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Canada’s economy is showing clear signs of deceleration, raising market-implied odds on rate cuts from the Bank of Canada by early 2024. Although some inflation measures remain sticky and above the central bank’s target range, excess demand is ebbing, and labour market tightness is beginning to ease. Conditions will likely worsen in the months ahead as the lagging impact of 2023’s surge in global borrowing costs inflicts pain on one of the world’s most deeply over-leveraged private sectors, and we expect rate differentials to tilt more firmly against Canada in the early part of the new year, offsetting commodity price gains and a generalized dollar decline in dragging the loonie lower.





















With higher borrowing costs and slowing credit growth inflicting serious pain on Canada’s spectacularly indebted private sector, the economy appears poised for a hard landing.

The direction of travel for residential investment is clearly down: after an early-2023 dead-cat bounce, prices and activity levels are subsiding across the country, and developers are moving to the sidelines. Energy prices are well off peak levels, and business confidence has fallen to post-pandemic lows. Per capita household consumption is falling as higher debt carrying costs eat into overall spending levels.

Perhaps most critically, the labour market is weakening, with vacancies down about a quarter from last year’s highs, and population growth outpacing demand for new workers. The three-month moving average level of unemployment is now 0.7 percentage points above its 12-month low – in the period since comparable modern data has been collected, the country has never avoided recession when this has happened.

Change in 3-Month Average Canadian Unemployment Rate Relative to Trough over Prior 12 Months, % Points

Market illusions about the relative resilience of Canada’s economy have been exhausted in recent months, and swap-implied rate projections for the Bank of Canada and the Federal Reserve have converged in a dramatic fashion. Yield differentials and the loonie have come under sustained pressure, with central bankers on both sides of the border now seen delivering rate cuts at a roughly-similar pace through the course of 2024.

Number of Rate Cuts Expected, By Meeting

Over the next month or two, we think economic surprise indices will soften in the United States, with consumer spending and labour market measures weakening relative to still-optimistic market forecasts. Global financial conditions should ease as US yields stabilize, and expected growth differentials should narrow, adding momentum to an already-underway portfolio rebalancing process in major investment portfolios. Against this backdrop, high-beta (growth-sensitive) currencies should broadly gain against the dollar, with the Canadian dollar near the head of the pack.

Bloomberg Consensus 2024 Growth Forecast, %

We think the loonie will struggle to sustain any gains achieved in the coming months and could push above the 1.40 mark in the early new year as the lagging effects of last year’s increase in borrowing costs hit home. Although we expect a modest recovery toward the end of 2024 – mostly driven by a broader easing in global financial conditions – we remain bearish on the loonie over longer time horizons. Canada faces serious and long-term economic challenges, with overvaluation in real estate markets, spectacularly-high private sector debt levels, poor productivity, and an outsized government sector likely to impede the country’s growth potential for many years to come.

Estimated USDCAD Expiration Range by Confidence Interval

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