The economic climate presents a complex picture, especially regarding interest rates. According to FCC Economics, there's a significant shift in conversations from rate increases to potential cuts.
The expectation is a 75-basis point reduction in the overnight rate starting in the second half of 2024, with long yields likely decreasing sooner to lower long-term borrowing costs.
The Consumer Price Index (CPI) in October revealed a mixed bag of results. Positively, the year-over-year inflation rate fell to 3.1%, down from the previous months. However, core inflation, a more stable measure that excludes volatile components, remains above the Bank of Canada's target of 2.0%.
This persistent high core inflation is why the overnight policy rate stayed at 5.00% as of December 6.
Weak GDP growth in 2024 is expected to further temper inflation. The Bank of Canada, aware of impending rate shocks for households and small farms, such as mortgage renewals, plans to provide relief as soon as it sees sustainable inflation reduction.
Although the Bank of Canada doesn't foresee reaching the 2.0% inflation target until the end of 2025, FCC Economics predicts a quicker arrival.
Financial markets have already anticipated these changes. As of December 6, they have fully priced in the first rate cut for June 2024, with a possibility of it occurring as early as April. The expectation is a 100-basis point reduction in the overnight rate throughout 2024.
Fixed rates in 2024 are another area of interest. Recent months have seen significant fluctuations in bond market yields, which are crucial in determining fixed-rate loan borrowing costs.
Movements in Canadian bond yields often mirror those in the U.S., and with the Federal Reserve likely done with rate hikes, both U.S. and Canadian bond yields should decline.
This could lead to an inverted yield curve initially, but as rate cuts commence, a return to a normal curve is expected by the second half of 2025.
The Canadian dollar's performance has also been noteworthy. Despite resilient oil prices, the currency has weakened, primarily due to the strength of the US dollar, fueled by high bond yields and a hawkish Federal Reserve. However, this trend is expected to reverse, offering a potential rebound for the Canadian dollar.