The president wants to see big US rate cuts. Could that complicate the BoC’s approach?
Donald Trump ended months of speculation last week by naming his choice to lead the Federal Reserve when current chair Jerome Powell’s term expires in May, a decision that could have big implications for Canada.
The president announced on Friday he had chosen Kevin Warsh – a former bank executive and member of the Fed’s board of governors in the late 2000s – to head the central bank, ending a race that was closely followed by Canadian financial and mortgage market watchers.
The Fed’s approach to interest rates strongly impacts US Treasury yields, which in turn have a big effect on Government of Canada bond yields and, by extension, Canadian fixed mortgage rates. That means even though the Fed doesn’t decide policy for Canada, its decisions set the backdrop for mortgage rates here.
It’s also significant because a big divergence between the Fed and the Bank of Canada can put pressure on the loonie – and Trump has long advocated much steeper US rate cuts, which could leave the Fed substantially more dovish than the Bank of Canada if policymakers in Ottawa stay cautious.
Warsh was viewed by some observers as a surprisingly hawkish pick for the Fed by Trump, having often highlighted the risk posed to the inflation outlook by lower interest rates. But the president will likely still expect the incoming Fed chair to slash rates, potentially complicating the outlook for the Bank of Canada.
The good news for Canada: Warsh could find the task of dramatically cutting rates much easier said than done.
Why the new Fed chair may not be able to cut rates right away
Speaking to Canadian Mortgage Professional last week before Trump announced Warsh as his pick, Bank of Montreal (BMO) chief economist Doug Porter (pictured below) noted financial markets were taking a calm approach to the impending decision – potentially because a Fed chair can’t simply snap their fingers and lower rates.
“What I find interesting is that financial markets, which know darn well what’s going on here, are really not pricing in anything unusual for the rest of the year,” he said. “In the US financial markets, they’ve got just a little bit less than two rate cuts built into the market forecast through the rest of this year, with most of it starting around the June meeting and then another one in the second half of the year at some point.
“That’s not exactly a radical forecast. So despite all the noise around the Fed, the market’s still pretty comfortable that nothing really unusual is going to transpire for US interest rates this year, because I think the view is that the governance structures there will not allow a new Fed chair to just rule the roost and do whatever they want.”
The Fed chair is just one of 12 decisionmakers on the Federal Open Market Committee (FOMC), which votes on rate policy at eight scheduled meetings each year.
Two FOMC members voted for a rate cut in last week’s decision – but 10 favoured a hold, meaning supporters of a 25-basis-point reduction were comfortably outnumbered.
“There are 12 voters on the FOMC. And precious few of them turn over in any given year,” Porter said. “So even though there’s a lot of noise around the Fed, the market’s view – and I think, most forecasters’ view – is not a lot is really going to happen in terms of what really goes on with US interest rates.”
Other US-Canada challenges lie ahead for BoC
While that means the Bank of Canada may be able to breathe a sigh of relief for now on the Fed’s potential impact on its own rate policy, plenty of other aspects of the US-Canada relationship continue to present challenges for the year ahead.
There’s no sign of an end to the trade tensions that have rumbled since Trump launched his wave of global tariffs last year – and the Canada-United States-Mexico Agreement (CUSMA) is also up for review in July, sparking the prospect of difficult and complex negotiations.
Bank of Canada governor Tiff Macklem suggested those discussions could complicate the economic outlook for the year ahead, although Porter didn’t detect any panic from the central bank.
“I actually have the sense they’re quietly optimistic on that front, probably more so than I am,” he said. “I’m personally quite concerned about them actually being able to reach a deal this year. But I would love to be surprised.
“I think they know these are not going to be easy negotiations. Canada is probably going to have to give way on something. It’s just a matter of where and by how much.”
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