This morning, weaker-than-expected US job creation in November adds to the growing list of negative economic surprises globally and reinforces the expectation that the Bank of Canada today and the US Fed next Wednesday will make no rate changes for the fifth consecutive meeting.

Before this morning’s data, the futures market was pricing in 120 basis points of Fed rate cuts in 2024 (shown below courtesy of Bloomberg)–the odds they begin in the first quarter just rose. Government bond prices have been moving higher across the board.

Canada’s 10-year Treasury yield is down a whopping 100bps since October 3rd and at 3.28%, is back to where it was six months ago. Rising Treasury prices help lower interest rates on new credit while hurting speculators still holding near-record short contracts against 10-year Treasuries (CBOT). As these shorts move to cover, their buying pressure should further boost government bond prices and help lower interest rates.

Oil (WTIC) has slumped under $71 a barrel- the lowest since last June- despite the recent extension of OPEC+ production cuts.

Shares in the oil and gas sector (XEG) comprise nearly 20% of Canada’s TSX and are -10% since October 19 and flat year-over-year. We watch with interest because oil and gas companies–late-cycle performers–are the only sector that has propped up the broad TSX index since April of 2022. As shown below, courtesy of my partner Cory Venable, all other sectors have lost ground (see red band), including materials (XMA) and gold producers (XGD), despite another rebound in bullion prices year-to-date. We expect oil and gas companies to follow the rest down as oil demand slumps and stockpiles mount.

Canada has long been known as a resource-centric economy. Traditionally, the small-cap-junior-mining-heavy TSX Venture Index (CDNX in green below since 2000, courtesy of Cory Venable) has moved in correlation with the large-cap TSX index (in blue). That changed around 2012, however, when the world economy turned down again, and central banks turned to the monetary magic of Quantitative Easing and zero-interest policies to stimulate asset prices. This helped boost profits for the financial and real estate sectors (which comprise more than 30% of the broad TSX) while other sectors struggled.

The garish gap between the Venture Exchange Index price today (-61% since 2000) and still-elevated TSX (in blue) suggests magnified downside risk for the broad Canadian stock market as financials and real estate catch down in the post-bubble pay-back cycle.

After 475 basis points (bps) of rate hikes between March 2022 and July 2023, Canada’s economy has ground to a halt, with economic activity contracting at a 1.1% annualized rate in the third quarter. Per capita, Canadian GDP has contracted for the past five quarters (below courtesy of RBC Economics). The rate of change matters most, and as shown below, since 1977, courtesy of Trahan Macro Research, 2022-2023 was the most aggressive tightening cycle in more than 50 years.

With spending off the boil, the inflation rate (CPI) has fallen from 8.1% in June 2022 to 3.1% in October. Futures markets expect the Bank of Canada to stand pat with a fifth consecutive pause tomorrow and a first 25 bp cut by March or April.

Emerging economies had no choice but to follow suit to defend their currencies. But as global demand slumps, emerging economies in Latin America, Central and Eastern Europe have already returned to easing in 2023, with Chile, Hungary and Poland lowering their benchmark interest rates by a cumulative 150 bps to the end of November.

If North America is not in recession already, it is typical for one to start within six months of the last rate hike (i.e., January will be six months since the July hike) and within two years after the first (i.e., by March 2024). Historically, this suggests that the stock market may bottom around the fall of 2024, with corporate earnings and employment troughing several months later.

This typical pattern is on display in the world’s second-largest economy, where the Chinese central bank has already cut the one-year loan prime rate— the peg for most household and corporate loans–and pumped liquidity into the financial system. Not surprisingly, Beijing’s rescue efforts have proven no quick fix for an imploding real estate market, faltering economy, and rising unemployment where Chinese borrowers are defaulting in record numbers. Yesterday, China’s CSI 300 stock Index dropped to its lowest price level since February 2019.

In the 2001 and 2008 recessions, the US and Canadian central banks cut policy rates by 500 bps. There are hopes they may want to avoid a return to the zero bound this time and limit easing to 300 bps to hold overnight rates around 2 percent. That would be better for longer-term financial stability, but we shall see.

Either way, there are key takeaways here. While 80% of equity market losses have historically happened while central banks cut interest rates, Treasury prices have moved in the opposite direction. As shown below, courtesy of Bloomberg, a 300 bp rate-cutting cycle has historically generated an average 12-month return of about 18% on a 2- to 10-year government bond portfolio. Longer-dated Treasuries have traditionally delivered even higher returns but with much greater volatility.

A greater than 300 bp cutting cycle would suggest potentially larger capital gains for Treasuries but also a very bad economy, leaping unemployment and a deeper-than-average bear market for stocks.