CIBC's Senior Economist, Ali Jaffery, interviews Chief Economist, Avery Shenfeld, about his outlook for the Bank of Canada and the Federal Reserve. They examine the latest economic data, explore historical policy precedents, and consider how current political developments—including trade negotiations and U.S. Fed leadership changes—may influence central bank decisions.
Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.
Ali Jaffery: Hello everyone, I'm Ali Jaffery, Senior Economist at CIBC and today I'll be your host of our podcast, Eyes on the Economy. And I'm joined today by our Chief Economist, Avery Shenfeld. Hey Avery, how's it going?
Avery Shenfeld: Nice to be here.
Ali Jaffery: We want to give the people what they want. We're going to be talking today about the outlook for the BOC and the Fed, talking about the latest data developments, as well as some of the latest political developments. And just a note to our listeners, we're speaking one day before the CPI numbers come out tomorrow. So, Avery, let's just jump right in. What's your forecast for the Bank of Canada policy rate in 2026? And if there's a risk to that forecast in the next couple of quarters, would it be for rates to be higher or lower than your base case?
Avery Shenfeld: Well, it's not the most exciting forecast because we think that the Bank of Canada will be on hold right through 2026. And while that's likely the consensus, there are a few bank economists forecasting a hike this year. I think where we differ is that if there is a move, at least in the next couple of quarters, it's more likely to be a cut than a hike.
Ali Jaffery: So your forecast would imply that the BOC has policy on hold for at least five quarters. Is there any historical precedent for such a long pause?
Avery Shenfeld: Well, not only is it not unprecedented, but it's, if there is a word, very precedented in the sense that it's quite common for the Bank of Canada after an easing cycle to actually just sit there and do nothing for an extended period waiting for the economy to respond to the medicine that they've delivered. So if you actually go back to the last three major troughs, 2009, 2015, 2020, they basically maintained the rate they achieved for at least a year, in some cases longer.
Ali Jaffery: Okay, but some people might contend that underlying inflation is still running a bit above target. So why won't the bank be hiking at some point in 2026?
Avery Shenfeld: Well, there's a few reasons for that. One is that relative to those past troughs, they haven't exactly been very aggressive in terms of cutting rates. So remember, in those past examples where they kept rates on hold for more than a year, rates were at a quarter of a percent. They reached very, very low levels, and they really only marginally dipped into maybe slightly stimulative, but still close to neutral territory. Having not eased aggressively, there's no hurry to start tightening if the economy does show some reasonable pace to growth. They can leave it there. As far as the inflation threat is concerned, the various measures of core inflation are still above the Bank of Canada's target, sitting around 2.5, maybe a bit above 2.5 in some cases. But there's a substantial deceleration underway in rent inflation in the market measures that we look at. The CPI is likely to play catch up to that and rent is a fairly significant component. And of course, there's a fair bit of slack in the economy that should put downward pressure, not only in terms of slowing labor costs for businesses, but also putting a cap on consumer spending power and not letting inflation, therefore, run away to the high side. So I think for all these reasons, the bank can be very, very patient, waiting for signs that we've narrowed that slack, getting closer to full employment. And that could take a while in our view. There's still headwinds to economic growth. There's still a fair bit of uncertainty facing where we're headed on the trade front that may take some ways to resolve. And in fact, that's the reason why we see if there is a move, it's more likely to be a cut because there is some downside risks if these trade negotiations don't go well. Donald Trump is certainly a mercurial president who's hard to predict. And if any of that news flow is less favorable than we hope it will be, the Bank of Canada might end up returning with a rate cut. But our base case is that those talks will go well enough that the Bank of Canada can just stay on hold.
Ali Jaffery: Right, and a lot of that above target inflation doesn't really look like it has much to do with demand, I would add. Let's turn to the US. Friday's job data seemed to tell us that the Fed has some additional elbow room to stay on hold in January, despite the pressure from the White House, which we'll get to in a moment. But are we done with rate cuts in the US?
Avery Shenfeld: I don't think we're done-done with rate cuts. If you look at past cycles, it would be rare to end up permanently stuck above the neutral rate. And certainly there is evidence that despite the good GDP numbers we've been getting, that the interest rates are still above neutral, still in other words, a drag on growth. If you look at housing, for example, it's declining in terms of activity. Housing starts are on the downtrend. It does look like housing will continue to be a drag. And that is one of the intrasensitive parts of the economy. Business capital spending, there are elements of it, which is another intrasensitive sector that are doing well, but they're the ones tied to AI. I don't think we're seeing elsewhere quite that much momentum. So those are reasons to suggest that we're not at neutral yet, that at some point the economy will likely need that. That is showing up at least in some doubts in the labor market. Businesses aren't hiring, which is a sign that maybe in many cases they don't have the confidence that we're at sort of a steady state where they can hire some people. And I think those are all reasons to suspect that we will still get some rate cuts. And then again, there's also the bias from the Fed that became evident in recent months. I mean, it didn't take much of an uptick in the unemployment rate to have the Fed delivering cuts in the back half of 2025. And that was when inflation was clearly above target, in fact, more above target than it now is and is likely headed. So their bias is if they get a little bit of a jitter over growth or employment, they're likely to cut. And then the other thing we're looking at is that the inflation numbers, while the last estimate may have been a bit downside bias due to issues with the survey, the reality is that the inflation does seem to be edging towards at least territory where it gets closer to the Fed's target. And the big factor there is also on the rent side. Rent has a huge weight in core measures of US inflation because they use a rent measure for both owner-occupied and rental housing. And it's clear that we're seeing those rent measures in the CPI and the PCE prices catch up to what some other more leading indicators of rents were telling us over the past year, which was rent inflation is melting away. And indeed, in many parts of the U.S., rents are actually an outright decline. So that is a heavy weight. And the Fed can look past whatever upside we're getting from tariffs because that is a one-off lift to the price level rather than likely to be a source of ongoing inflation.
Ali Jaffery: Yeah, and inflation expectations have been pretty well behaved. I think there's good grounds for that. But let's turn to politics, Avery. So how are you factoring in the political backdrop for the Fed, obviously including the appointment of the new chair, the upcoming Supreme Court ruling, and also the news over the weekend about the criminal investigation underway?
Avery Shenfeld: So we're forecasting two cuts from the Fed, two quarter point cuts in the first half of the year and nothing after that. So the first one likely in March rather than January, given those employment numbers. That's not really that far from the pack in terms of what we see in the dot plot survey of current members of the FOMC. So it's quite clear then the way our base case looks, our forecast looks is we're not factoring in any major shakeup at the Fed, either because of a new chair being appointed or more dramatically from the Fed being totally politicized and doing Donald Trump's will. And I think the market is pretty much in the same story. Even if you look today when this was all the rage and the headlines and all the discussion on the trading floor as we came into work today, if you look at two-year yields, one-year yields, they really haven't moved today. In fact, earlier today, two-year rates were up a little bit. So no one is really believing this story that actually either the Fed chair will be indicted or there'll be a wholesale political change at the Fed. And remember that several other current and past members of the government in Washington, whether they were prosecutors or FBI heads, have been investigated by this Justice Department, but ultimately we haven't actually seen indictments in these cases. So I think that's a reasonable bet that that won't happen. And the reality is that even if Trump appoints someone who is very much a Trumpist or a MAGA person, there's a constraint from the bond market on just how far a Fed could go in cutting aggressively at the front end if the purpose of that is actually to lower interest rates for real borrowers. Remember that Donald Trump is a real estate investor. What he wants is low long-term rates and the bond market effectively has a veto in that if you cut short rates more than justified by the state of the economy, ignite inflation fears in the process, the net result of that is that long-term rates will go higher rather than lower and even Donald Trump won't vote for that. So ultimately at this point, our forecast as well as what the street is pricing in, assumes that rational behavior remains in place at the Fed. And I think the reality is that if anything, this flap over the weekend, one thing it could end up doing is it could convince Jay Powell that even when his term as chair is up, he should hang in there and complete his term on the board of the Fed. And that will be one more vote on the side of that sort of rational decision making.
Ali Jaffery: Thanks, Avery, I think that's a good place to stop here. Please be sure to check out the CIBC Economics website for all our economic content. Until next time, we'll be keeping our eyes on the economy and calling it as we see it.
Outro: Please join us next time on the Eyes on the Economy where we will share our latest perspectives and outlook for the Canadian and US economy.
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