Canada: The slowdown has already started

Jules Boudreau, MA, CFA
Senior Economist, Mackenzie Multi-Asset Strategies Team


  • The Canadian economy has softened across the board in recent months, but inflation hasn’t eased.
  • The Bank of Canada is not facing the same economic context it did when it decided to resume hikes in June.
  • We don’t think additional hikes are on the table, but rate cuts are not around the corner either.

Back in the spring, the Bank of Canada had no choice but to resume hikes. Its decision to pause in January had a strong psychological effect on consumers, businesses and markets: yes, rates were high, but at least they wouldn’t move any higher. The rate pause prompted Canadians to start borrowing again, after a few months of credit deadlock at the end of 2022. As a result, the economy rebounded and the real estate market reignited. To quell an overheating economy, a revived housing market and stubborn inflation, the Bank had to unwind its January pause by hiking in June. 

The Bank of Canada’s January “pause” reignited the Canadian real estate market

Home sales and prices before and after the Bank of Canada’s January decision

Chart: Impact on real estate market of Bank of Canada’s January pause, house sales and prices both increased.

Source: Canadian Real Estate Association. Home sales are seasonally adjusted.

The current macro backdrop is unlike the one the Bank was facing in June. Inflation is still high, but the economy is no longer accelerating. Growth, employment and housing have been on a softening trend since the summer, reversing their Q2 bounces. Record population growth has been hiding the underlying softness, but the trend is clear. Plus, the full impact of the Bank’s 50bps hike is still waiting to be felt. Hence, the Bank won’t feel the same urgency to hike, even in the face of sticky inflation.

Inflation isn’t trending down, but growth has clearly slowed since June’s hike

Trends in Canadian economic indicators, pre-June rate hike vs. today

Table: GDP, employment, housing and inflation were rising before June rate increase. After, GDP, housing falling. Employment unchanged. Inflation rising.

Source: Bloomberg, Mackenzie Multi-Asset Strategies Team. Indicators used to compute trends for each row: GDP and Consensus Economics GDP forecast (“Gross domestic product”; employment rate 25-54, employment and unemployment rate (“Employment”); real retail sales (“Retail sales”); housing starts, building permits and house sales (“Housing and construction”); CPI, trim CPI, median CPI and Consensus Economics inflation forecast (“Inflation”).

Absent a monster inflation print for September, the Bank of Canada will probably tiptoe on the 5% tightrope for a few months. Growth and employment data will be too soft to justify a hike, but inflation data will remain too hot to allow for a cut. Over the next few quarters, Canada will likely take the way of New Zealand, the first G10 economy to reach its (probable) peak interest rate following a shallow recession. The Reserve Bank of New Zealand stopped hiking a few months ago, but didn’t cut rates to avoid the downturn, with inflation still above its 2% target.

Record population growth hiding recent softness in the Canadian job market

Employment data, Canada

Chart: Since June 2023, prime-age employment and hours worked have declined.

Source: Statistics Canada. “Prime-age” refers to Canadians between 25 and 54 years old.

We see Canada’s economy sliding into a recession in the next few quarters. On the other hand, as covered in our July commentary, we expect the US economy to be resilient, with loose fiscal policy, positive investment trends and still-too-low interest rates allowing it to avoid a recession. Canada will trail its southern neighbour economically in 2024, but US strength should put a floor under Canada’s slowdown.

We’ve been playing the theme of a Canadian recession by betting on a steepening in the Canadian yield curve. The spread between yields on 10- and 2-year Canadian government bonds has gone from -1.3% to -0.9%, and we expect it to further shrink towards zero as the Canadian economy lands. In the Mackenzie Global Macro Fund, we are also short the Canadian dollar against most of the 23 currencies in our investment universe, but, notably, not against the US dollar. While we expect the Canadian economy to sharply underperform the US economy, much of that is already priced into the exchange rate. Plus, we try to be humble regarding our macro forecasting ability. The US dollar is currently severely overvalued relative to other major currencies, as we explained in last month’s commentary. If we are wrong, and the Canadian economy keeps overheating instead of slowing towards a recession, the Canadian dollar could bounce towards its fair value of around $0.80 USD. In sum, the long-term undervaluation of CAD/USD slightly outweighs our macro concerns for Canada. 

Capital markets update

What we’ll be watching in October

October 17: Canada September CPI

  • Canadian CPI surprised to the upside in August, as energy and rent rose more than expected.
  • Gas prices declined slightly in September, so the headline monthly print should return to the 0.2%-0.3% range. In our view, absent a significant upside surprise in Canadian CPI, the Bank of Canada will hold at its October meeting.

October 25: Bank of Canada policy decision

  • As explained in detail above, we see the Bank of Canada tiptoeing on the 5% tightrope for a while. We don’t expect it to hike in October, but we also don’t see Tiff Macklem cutting rates before mid-2024.
  • On a wonkier note, quantitative tightening (QT) has halved aggregate reserves in the Canadian banking system from $390 billion in 2021 to $148 billion today, with the pace of balance sheet runoff accelerating over the past five months. The pace of QT in Canada has been much faster than in the US, which could partly explain the recent underperformance of Canadian long bonds.

October 26: US third quarter GDP

  • As explained in our August commentary, we think the US economy has been accelerating recently, as government spending and business investment compensate a slight slowdown in consumption.
  • The Atlanta Fed estimates that US GDP grew an annualized 5% in the third quarter. Even if their headline estimate almost certainly overestimates growth, it underlines the strength of recently released US economic data.

Emerging theme: Japan’s economy is chugging along

The Bank of Japan is the only major central bank still maintaining its policy rate below zero. The Swiss National Bank, once a paragon of negative rates, has hiked its policy rate from -0.75% to 1.75% over the past two years. But the Bank of Japan has remained mostly unfazed in the face of rising inflation.

While it didn’t raise its short-term interest rate, the Bank of Japan did widen the tolerance band around its 10-year yield target by 25bps back in December 2022, and by an additional 50bps in July 2023. In our view, it is attempting to slowly normalize monetary policy, while trying to avoid speculative attacks by global investors that would force it to raise rates faster than it intends too.

The Japanese economy is not overheating to the same degree that North American and European economies have over the past two years. But its economy is clearly picking up steam. A depressed yen has boosted exports, juicing overall GDP growth. Forecasters expect the Japanese economy to outgrow the US, Canadian and European economies in 2024. And inflation expectations for 2023 and 2024 are now at or above the Bank of Japan’s target, something we haven’t seen in decades.

We know the Bank of Japan cares deeply about inflation expectations and wage growth, the latter of which is also at decade highs. Governor Ueda recently hinted at ditching negative interest rates in the coming quarters. And if inflation stays sticky and expectations keep firming, the Bank of Japan won’t have a choice but to catch up to other global central banks by raising rates.

Consensus forecasts for GDP growth and inflation in Japan

Chart: Forecasts for GDP growth and inflation in Japan are trending higher in 2023, with 2024 GDP seen softer.

Source: Consensus Economics. Forecasts are for annual values.

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Tactical investment views

Stocks: neutral. Sovereign bonds, underweight. US stocks, underweight. USD, underweight. Euro, overweight. UK pound, neutral. Yen, overweight.

Source: Mackenzie Investments
Note: The views expressed in this piece apply to products that are actively managed by the Multi-Asset Strategies Team.

Positioning highlights

Neutral equity: Our overarching macro view is that of a “delayed landing” for the rest of 2023: resilient growth (no recession in the US), sticky inflation and higher for longer rates. Momentum of growth in the US is strong, with employment, investment and industrial production all showing resiliency over the past few months. A “no landing” scenario is both good and bad for stocks: financial conditions will tighten, putting pressure on valuations, but (nominal) company fundamentals should remain solid. We have a slight preference for international stocks in the equity mix. US stocks are more expensive after the recent AI-driven rally, and international stocks should benefit from solid nominal economic growth.

Underweight bonds: Inflation in the US will be sticky and will stay well-above target for the rest of 2023 and most of 2024. We do like certain pockets of fixed income on a relative basis, such as short-term Canadian government bonds and German bunds. But we remain underweight bonds in general.

Commodity-exporting EM currencies: Commodity-exporting EMs are well situated to outperform in this macro environment. Their budgetary and external balances have improved due to high global nominal growth and high commodity prices. Their central banks started raising rates much earlier than the rest of the world. As a result, they have generally reached the end of their tightening cycle, reducing the risk of overtightening into a recession. But the level of rates remains high, offering positive carry over most other currencies. On the other hand, we have a negative view on the currencies of Asian EM countries. Their external positions have severely deteriorated, and their interest rates are relatively low.

Oil market tightness: The physical oil market is currently very tight, especially with the ongoing one-million-barrels-per-day Saudi production cut. In the absence of a global recession, which we don’t expect to occur anytime soon given the positive momentum in the US and the expansionary deficits from governments around the world, oil should remain undersupplied. Positioning is also constructive for the oil complex. For much of 2023, investors were expressing recession bets through short oil derivatives positions. These bets have started to come off, with room to run.

Japan policy divergence: The Bank of Japan widened the tolerance around its 10-year yield target by 25bps back in December, and by an additional 50bps in July 2023. With the yen severely undervalued and core inflation rising quickly, the BoJ could take more steps towards tightening in 2023, sending rates higher. We overweight the Japanese yen in our funds, and dislike Japanese long-term government bonds.

For more market news and comments, check out our market updates page

Capital market returns in September

Capital markets returns

Notes: Market data from Bloomberg as of September 30, 2023. Index returns are for the period: 2023-09-01 to 2023-09-30. In order, the indices are: MSCI World (lcl), BBG Barclays Multiverse, S&P 500 (USD), TSX Composite 60 (CAD), Nikkei 225 (JPY), FTSE 100 (GBP), EuroStoxx 50 (EUR), MSCI EM (lcl), Russell 2000 - Russell 1000, Russell 1000 Value - Russell 1000 Growth, USA 10-year Treasury Future, CAN 10-year Gov't Bond Future, GBR 10-year Gilt Future, DEU 10-year Bund Future, JPN 10-year JGB Future, BAML HY Master II, iBoxx US Liquid IG, Leveraged Loans BBG (USD), Provincial Bonds (FTSE/TMX Universe), BAML Canada Corp, BAML Canada IL, BBG Gold, BBG WTI, REIT (MSCI Local), Infrastructure (MSCI Local), BBG CADUSD, BBG GBPUSD, BBG EURUSD, BBG JPYUSD.

Meet your authors

Jules Boudreau, MA, CFA
Senior Economist, Mackenzie Multi-Asset Strategies Team

Jules Boudreau is the Senior Economist in Mackenzie’s Multi-Asset Strategies Team. Jules leads the team’s macro investment research, informing the positioning of multi-asset funds totaling upwards of $40 billion in assets. In addition, he provides analysis on economic trends and events and delivers presentations on the interaction between markets and the global economy.

Prior to joining Mackenzie, Jules worked at the Bank of Canada, where he contributed to the Bank’s Business Outlook Survey and produced research exploring inflation dynamics and the effectiveness of monetary policy. Jules holds an MA in Economics from UBC, where he was a Social Science and Humanities Research Council (SSHRC) Scholar, as well as an Honours BA in Economics and Math from McGill University. He is also a Chartered Financial Analyst (CFA) charterholder.