What Are Central Banks Seeing That Markets Aren’t?

Over the past two weeks, markets have responded to escalating tensions in the Middle East, with the most immediate impact felt through a rapid increase in global energy prices. While this has introduced a renewed bout of volatility, our view remains that the current market reaction is largely event-driven, rather than reflective of a meaningful shift in underlying economic fundamentals.

In Canada, the effects of higher oil prices have yet to fully materialize in the data and will likely not be meaningfully reflected until March trade figures are released. In the near term, this suggests net trade could modestly detract from Q1 GDP growth. More importantly, the key question for policymakers is persistence. If elevated energy prices prove temporary, the broader inflation impact should remain contained. However, a prolonged shock raises the risk of cost pressures spreading beyond energy, potentially lifting inflation expectations.

For now, the Bank of Canada has opted to hold its policy rate at 2.25%, emphasizing uncertainty around the duration of the current shock, alongside a still-soft domestic economic backdrop. In our view, absent a sustained inflation impulse, conditions do not support further tightening this year, despite modest market pricing suggesting otherwise.

In the United States, recent inflation data, prior to the oil shock, already pointed to somewhat sticky price pressures. Against this backdrop, the Federal Reserve also held rates steady, projecting just one rate cut this year. Importantly, Chair Powell reinforced that policymakers are inclined to look through energy-driven inflation spikes, consistent with past supply shocks. The expectation remains that any inflationary impact from the current conflict will be transitory rather than structural.

From a practical standpoint, we are beginning to see some spillover into fixed income markets, with modest increases in government bond yields translating into slightly higher fixed mortgage rates. For clients with upcoming financing decisions, particularly where cash flow sensitivity is a key consideration, evaluating options sooner rather than later may be prudent.

Stepping back, the global economy continues to demonstrate resilience, and central banks on both sides of the border are signaling patience and discipline. While geopolitical developments are inherently unpredictable, the policy response thus far reinforces our confidence that this remains a cyclical, not structural, disruption.

As always, we are actively monitoring developments and positioning portfolios accordingly.

Please reach out if you would like to discuss your specific situation in more detail.

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