With a long-awaited rate cut announced by the Bank of Canada last week, all eyes are now on the magnitude and number of rate cuts the central bank will deliver.
Chief economist and strategist at Desjardins Group Jimmy Jean is making a bold call by forecasting a total of 11 cuts of 25 basis point each, taking the overnight rate down to 2.25 per cent in 2026.
The Globe and Mail recently spoke with Mr. Jean to discuss what these rate cuts could mean for the economy, the Canadian dollar and the markets.
With last week’s rate cut announcement, did the messaging from the Bank of Canada support your call for three additional 25-basis-point rate cuts by year-end?
Absolutely, I think it does. I wasn’t even expecting the governor to say that conditions are reasonable to expect more rate cuts. I thought they would leave that out, but he made that pretty explicit.
We currently have a rate cut in July, then we have them taking a pause in September, and then resuming cuts in the last two meetings. We have this profile right now – depending on data, that could easily change.
What are your rate cut expectations for next year by the Bank of Canada?
Currently, we have six cuts in 2025. By the end of 2025, we have the overnight rate cut in half to 2.5 per cent.
What’s your forecast for rate cuts by the U.S. Federal Reserve over the balance of this year and into 2025?
We have the Fed starting in the fourth quarter, after the election. We have two cuts, in November and December, and then next year we have five cuts, ending the year at 3.75 per cent.
How much can interest rates in Canada diverge from the U.S. before risks rise?
Usually, movements tend to be very similar, broadly speaking, but there have been some situations where the Bank of Canada went on its own path. In 2016, when we had the oil shock, given oil’s importance to our economy, the Bank of Canada had to take a different path than the Fed, regardless of the currency.
We think the rate differential is less of an important variable explaining the currency these days. Also, the pass through [or impact] of a weaker currency to inflation tends to be very small.
I would say that a real issue would be if the Fed had to hike rates. It’s not what we’re expecting. That might be a problem, but it’s a low-odds scenario.
You have a 125-basis-point spread by the end of next year. Could it widen?
No, that’s the highest point for the differential because we have the Fed continuing to cut rates into 2026, so that spread narrows. At the end of 2026, we’re at 75 basis points with an overnight rate of 2.25 per cent in Canada and 3 per cent in the U.S.
In a research note, you indicated that the Canadian dollar could fall to 71 cents this summer. Would that mark a bottom for the Canadian dollar in 2024 or is there further downside risk?
That’s the lowest we have it going down to. Those are quarterly estimates as of the end of the quarter. Within a quarter, it could go a little bit lower on a temporary basis.
We don’t think it has that much room to go lower because we’re seeing U.S. economic data starting to deteriorate a little bit, so that’s giving the Canadian dollar support.
What is your Canadian economic growth forecast?
We have annual GDP coming in at about 1 per cent for this year. It should resemble 2023, which was 1.2 per cent. This economy is not collapsing, but it’s still struggling under the plight of mortgage renewals.
With a significant number of mortgages set to reset in 2025 and 2026, what’s the minimum amount that the overnight rate must come down by to avoid a potential recession?
I think in 2023 we would have had a recession largely as a result of the monetary policy tightening and the impact on renewals. What really helped us avoid a recession was demographics and also the U.S. economy, which was very strong. So it’s difficult to kind of isolate one factor when there are a lot of moving parts.
But I think, generally speaking, this rate-cutting cycle is essential to avoid a much bigger contraction in consumer spending per capita than we’ve seen, given that you have the renewal wall in 2025 and 2026.
How great a risk is there for a recession?
I think with rates going down, even though they remain penalizing, that lessens the risk. We think government spending is going to be an important factor. There’s lots of investments, in clean manufacturing, in housing – those initiatives are going to be supportive.
The recession risk, I would say it’s not nil. I would have said 40 per cent a few months ago. Now, I would say it’s maybe 25 per cent. I think it’s tied to the U.S. If the U.S. were to go into recession, we wouldn’t escape it.
There is a significant productivity differential between Canada and the U.S., with U.S. productivity outpacing Canada’s. Will AI adoption widen this productivity gap, leading to a larger differential between U.S. and Canadian economic growth and a weakening Canadian dollar, potentially breaking below 70 cents? AI adoption will take some time, but I’m just thinking longer-term.
We want to avoid this scenario – and we actually can because we have lots of intellectual capacity and human capital in this space. But we need more investment in computing capacity, particularly. That’s what the U.S. has and is very actively developing, but Canada has been lagging. Right now, it’s really China and the U.S. dominating in terms of computing capacity, and Canada is not there yet. So that’s a risk. Governments hopefully make conditions more stimulating to see investment in that space because that’s going to be critical.
Mortgage rates have cooled the housing market. How do you see home prices trending with rate cuts expected to continue?
Maybe not now, but eventually it will start to bring more people into the housing market. More first-time homebuyers being able to qualify at lower interest rates. And in some markets where you still don’t have the supply, it could very easily boost prices, not as we’ve seen in the pandemic, but if we’re talking 5-per-cent gains on an annual basis, it could quickly erode that affordability improvement.
Vancouver and Toronto are very particular because affordability is so eroded. But elsewhere in the country we’re not seeing that, so it could quickly bring back some heated activity in some markets.
Given the current macroeconomic environment, what are your return expectations for the S&P/TSX Composite Index? Do you publish a target for the TSX Index?
We have a return target.
Looking at the current conditions, earnings have been strong, rate cuts have begun and, based on our current economic outlook, we see the S&P/TSX topping 10 per cent this year.
Many resource stocks have realized impressive returns in 2024. The materials and energy sectors are the two top-performing sectors in the S&P/TSX Composite Index. Looking to the back half of this year, what sectors do you believe may outperform?
It’s going to be interesting to watch the banks. With the Bank of Canada progressively cutting rates, it will bring back some confidence in bank stocks. Rate cuts will help mortgage renewers better tolerate the payment hikes, as it will make for a lower step from the mortgage rate they had in their previous term. I think it could help banks perform a little bit better in this environment, especially if our call that the Bank of Canada will announce more cuts in the next 18 months than is currently discounted in the markets materializes.
Then on the consumer side, I think consumer discretionary stocks probably have better days ahead as well. We think that the biggest impact of the rate cycle shock to the consumer is probably behind us. And given that we have an orderly labour market adjustment, strong pent-up demand from higher population growth and declining rates, these drivers should be constructive looking ahead.
Some investors have benefited from GICs with rates topping 5 per cent. With the Bank of Canada now lowering rates, where is the investment opportunity for risk-averse investors seeking income?
I think they’re going to have to take a little bit more risk going forward to match these returns. There are some good returns to be made in some quality corporate bonds.
I like 10-year bonds. It’s a space with good liquidity. Assuming interest rates move lower, you could see 10-year bond yields continue to move lower, and that would generate some decent price appreciation. But, very importantly, some coupon income that can be locked in over a good stretch of time.
Is there anything else that you think is important to highlight to readers that we didn’t cover?
Maybe a quick point about the demographics in Canada, because I think it’s going to shape 2025 and 2026.
There was an announcement in March by the federal government that they will reduce the number of temporary residents by 20 per cent next year, and that’s been one of the key reasons Canada avoided a recession, because we’ve seen the biggest demographic growth in 65 years and the lion’s share of it was temporary residents. Now those numbers are going to come down, and that’s going to have a significant impact on the economy. That means less workers, less consumers than otherwise. You have the rate cuts that will help, but the demographic reduction will not help growth. We shaved our expectations for economic growth for 2025 a little bit as a result of this announcement. The thing with this announcement is that we don’t know exactly how it’s going to be implemented. People have to be mindful of this risk to the outlook.
This interview has been edited and condensed.
Jennifer Dowty