By Douglas Porter

December 06, 2024

North American markets remain in a mostly festive mood as we enter the late stages of 2024, with stocks broadly rolling to record highs and bond yields receding again. The clear prospect of further rate relief in coming weeks is paving the way, supported by a reasonably constructive growth backdrop. Friday’s hotly anticipated jobs reports did not disappoint, with both the U.S. and Canada posting sturdy gains—consistent with the growth outlook staying on track—but both also with a rise in unemployment rates—consistent with further rate relief. But that’s about where the similarities end for the U.S. and Canada, which have been carving out very different economic paths over the past year. And that wide divergence has been highlighted by a record gap on 10-year bond yields between Canada (at just below 3.0%) and the U.S. (at just above 4.15%), and an associated deep sag in the Canadian dollar.

In the U.S., Treasury yields drifted lower this week, fully erasing the post-election pop. A mixed employment report added to the downward momentum, which had already been given a shove by sluggish PMIs, and various Fed commentary that a December cut looked likely. While payrolls were about in line with consensus at 227,000 last month (after the hurricane/strike distortion of +36,000 in October), there were plenty of other signs that conditions were far from hot. Exhibit A was a 355,000 employment fall in the companion household survey, which lifted the unemployment rate a tick to 4.2%. That’s still a snick below the July high of 4.3%, but it’s up half a point from a year ago and a bit moreso from pre-pandemic levels.

Given that Chair Powell has previously stated that the Fed does not seek or want a further softening in the job market, even that small back-up in joblessness is likely enough to lock in a 25 bp rate cut at the December 18 meeting. We suspect, though, that the solid growth underpinnings, robust financial market conditions, and moderately hotter-than-expected core inflation in recent months will then prompt a pause at the first FOMC in 2025. Powell noted this week that the Fed now has the luxury of proceeding more cautiously, and others have suggested that the job market is now balanced. With fiscal and trade policy headed for some serious uncertainty in the year ahead, it’s also a prudent option for the Fed to tread carefully.

It’s a very different story for the Bank of Canada, as usual. The November Labour Force Survey carried a similar message as the U.S. version, just a bit louder on all fronts. Headline jobs were surprisingly sturdy at a 50,500 advance, but this was swamped by one of the largest increases in the labour force on record (up 138,000). Just to put that latter number in perspective, the average monthly increase in the U.S. labour force in the past 25 years has been 94,000, in a population that is more than 8 times larger than Canada. As a result of the population pop, the unemployment rate spiked three ticks to 6.8%, taking the rate a full point above year-ago levels. Yes, Ottawa has abruptly shifted immigration policies to chill population growth, but that will take some time to show up in the labour force tallies, and it’s not fully clear that the targets will be hit. So, in the meantime, we expect the jobless rate to push higher yet, likely averaging 7% in the first quarter of next year, before receding slightly.

One key reason we expect the jobless rate to top out early next year is that Canada’s underlying domestic economy is showing some flashes of spunk. The initial reports from major cities suggest that home sales rose again in November after finally getting back close to normal in the prior month. At the same time, auto sales rose a sturdy 8.8% y/y in November, and are on course for their best year since 2019. Even in the details of the jobs data, we saw good gains in retail and hospitality, suggesting that spending is stirring again. Recall, Canada is one of the most interest-rate-sensitive economies in the world; that sensitivity weighed heavily the past two years, but is now helping conditions turn for the better. Piling on in coming weeks will be the GST/HST holiday, as well as rebates from Ontario, and possibly B.C. and Ottawa.

Even with the brighter outlook for the previously beleaguered Canadian household, the steep rise in the jobless rate has tipped us into the camp of calling for a heftier 50 bp rate cut from the Bank of Canada at next week’s decision. We still see it as a close call, especially with the loonie in heavy retreat and inflation backing up last month. But the Bank has openly stated that it is now trying to boost growth, and the softer jobless rate is a large warning flag. Moreover, there is a reasonable case to be made that the deepening trade uncertainty with the U.S. is alone a justification for an easier stance, to help inoculate the economy from external pressure.

If our rate expectations play out—Fed cuts 25 bps, BoC 50 bps this month—that will rewiden the short-term rate gap to below -100 bps (BoC target at 3.25%, Fed at 4.25%-to-4.50%). Governor Macklem has often suggested that there are limits to Canada/U.S. spreads, but we are not close to those limits. In fact, this is about as deep a negative spread as seen this century, and the loonie is paying the price. The currency weakened more than 1% this week, flying above $1.415/US$ (or below 70.7 cents), with most of the move in the wake of the jobs data.

That weakness in the currency is entirely consistent with the relative weakness in the economy. As illustrated in Chart 1, there is a longstanding relationship between the currency and the Canada-U.S. unemployment rate spread. When Canada’s jobless rate is relatively much higher, as has been the case in recent years, the currency is on the defensive (or, as per chart, the U.S. dollar is strong). And, in November, Canada’s 6.8% unemployment rate was a full 2.6 ppts higher than the U.S. jobless rate. That is the widest spread since 2001, aside from a couple months during the deep pandemic distortions of 2020/21. Moreover, history suggests that the unemployment rate gap leads the currency by six months or more, suggesting that the Canadian dollar will remain soggy through the first half of next year. And that’s even before accounting for any possible damage from U.S. tariff threats, which would further undercut the Canadian dollar (see this week’s Focus Feature for details). So, in a word, the lowly loonie has been left out in the cold, while most global financial markets are rollicking into the finish of what has been a banner year.

Douglas Porter is chief economist and managing director, BMO Financial Group. His weekly Talking Points memo is published by Policy Online with permission from BMO.