Choose your settings
Choose your language
Retail Rate Forecasts

With Inflation at 2.0%, Canada Can Now Pick Up the Pace of Interest Rate Cuts

September 24, 2024
Jimmy Jean, Vice-President, Chief Economist and Strategist
Lorenzo Tessier-Moreau, Principal Economist • Hendrix Vachon, Principal Economist

Highlights

  • The US Federal Reserve kicked off its rate‑cutting cycle with a 50‑basis‑point adjustment.
  • The Bank of Canada could speed up the move to neutrality with more aggressive rate cuts.
  • The US dollar could very well continue trending downward.
  • Stock markets are feeling optimistic again—for now.

Exchange Rates

The US Dollar Could Very Well Continue Trending Downward

The Greenback Won't Get a Boost from Monetary Policy Divergence

Not too long ago, the US's robust economy and sticky inflation seemed to suggest that the Fed would diverge from most other central banks by holding back on interest rate cuts. But the situation is changing, to the detriment of the US dollar (graph 4).


Easing Economic Fears Have Also Hurt the US Dollar

The US dollar doesn't typically gain strength when the economy is doing well. In fact, it tends to thrive in times of economic uncertainty thanks to its reputation as a safe haven currency. But investors will likely feel reassured by the Fed's decision to cut interest rates in hopes of reducing recessionary risks.


Tempered Optimism for the Canadian Dollar

If the United States succeeds in avoiding a recession, that would be good news for Canada and the Canadian dollar. But the Canadian economy can still expect to face significant headwinds brought on by slower population growth and mortgage renewals that remain costly despite falling interest rates. These reasons have tempered our optimism for the Canadian economy and will likely hold back the Canadian dollar's potential to appreciate.

 

Rising commodity prices could also help the loonie, as could narrower interest rate spreads with the United States. While the loonie is currently trading at CAN$1.36/US$, we expect the exchange rate to settle around CAN$1.33/US$ next year (graph 5).


Things Are Looking Up for European Currencies and the Yen

Conditions may remain favourable for European currencies and the yen over the short term. Since inflation is proving to be persistent across Europe, central banks in the region can't keep pace with monetary easing in the United States and Canada, though this is likely to change in 2025.

 

The contrast is even starker in Japan, where the central bank has finally started raising interest rates after leaving them unchanged throughout 2022 and 2023. This should continue to buoy the yen.


Asset Class Returns

Stock Markets Are Feeling Optimistic Again—for Now 

The Stock Markets Seem to Be Looking for Direction 

The markets often experience a chill in September, and the trend proved true once again this year just after Labour Day. But then summer weather made a comeback in Eastern Canada and the global markets warmed in the days that followed (graph 6). The Fed meeting initially sparked a negative reaction, but this was followed by a major bump the next day. This indicates that investors aren't sure what to think about the current situation. On the one hand, investors are optimistic because it looks like a soft landing is possible for the US economy. But on the other hand, they're acutely aware that a soft landing is crucial for justifying the current valuations of S&P 500 stocks. And any gains driven by anticipated rate cuts may have already peaked.


High Valuations Go Beyond the S&P 500’s Tech Sector

We've been concerned about S&P 500 company stock valuations for months. In many cases, the ratios reflect the anticipated productivity gains and exponential growth prospects for companies that develop and adopt artificial intelligence. But if we look beyond the high‑tech sectors, nine of the eleven S&P 500 industrial sectors now have high average price‑to‑earnings ratios compared to their historical values (graph 7). Sure, artificial intelligence could spur productivity gains in a number of sectors, but until these gains translate into improved corporate earnings, it makes sense to take current valuations with a grain of salt. 


Fast-Falling Interest Rates May Be Good News for the Canadian Stock Market in Particular

The S&P/TSX has performed well recently, pushing its 2024 gains up to nearly 13.0%. Canada may be facing economic challenges, but this weakness has already been priced into Canadian stock valuations. Plus, things are looking up for Canadian stocks now that inflation is back on target and the key interest rate is coming down quickly. Not only do lower interest rates help stimulate the Canadian economy, but they also make dividend payouts more attractive—and S&P/TSX companies already offer relatively high dividends. The opening of the Trans Mountain pipeline (TMX) also seems to have shielded the Canadian energy sector from losses related to falling oil prices (graph 8). 


Despite Gradual Rate Cuts, the Outlook for Europe Is Positive

Unlike its counterparts in North America, the European Central Bank can't yet justify a faster pace of rate cuts. That said, the economy seems to be picking up across the eurozone after several difficult quarters in 2022 and 2023. European corporate earnings expectations have also improved recently. And since the ECB's monetary policy is now less restrictive than before, there's reason to be relatively optimistic about Europe's outlook for 2025. Meanwhile, Asian markets are still facing higher risks. This is especially true in Japan, where the central bank is expected to continue with monetary tightening. However, the outlook for the economy and corporate earnings is good.


The Stock–Bond Correlation Is Back to Negative

Long‑term bond yields shrunk in early September, reflecting increased recessionary fears. Yields then improved after the Fed announced that it would be cutting interest rates by 50 basis points, as this decision reassured investors about the economy. This suggests the stock markets are now less sensitive to bond yields and more attentive to the economic outlook. As a result, the correlation between stock and bond returns is back to negative (graph 9). And since investor expectations have already priced in a series of interest rate cuts, attention could remain focused on economic forecasts for the next few months. The negative correlation between these asset classes could therefore be around for a while yet.



NOTE TO READERS: The letters k, M and B are used in texts, graphs and tables to refer to thousands, millions and billions respectively. IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. Data on prices and margins is provided for information purposes and may be modified at any time based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. Unless otherwise indicated, the opinions and forecasts contained herein are those of the document’s authors and do not represent the opinions of any other person or the official position of Desjardins Group.