FidelityConnects: Bank of Canada Reaction: Live with Economist Don Drummond

[00:02:45] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. The Bank of Canada has lowered its key interest rate to 2.25%. The quarter point cut is the second consecutive rate cut by the central bank and comes amid the ongoing U.S. trade tensions. The bank also released its monetary policy report warning that the trade conflict is quote fundamentally reshaping Canada's economy. Is the Bank of Canada optimistic or pessimistic on the economic future, and could future cuts, rate cuts, be on the horizon? Joining us here today to unpack what the latest Bank of Canada decision means for markets and for the economy is renowned economist, Don Drummond. Don is a former chief economist at TD Financial Group and current Stouffer-Dunning Fellow and distinguished visiting scholar at the School of Policy at Queen's University. Great to see you again. A warm welcome to you, Don. Thanks for joining us here, today. Great to have you here. Can you hear me okay?

[00:03:47] Don Drummond: Yes, yes.

[00:03:48] Pamela Ritchie: Perfect. I'll just remind everyone joining us here today that we do have live French interpretation for everyone to join us in either official language, that would be great. Do send questions in for Don over the next half hour or so. Let's begin. We know the cuts there, we know that they've gone there, what did you make of the monetary policy report in terms of how it lined up with the action taken?

[00:04:12] Don Drummond: My starting point is the statement that Governor Tiff Macklem has made many times that the tariff threats are a fundamental structural shock to the Canadian economy, and he's gone on to elaborate that what he means by that fundamental is deep cost and it's going to be prolonged. It's against that benchmark that I look at the narrative and the words and to me the narrative and the words don't line up with that overall summary. I think they're trying to present something, they want us to interpret their outlook as being quite negative but is it really? If we look at their real GDP, and don't look at the annual numbers because those are kind of distorted, if we look at the growth rates from the fourth quarter to the fourth quarter we see 2025 is bad, it's only 0.5%, but there's a recovery to 1.6 and 1.6 in both 2026 and 2027.

[00:05:04] Pamela Ritchie: Sorry, this is year-over-year? You're doing year-over-year?

[00:05:06] Don Drummond: Yeah, the fourth quarter to the fourth quarter. There's a substantial pickup, it doesn't make up for the weakness in 2025. The level of output remains depressed. As I said, by the end of 2026 the level of output's 1.5% lower than in their January 2025 forecast, i.e., before we ever knew about all this tariff mess. There is definitely a cost but I'm focusing on why is there a pickup. Go right to the heart of their assumptions. The key assumptions is that the tariffs stay exactly the same as they are today. Implicitly, that means that CUSMA survives as is for--

[00:05:47] Pamela Ritchie: Free trade, free trade.

[00:05:48] Don Drummond: --something akin to CUSMA survives for the bulk of things. We'll still have the aluminum and the steel because those are in place today but for everything else it is still free trade. That doesn't feel like a safe bet today. I sure hope that's the outcome but I have a feeling that's not a safe bit. When we look at the agreements that Trump has been striking with other countries they always seem to have a base tariff for 10 or 15%, which maybe in the context of discussions of 50 doesn't seem so bad but keep in mind, 10 or 15% will wipe out the profit margin for most Canadian exporters. That's very bad. The assumption itself might be quite optimistic, it just takes something like business investment. They say it will recover, albeit slow, and it's modest, it's a barely positive growth in 2027 but I look at it the other way around.

[00:06:36] Canadian businesses were not investing when they thought they had relatively free access to this U.S. market, why would they invest now when they don't think they've got that? You don't have enough scale in the domestic market to invest and grow an awful lot your business, you have to have an outlet for it, if not the U.S., well where else is that product going to go? Not Europe, China, India anytime soon, maybe one day but not in the next couple of years. I worry that as seemingly negative as they're trying to be maybe they're not negative enough.

[00:07:12] Pamela Ritchie: It's interesting. I mean, there's some optimism pointed there in the report itself, as you say, how much of what Canada needs to do in the short term ... because you just painted a picture of what may well be part of a pivot that takes 5, 10 maybe years longer to do but more short term, is it not just a natural resources story right now? We have things in the ground that we will sell and that is the demand that we can turn around more quickly. It doesn't mean we shouldn't be refining it and [indecipherable] add value and so on but for the economy is that not the direction we're going in, which takes us away a little way from a sort of more green policy, certainly. Is that the direction that we're not going in?

[00:08:00] Don Drummond: The announcement of the death of the fossil fuel business has been announced prematurely many, many times. It's clearly phasing out. There's a trend there and at some point it probably will have been phased out but that's not coming anytime soon. There's still some mileage to be taken from that. If you look at the prospect of exporting more than to Europe, well, they pretty much produce everything that they want except for our natural resources. Clearly, there could be a market there but we have a transportation problem on virtually all the natural resources. We're one of the few countries that do have the critical rare earth minerals, but keep in mind the normal course of delay and getting those out of the ground and selling them is about 20 years. We're putting efforts to try to accelerate that but that may just pull it up to about 14 or 15 years. That's not going to be a short term.

[00:08:53] I think we're talking about doing all the right things. We absolutely have to increase our level of productivity, increase our competitiveness. We have to build up our domestic market. Let's get rid of these really silly domestic tariff barriers and the like. We have to pivot some of the production. The steel industry actually has to produce structural steel beams because we don't produce that and that's what we need in the Canadian market. We import them right now. Again, that's not going to come tomorrow. My point is all these things have to start now, they should have started a long time ago, but they have to start now but they're not going to pay off in the next couple of years. It's definitely not a reason not to do them but we can't expect a net positive outcome to come that quickly.

[00:09:38] Pamela Ritchie: Short term, I mean, a natural resources amping up is one answer to it but, as you say, otherwise it does look concerning. What did the rate cut itself do? I'll ask that as a two-pronged question. What did it do and also, what would another cut signal?

[00:09:57] Don Drummond: I think it's very marginal in terms of what it would do. Clearly, the housing market is softening, it's particularly softening in the major urban centres on condominiums. That's not so much an affordability issue as particularly the smaller investor-owned condos. There's been a shift in preference away from that. Certainly, anybody with a variable interest rate will notice immediately the relief on that. Others, for business investment and for fixed income holders the rate cut's not that important. The longer term bond yields are already fairly low. Look at the 10-year government account of the bond yield, this is barely over 3%. Yes, it did go below 2% at one point but historically it's typically been more like 4, 5, 6 and even higher than that. The interest rates, where they really count for the general economy are already fairly low. I'm always surprised because the media present the interest rate cuts as themselves a great thing but we have to realize the only reason the Bank of Canada cut the interest rate is because the economy is not doing well. If you lost your job an interest rate cut is not going to be much of a compensation for you.

[00:11:07] Pamela Ritchie: He did say, Tiff Macklem did say almost right out of the gates in the press conference that it goes back to the blunt instrument. There's not a lot that a rate cut can do specifically for areas of the economy. There's nothing really it can do. This is why I'm kind of asking you, is it more signal or is there an actual effect?

[00:11:28] Don Drummond: I think you're talking about a policy authority has one instrument and you're sitting there and things aren't going too well, what are you going to do? You have to press the button on your one instrument even if you know it's not going to do very much. Department of Finance with all the spending and the tax have got many, many different buttons they can push but the Bank of Canada has only got one. Those bond yields didn't actually even change after they cut by 25 basis points so they don't even control interest rates across the yield structure.

[00:12:02] Pamela Ritchie: In terms of seeing where ... I'd like to know what your call on inflation is going forward. It seems to be coming down. It allows for the rate cuts. There's lots of pieces that go into sort of the ingredients for that decision to be made. There's also discussion that inflation will go higher, particularly if it goes higher in the United States. Will we not import some of that? What's your call in inflation, let's say medium term, out sort of 9, 12 months.

[00:12:28] Don Drummond: I think particularly since the chances of us putting retaliatory tariffs is lower now, we may come back into that but we're out of it for the moment. If we do come back with it, obviously, that will raise inflation, at least temporarily, while it's put in place. Other than that I think the balance is that inflation is going to continue to come down simply because the economy's been weaker. In the Bank of Canada speak we have an output gap, the demand in the economy is less than supply in the economy by a significant amount. The labour market is quite weak. We've seen very low job vacancies. They're actually, in the whole time we've had the job vacancy series this is the weakest we've seen for demand for new jobs. It's particularly hitting young people that are trying to get into the labour market. Wages are still increasing at a reasonable pace but they've softened quite a bit from what they were before.

[00:13:18] I think we will continue to see inflation coming down. There's an area unlike output where the Bank of Canada seems to be trying very hard to put a positive spin because all their measures of underlying inflation are in the low 3% but they keep insisting that underlying inflation is more than 2 1/2%, and they're doing that by annualizing the more recent monthly numbers. That's a legitimate way of doing it but month after month their own three indicators just keeps coming out 3, 3, 3, 3.1, 3.2.

[00:13:51] Pamela Ritchie: Let's actually just ask you to comment on the Fed. The decision yesterday was expected, certainly, out of the Federal Reserve in the U.S. There seemed to be setting up for some real concern over what a next cut, well, if it's needed, essentially, and there seems to be some real discussion on that. Discussion might be a kind word. What did you think of that move?

[00:14:15] Don Drummond: Well, the United States Federal Reserve was increasingly difficult to read because politics have taken over with the recent appointment as a governor and, of course, we will absolutely have a different chair come next spring.

[00:14:30] Pamela Ritchie: Will it be Scott Bessent?

[00:14:31] Don Drummond: Probably going to be a political appointee.

[00:14:32] Pamela Ritchie: Do you think it'll be Scott Bessent?

[00:14:36] Don Drummond: They claim they've got a list of five, it probably doesn't matter. The only thing that matters is you could be darn sure it's somebody who shares the mindset of President Trump. He's always pushed, no matter what the circumstances are, for lower and lower interest rates, seemingly without realizing that actually will probably backfire by pushing up the longer term interest rates and raising inflation and causing that house of cards to come tumbling down. I think that's the future. It's a very troubling future that we're in. To our credit in Canada and the European Central Bank, the Minister of Finance is on the board of the Bank of Canada but I don't think there's any pressure on policy. We haven't actually seen that in decades in Canada so we do have that independence and I think it's no accident longer term interest rates are lower in Canada than they are in the United States, and that's not the historical pattern.

[00:15:29] Pamela Ritchie: Back to sort of the structural nature of what we're going through rather than cyclical. Some of the bleakness that's being painted sounds like a recession, for instance. You've made the point that that's a more cyclical story. Structurally, though, what is going incredibly well are equity markets or stock markets or those that are invested in what appears to be the future of a so-called productivity pivot because of AI. I guess I'm just looking to you for some positive news on what might be the other side of this.

[00:16:19] Don Drummond: I don't know what the equity investors are seeing in the future that I'm not seeing. Canadian bank stocks are an interesting example, over-weighted in the TSX. Banks tend to go where the economy goes. You know the old saying, General Motors goes where the economies go but it's particularly true with the banks. They're invested in individuals across the country, they are loaning to cost businesses and they just rising and rising and raising. If we have this difficulty, even if we have the relatively benign outcome in the Bank of Canada stories you can't think the Canadian economy is going to do very well, therefore the Bank shouldn't be doing all that well, why are the bank stocks, and just generally the TSX rising and rising and rising?

[00:17:04] Very interesting report this past week from Statistics Canada which tallies up all the effects so far from the tariffs, one that caught my attention was that Canadians are investing more in the United States. The rhetoric was at the beginning we're so angry at Trump and the United States that we're going to pull our money out of the U.S. That came out of our mouths but it didn't come out of our actions. Foreign investment in bond markets and equity markets in Canada has come down an awful lot. Others seem to be seeing that, maybe to a degree that Canadians aren't seeing that. You have to posit that as another risk that there could be a quote-unquote correction when people realize that these high valuations in the equity markets are not justified by our economic prospects.

[00:17:55] Pamela Ritchie: That's a concern, certainly. That said, there is liquidity everywhere. With liquidity more money can generally be invested and made. What would you say on that side of things? Money supply, there's liquidity everywhere. That is a positive.

[00:18:15] Don Drummond: The equity market should be forward-looking. If we're reading what's happening they're saying that they are expecting these companies to do very well in the future. I wonder on what basis you think that. Certain ones will if we succeed and get more of our natural resources into new export markets. Obviously, that's a bet and that will pay off. Do you think that a Canadian automobile production is going to go somewhere else other than the United States? I kind of think not in the short term. More likely we're going to see more of that kind of advent we see with Stellantis of pulling out a major production. Why would you put a positive valuation on that?

[00:18:59] Pamela Ritchie: You brought to us some interesting thoughts on the EV market here in Canada. It was within the tariff universe, so in the last year, which seems like it's been longer than a year, but in any case, you mentioned because the investments have been made for EV infrastructure to be making the batteries and so on, that there was a thought that maybe Canada, particularly Ontario, could become kind of the centre for the manufacturing of batteries in the EV centre for North America to feed the rest of North America sort of within a CUSMA, USMCA, new reality. Do you think that that is still a possibility, that we can use those investments, the assets thus far, in a way to create a new industry?

[00:19:44] Don Drummond: I think Canada can and should be a leader globally in clean growth. We have the technology, we have the smart people to put that into place. It is very unfortunate that the world at the moment is pulling back from EV consumption. All these big bets that we made on EV with massive government subsidies are not doing very well at the moment and don't look so bright over the next few years. I think that will come back. Obviously, as we get more charging facility and we get longer life of batteries and smaller batteries we will be moving into this area. We will probably in Canada have a much more extensive and integrated and low emission electrical grid. That's going to take a while to put in place but that will be in place. I think the future is still positive in that area  but it is very concerning that it's not going to arrive as quickly as we thought it would be as we see the demand. It's not just the U.S. and the turn from the electric vehicles, we're seeing a turn in favour towards electric vehicles against it in a number of countries, including in Canada.

[00:20:51] Pamela Ritchie: Couple of questions rolling in for you so let's go to these. Don, do you have any comments on impact of housing markets, mortgage rates, particularly on the variable rates long term? The direction of interest rates vis-a-vis the housing markets, specifically.

[00:21:09] Don Drummond: It's very interesting because the take on mortgages really depends on your age. At my age my first mortgage was 17%. I think all these interest rates are phenomenally low. Of course, people who had phenomenally low mortgages, I mean, people had 5-year fixed interest rates as low as 1.65 a few years ago. Don't let that get into your benchmark. That had never happened before and probably won't happen again. I think the right interpretation is mortgage rates right across the spectrum are, by historical standards, extremely low at the moment. That's not the issue of financing. The level of house prices still remains very elevated, albeit softening in some of the markets, depending on an opportunity if you're trying to buy but a risk if you are a homeowner that those prices will continue to soften.

[00:21:59] Just to introduce the other dynamic we haven't talked about yet, we had 3% per annum growth in population for several years. Now the population is barely increasing. Everything comes down, the price is demand and supply and the demand was just growing like crazy with that surge in immigration. That has pretty much dried up now. We're going to get the announcement, I guess it might even be in the budget ,the immigration targets and they're going be much lower than they've been in the last few years.

[00:22:31] Pamela Ritchie: In theory, that's something they could turn the taps back on, though, if the economy was struggling. What do you think?

[00:22:38] Don Drummond: I think there are three things that went wrong with that plan. The first is they dropped their standards on putting the emphasis on high-skilled immigrants who were going to successfully immigrate into the market. They got fixated on lower skill, lower wage jobs that Canadians didn't want at current wages. Instead of forcing companies to change their working conditions they flooded the market with temporary foreign workers and others. The second aspect is it's very strange how you can compartmentalize things. On the one hand we have 6.5 million Canadians that don't have regular access to a physician or a nurse. On the other hand we had this shortage of housing, and yet we've brought in over a million immigrants per year into those supply shortages. What was anybody thinking? Obviously, they weren't thinking. You had immigration over here completely divorced from housing and from health care.

[00:23:39] It's dawned upon people but only when the public spoke up and said, this doesn't make any sense. We want to have access to a caregiver and we want to have housing we can afford that they changed it. I marvelled when Miller was the Minister of Citizenship and Immigration, he said the immigration system's got out of control. I applaud the honesty but you can't help but think, well, wait a minute, you're responsible for it, how did your government let it get out of control? They're trying to bring it back to control but bringing it back into control is going to have implications.

[00:24:14] Pamela Ritchie: A couple of other questions coming in, still sticking with housing. This is a little bit of a follow-up. Might the rate cut trigger a rebound in the residential real estate market? It sounds like you're saying no, actually, for all of the reasons that you just listed there but maybe you want to address that more directly.

[00:24:29] Don Drummond: Well, I think the pressure is a weakening in the real estate market so I don't think it's going to lift up the demand, increase the demand for housing or increase housing prices. I think it might mitigate the downside of the housing market. Also, keep in mind if governments follow through on their plans we're going to be building not a lot of new housing units, probably not as many or as quickly as governments have laid out in their plans. There is a lot of supply coming on stream and that should flatten out housing prices.

[00:25:02] Pamela Ritchie: A question about the rate cut itself, its impact on currency over sort of a medium term, CAD to USD.

[00:25:11] Don Drummond: Yes, the Federal Reserve Board cut as well so in this case the differential didn't widen but it is a very wide differential. I'll come back to this productivity issue. We're running our growth rate of productivity, our level of productivity is running at the bottom end of the developed economies. We cannot compete unless we raise our productivity, cut our wages or have a still weaker dollar. That pressure's going to be there. You may look at the weakness of the Canadian dollar relative to the U.S. dollar. This seems to be hard to comprehend but it roughly matches our productivity gap with the United States. We had about 70% of the productivity level of the United State at the end of the Second World War  and then for many years we were running around 90. We're back to 70 now, that's terrible. An economy we're so similar to that's right to us we have a 30% productivity gap so we don't quote- unquote merit a dollar anywhere close to parity.

[00:26:21] Pamela Ritchie: Another question, slightly different direction on this one. What are your views on private equity and debt issues therein? I mean, where we have seen some cracks in the U.S. market it's gone to sort of private markets or to some regional banks. Again, it has been contained so it's not been a huge deal. What are your thoughts on private equity and if you think they have debt issues? Then I'm going to close out with the budget.

[00:26:46] Don Drummond: As you said, there is that liquidity and I think that people are going to look for an outlook and a lot of that will go to the private equity markets. Just the disruption of the economy sort of feeds into that private equity market as well, picking up the stress assets and then trying to get some value out of them.

[00:27:03] Pamela Ritchie: Fascinating. From the budget, we started off saying that what monetary policy has is a blend instrument, you pointed to that, the real levers that can be pulled are fiscal. What would be good to have out of the budget from your perspective for the Canadian economy?

[00:27:21] Don Drummond: I'll flip that and start with what I don't want to have. It's hard to believe but there are 100 election platform promises in the document from this spring that the Liberals used that still have not been implemented. I would like to not see those implemented, at least the vast majority. They're over $20 billion a year and most of them have little or no impact on productivity and economic growth. I want to see them tilting the structure of spending and the tax structure to promoting productivity, competitiveness and growth. A lot of it is just promoting stagnation in the economy. I don't have social policy, it can have great benefits but they're more social in the orientation. It doesn't need to be always new spending. It can be reorientations within the existing spending.

[00:28:12] We're probably not going to see our net debt-to-GDP ratio going down, and I would like to see that going down. At least that we can tilt it towards something that's supportive of growth, that's the number one thing I'm looking at. The Prime Minister promised the budget is going to deliver a competitive tax regime. Six of the hundred items left over from the election Liberal platform are corporate tax relief measures. They will not deliver a competitive tax measure. They're all minor, they're scattered, they don't even build a synergy amongst them. They're going to have to do something much more fundamental, but we don't have any idea what that might be.

[00:28:52] Pamela Ritchie: But could they? I mean, do you see that there's room to do that 'cause you get into the discussion of unfunded tax cuts.

[00:29:01] Don Drummond: I don't think there's room but I don t think that's going to stop the government. Even our first parliamentary budget office and the head of the IMF said we had room. I caution, they say we have room because we have a lower net debt-to-GDP ratio than other developed countries  but check out in France and in Britain and the enormous pressure they're under to raise taxes and slash spending. It's crept over into political instability. Is that our benchmark we want to pick? I don't think so. I think we would want to have the net debt-to-GDP ratio resume its downward path but I don't think that's what we're going to see next Tuesday.

[00:29:34] Pamela Ritchie: What are we going to see in terms of spending in this country that ultimately can ignite aspects of our ... it sounds like we're going to hear a lot of defence announcements but there are a lot other announcements that are geared to get a kickstart within our own economy, investments in our own economy. You've got 30 seconds.

[00:29:53] Don Drummond: They absolutely have to show in numbers the NATO commitment, and that's huge, that's over $20 billion a year. We've got to see if we can get a good chunk of Canadian domestic production to that that we don't end up all importing it. We're clearly going to see a lot of infrastructure spending and then we've got to look at we have to become more innovative and we're going to have to see what kind of supports that they offer. There's all kinds of things that they can do. Just a minor one, taking our research and development tax credit, instead of applying that way down the road against future profits let them apply it right away. Simple trick that would unleash some money to help people right now.

[00:30:29] Pamela Ritchie: Okay, any other simple tricks? They're listening. The government's listening.

[00:30:34] Don Drummond: Nothing simple in this. I go back to the Prime Minister's speech at the University in Ottawa. He started off the right way, he said this is a serious shock, it's going to take a long time to get out of. Then he deviated from that and said we're going to have growth like you've never seen before. I said, don't say that because that's not going to be true. Recognize we've got a problem, do the hard work and we're going to have to be a bit patient to see this pay out. This is big shock to the Canadian economy and we're paying the price of becoming too aligned with the U.S. Looked like it was a good bet, doesn't look like such a good bet now.

[00:31:09] Pamela Ritchie: Thank you for being with us here in this moment. Don Drummond, great to get your expertise here on Fidelity Connects. Thank you for joining us.

[00:31:16] Don Drummond: You're welcome.

[00:31:17] Pamela Ritchie: That's Don Drummond joining us today on the show to talk about the interest rate cut that we saw yesterday. Tomorrow we'll be wrapping up the trading week with portfolio managers Michael Kim and Priyanshu Bakshi for an informative look at the global technology sector and where they're finding market movers. We are going right into the heart of the disruptors, which ones are investable, which ones aren't, and ultimately how these two portfolio managers tackle that in terms of investing.

[00:31:42] On Monday Jurrien Timmer, Director of Global Macro, will be back with his incredible charts and graphs to help you shape your week of trade ahead.

[00:31:50] On Tuesday we'll be sitting down with portfolio manager David Way to celebrate five years of Fidelity Long/Short Alternative Fund, hard to believe it's been that long. We'll take a look at the fund, how it's evolved, what it has invested through. It's been extraordinary markets since its inception and, ultimately, where David Way is looking to take it next.

[00:32:08] Oh, on Tuesday, we've got Tuesday. This is a really exciting day. This is going to be presented in English and French audio interpretation. Actually, it's Wednesday I was going to point to. We'll tell you about Wednesday tomorrow. All the best. Have a good day. I'm Pamela Ritchie.