The Bank of Canada rate decision is on Wednesday and a strong consensus has formed around the likelihood of a 50 basis point cut. It would be the first jumbo rate cut of the cycle that started in June and has seen three 25 bps cuts so far.
The OIS market is priced for a 90% chance of a 50 bps cut with a small chance of 25 bps. Five of the six major Canadian banks also forecast a 50 bps cut with the remainder saying it's a tossup between 50 bps and 25 bps. CIBC even says that a 75 bps cut is more likely than 25 bps.
More important than what happens on Wednesday is where rates are going. The market has 79 bps priced in by year end, which suggests another 25 bps cut on Dec 11 and maybe more. From there, rates are expected to gradually decline by another 100 bps in 2025 to 2.50%.
That would bring the Bank of Canada rough to neutral, or at least a pre-pandemic neutral. Unlike in the US, where the economy has proven to be resilient, Canadian consumer trends are worsening. In addition, CPI has fallen to 1.5% y/y after a series of downside misses.
I think it's a pretty easy decision for the Bank of Canada to cut 50 basis points but I worry it won't be enough. The Canadian real estate market -- particularly in Ontario and British Columbia -- is struggling and the condo market is headed for a reckoning, with new sales at a 30-year low.
That will be a significant hit to GDP and it will be compounded by a reversal in Canadian immigration in the coming years.
The hope is that rate cuts will at least stabilize housing but I fear that won't be the case. Canadian mortgages are priced off the 5-year note and yields have risen recently even as the market priced in a more-dovish path from the BOC.
I can see the Bank of Canada cutting all the way to 1% if a hard landing scenario, especially because they're already behind the curve. That's the kind of thing that would send USD/CAD to 1.45 but even in that scenario, there is little help for mortgage rates because 5s could price in inflation risks due to the weaker currency. Moreover, through 2027 there will be resets on mortgage rates that were sub-2% and that should curb spending.
The good news for the Bank of Canada is that the employment market hasn't cracked yet but I worry that there could be a tipping point when there is a change in government and potentially some large layoffs in the public sector.
As for trading around the Bank of Canada decision, my guess is that we see a dovish 50 bps because that's what they should do with inflation at 1.5%. That should be marginally bullish for USD/CAD but I can't envision a break of the one-year range unless there is a further deterioration in Canadian data.
