{"id":14601,"date":"2024-06-07T10:33:54","date_gmt":"2024-06-07T14:33:54","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/?p=14601"},"modified":"2024-06-07T10:33:55","modified_gmt":"2024-06-07T14:33:55","slug":"boc-fed-divergence-in-it-for-the-long-haul","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/insights\/boc-fed-divergence-in-it-for-the-long-haul","title":{"rendered":"BoC-Fed divergence: In it for the long haul?"},"content":{"rendered":"\n

By Josh Nye<\/strong><\/p>\n\n\n\n

\n The Bank of Canada (BoC) lowered its policy rate by 25 basis points on\n June 5, joining the Swiss National Bank and Sweden\u2019s Riksbank as the first\n G10 central banks to cut interest rates this year. The BoC gave limited\n guidance on future rate cuts, but RBC Capital Markets and Bloomberg\n consensus expect the overnight rate will be lowered to four percent by\n year-end from five percent at the start of the year. These same sources\n expect further rate reductions in 2025.\n <\/p>\n

\n That path would see the BoC diverging from its U.S. counterpart, with the\n timeline for Federal Reserve rate cuts having been pushed back by elevated\n inflation readings and generally firm economic data. This divergence is\n justified, in our view, by a softer growth backdrop in Canada and more\n benign inflation trends. Canada\u2019s economy is clearly feeling the effects\n of higher rates, while in the U.S., there is ongoing debate over the\n neutral interest rate and whether monetary policy is sufficiently\n restrictive.\n <\/p>\n \n

Divergence is nothing new<\/h2>\n

\n Policy rates in the two countries have diverged substantially in the past.\n In the mid-1990s, stubbornly high unemployment and fiscal consolidation in\n Canada necessitated greater monetary policy support from the BoC. The Fed\n lowered its policy rate by relatively more following the dot-com bubble\n when the U.S. experienced a mild recession while Canada avoided a\n downturn. A less extreme but more sustained divergence occurred following\n the global financial crisis, which caused a deeper recession in the U.S.\n that was followed by a period of household deleveraging and fiscal\n restraint.\n <\/p>\n

\n The market seems to imply we are in for another extended period of policy\n divergence. The spread between 10-year U.S. Treasury (UST) and Government\n of Canada (GoC) yields is at its widest level in at least several decades.\n It\u2019s even wider than the 2-year spread, which is influenced more by\n near-term monetary policy. We attribute this persistence to two key \u201cgaps\u201d\n between Canada and the U.S.: household debt and productivity.\n <\/p>\n

As the U.S. deleveraged, Canada racked up debt<\/h2>\n

\n Unlike the U.S., Canada didn\u2019t go through a deleveraging cycle post the\n global financial crisis. Rather, Canadian households continued to\n accumulate debt, pushing the country\u2019s debt-to-disposable income ratio to\n a record high and close to the U.S.\u2019s 2008 peak on a comparable basis.\n Today, the average Canadian household has about 20 percent more debt than\n its U.S. counterpart, adjusted for income.\n <\/p>\n \n

\n Canadian households are more highly indebted than their U.S. counterparts\n <\/h3>\n

Ratio of household debt to disposable income<\/h4>\n
\n
\n \"Ratio\n \n The line chart shows the ratio of household debt to disposable income for\n the U.S. and Canada, and Canada’s ratio adjusted to U.S. definitions. The\n U.S. debt-to-income ratio peaked at roughly 170% at the end of 2007 and\n declined through 2016 before stabilising at approximately 135%. The\n Canadian ratio continued to increase through 2016 but has stabilised\n around 180% since. The Canadian ratio adjusted for U.S. definitions\n follows a similar trajectory but is shifted lower, with a 2022 peak\n slightly below the U.S.\u2019s peak level at the end of 2007.\n <\/p>\n