is the size of it: 25 basis points or 50. On that point, markets were almost evenly split, but the smart money (read: the conclusion I have reached after pouring through approximately four analyst notes) is on the smaller side.
Why it matters to Ottawa and the Big Six
Whatever the outcome, the Fed’s decision on Wednesday will have a significant impact on Canada’s financial institutions as well as the country’s economic outlook.
The outsized role the U.S. plays in the financial world means any move Powell makes (and the signals he sends) will ripple across global bond markets, affecting borrowing costs and exchange rates and influencing how other central bankers are thinking about their own rate-cutting cycles.
“There’s no doubt that U.S. interest rates are still the most important in the world,” BMO chief economist Doug Porter told reporter Mark Rendell. “Whether you’re talking about the Fed funds rate or even the 10-year treasury yield. Those are really the rates that probably have the biggest impact on financial markets.”
The view from Bay Street
There’s the obvious impact for Canadian banks and their retail-oriented portfolios – especially those with larger footprints in the U.S. such as TD Bank and the Bank of Montreal.
But as reporter James Bradshaw told me, a cut by the Fed might be more important to Bay Street than the ones already made by the Bank of Canada, owing to the more complex spaces they occupy beyond consumer products like mortgages and credit cards.
“Think of a lot of the less plain-vanilla stuff that banks do,” he said. “The more esoteric products and services that they offer to corporate customers, corporate loans and bonds and derivatives. All the lending they do to small- and medium-sized businesses. All the complex, sometimes risky bets their traders make on foreign exchange rates or commodity prices or credit default swaps, where tiny changes in interest rates or prices make a huge difference.”
All of those moves, no matter where your bank is located in the world, are made within what Bradshaw called the “plumbing” of a banking system that flows through the U.S.
“So many of those things get priced off of U.S. interest rates. What is the rate on a 10-year U.S. Treasury? What is the Secured Overnight Financing Rate? That is the reference rate for all kinds of loans.
“And when the Fed cuts interest rates, to varying degrees, a lot of that stuff moves and re-prices.”
That’s not to mention the possibility that lower lending rates in the U.S. could help shake open the ice-cold market for dealmaking, which would represent another boon for Canadian banks with business in the U.S., Bradshaw notes.
In this stock image, a trader helpfully points to a chart to someone who can only hear him.
The outlook from Ottawa
For better and worse, the plumbing metaphor applies just as well to Canada and the U.S., whose economies are joined by so many fittings and pipes.
Policymakers like Macklem will be watching on Wednesday, parsing Powell’s words along with the rest of us, with very specific issues in mind. An oversized move from the Fed would likely strengthen the Canadian dollar against the U.S. dollar as the difference between Canadian and U.S. interest rates would narrow.
A bigger cut from the Fed could also encourage the Bank of Canada to pick up its own pace of rate cuts. Macklem and Co. would likely see that as a signal the U.S. economy is weaker than expected – bad news for Canada given how much we export to the Americans.
“I know officially they would never want to say that it matters that much. But of course, the reality is that it would matter,” Porter said. “A 50-basis-point cut by the Fed would probably open the door wide open for the Bank of Canada to go by 50 in October. I suspect that if the Fed were to cut by 50, the market would price in better than 50-50 odds of the Bank of Canada matching that almost immediately.”
Even if the Fed only cuts by 25 basis points, Powell could still push bond yields lower by sounding dovish: declaring “mission accomplished” on the Fed’s inflation fight and signalling more rate cuts are imminent. Monetary policy is almost as much about what central bankers say they’ll do as about what they actually do, Rendell told me.
Any move in U.S. treasury yields is not just a U.S. story, he said: “That’s going to influence Canadian bond yields as well – which in turn feeds into mortgage rates in Canada, and so on.”
If you’re in the market for fixed mortgages, which are tied to bond yields, you might have another reason to watch along with us on Wednesday.
Charted
Opinion: Why houses aren’t investment opportunities
Your house was never really meant to be treated as an investment, Tim Shufelt writes. A couple of decades of delirious price gains just made it seem like a good idea. And then the investment case unravelled. You can read more here.
Also in the news today:
Disruption averted: Air Canada’s pilots would receive cumulative raises of almost 42 per cent in a four-year tentative agreement announced on the weekend, averting a strike or lockout that would have disrupted travel for hundreds of thousands of passengers and harmed the Canadian economy.
Caution over cleanup: Efforts to fix a massive cyanide spill at the Eagle gold mine in Yukon have faltered after the receivership of Victoria Gold Corp., potentially posing new threats for the environment, a former top engineer at the company says.
Crime online: French authorities are seeking to extradite another Canadian to face criminal charges in connection with encrypted phone service EncroChat, which was used by organized crime groups in Europe to avoid police surveillance, after having already apprehended the company’s alleged mastermind.
Happening today
- Statistics Canada reports manufacturing and sales for July, as well as new motor vehicle sales for the month.
- The CMHC reports housing starts for August.
- Earnings include Canadian cannabis retailer High Tide Inc. and Lion One Metals.
Key this week
- U.S. Federal Reserve chairman Jerome Powell will steal the spotlight, but Canada’s top central bankers are taking the stage in Toronto: Senior Deputy Governor Carolyn Rogers speaks tomorrow and Bank of Canada Governor Tiff Macklem addresses an “Economics of AI” conference on Friday.
- Statistics Canada releases its consumer price index for August tomorrow.