The Bank of Canada is behind the curve and the loonie will endure

In the weeks ahead, we will see a picture of deteriorating
data and it will be clear the Bank of Canada is behind the curve. An overnight
rate at 4.75% is still very restrictive in an over-leveraged economy.

It’s clear from
Bank of Canada Governor Tiff Macklem’s latest speech that he wants to ease
rates further but he’s still reluctant to signal it. That’s left us with the
clunky line:

“With further and more sustained evidence that underlying
inflation is easing, monetary policy no longer needs to be as restrictive as it
has been.”

That’s an exact repeat of the line in the press conference
last week where he also added that it was reasonable to expect further cuts,
but only if inflation continues to ease.

I take it as a flimsy commitment to continue to ease by a
central bank that’s worried about getting burned. If not for the mistakes of
the post-covid cycle, the Bank of Canada would have lowered rates much further
by now but generals always fight the last war so being late was inevitable.

I give them some credit for easing ahead of the Fed but the
dynamics in the US and Canada are clearly different. Mortgages hit differently
and the US fiscal picture is far more stimulative. US data is also clearly
hotter.

Is this really a new world?

Secondly, Macklem’s speech touches on the probability of future
supply shocks. The title is ‘navigating a new world’ and he says: “Looking
ahead, technological change, geopolitical tensions, climate change, and
shifting trade and investment flows all suggest we may experience more supply
shocks than we did in the past.”

What he’s saying here is that he’s worried about trade wars
blocking the supply of critical components and about natural disasters or
droughts knocking out factories or commodities. I’m not entirely sure that’s
new but his comments suggest the reaction function to that will be to keep
rates higher to snuff out inflation. That’s unwise and if it’s the case, it
will compound the pain of these events.

Mostly notably though, he listed ‘technological change’ at
the front of his list. That’s telling because there is a very real scenario
where generative AI wipes causes a massive increase in productivity but sends
unemployment soaring. I think it will be the most-deflationary episode since
the Great Depression.

Add all this up and the Canadian dollar is in for a rough finish to the year that should see USD/CAD rise above 1.41 with risks elevated next year.

I spoke about this in an interview today with BNNBloomberg: