Douglas Porter

December 5, 2025

The Federal Reserve and the Bank of Canada have been on nearly the same flight path over the past 8 months or so. Not only have many of their rate decisions landed on the same day, but they both clipped rates 25 bps in each of the past two meetings after being on hold in the spring and summer.

Well, the paths are about to part ways significantly next Wednesday.

Starting with the Fed, the market view has gradually moved in line with our call of a third straight rate trim, taking the fed funds target down to 3.50%-to-3.75%, 75 bps below where we started this year. A cut is not a proverbial slam dunk, given that there are many Fed officials who have openly stated their opposition to cuts. Still, the Fed rarely surprises the market, and key speakers did not push back earlier on as the market leaned into a cut. The clear cooling in jobs, highlighted by a 32,000 drop in the ADP report, is the strongest argument in favour of rate relief.

While U.S. inflation has not exactly been helpful to the rate-cut cause, it also hasn’t been strong enough to get in the way. The much-delayed September PCE deflator nudged up 0.2% m/m on the core, shaving the yearly rate a tick to an okay 2.8% y/y pace. Earlier this week, import prices were flat for the same month, holding them to a mere 0.3% y/y rise. Even consumers are becoming a touch less glum on prices, with the University of Michigan reporting a pullback in inflation expectations—to 4.1% in the next year and 3.2% over the next five years; both are the lowest since January.

Despite growing conviction of Fed cuts next week and into next year, the latter amid widespread expectations that Kevin Hassett will be anointed the next Fed Chair in early 2026, Treasuries did not rally. With markets focused on the probability of Bank of Japan rate hikes, and rising JGB yields, 10-year Treasury yields rose 11 bps on the week to 4.13%, while even 2s edged up 6 bps to 3.55%. Note that with the anticipated rate cut next week, the funds rate will be almost on top of two-year yields for one of the few times in the past three years.

Canada—different country, different story. After leading the world on the way down in 2024, and following up with 100 bps of cuts this year, it increasingly appears that the Bank of Canada is now done. While the BoC leaned that way after its prior decision in October, the run of data since then has been so firmly planted on the strong side that market chatter is now that the next move could be a hike (albeit well down the road).

Full disclosure: we had been holdouts until recently, anticipating some additional BoC easing next year on the view that activity would be further hit by ongoing trade uncertainty. And, as highlighted by the latest musings on the fate of the USMCA from the White House, that uncertainty may well amp up again in the first half of 2026. But, as the IMF suggested in its annual review of Canada, the domestic economy has held up better than expected to the trade skirmish.

November’s employment report put a loud exclamation point on that view. After two months of surprisingly strong gains, we and the consensus were simply convinced that the Canadian job market was surely going to get its comeuppance this time. Why, the Blue Jays’ playoff run had pumped up hospitality sectors the prior month, and there would undoubtedly be payback.

Perhaps the most arresting development was a 0.4 ppt plunge in the unemployment rate to a 2025-low of 6.5%.

As well, a wave of layoff announcements in the auto sector and other manufacturing groups would certainly weigh on factory employment. Both points were partly true, but were brushed aside by powerful gains elsewhere. Jobs rose by 53,600 in November (or +0.25%; an equivalent percent rise in U.S. payrolls would amount to a 405,000 advance). Marking the third consecutive big gain, this left employment up a sturdy 1.5% from a year ago—precisely matching the growth rate in the prior 12 months.

Perhaps the most arresting development was a 0.4 ppt plunge in the unemployment rate to a 2025-low of 6.5%. Putting it in perspective, the jobless rate has only dropped by that much in two other months in the past 30 years (excluding the wildness around the pandemic years). And this followed a surprising two-tick step back the prior month. In a veritable heartbeat, Canada’s job market has gone from weak to almost normal. Yes, the job quality may not be top-notch, as all of the past two months’ gains have been part-time positions, and mostly in services. But, hours worked are grinding higher and wages are solid at 3.6% y/y, so incomes are growing nicely.

This heartening performance follows hard on the heels of the stunning upgrade to GDP and productivity over the past three years, and a nice bounce in Q3 of this year. In one fell swoop, StatCan revised productivity growth up by 0.7 percentage points in each of 2022, 2023 and 2024—a massive upgrade—suggesting that the economy was on a much better footing than expected heading into this year’s trade squall.

Pulling these strands together, there is now no doubt the Bank will stand aside next week. There wasn’t much debate on that matter heading into this week, but the strong jobs data makes the Bank’s decision very easy. Looking into next year, the sudden show of economic strength has emboldened the hawks to call for hikes.

It certainly doesn’t help that almost all measures of core inflation are now running from just above 2.5% up to 3.0% y/y, and food prices are on the march again. Bond yields have unsurprisingly forged higher amid this revised view on the BoC, alongside a broader back-up in global yields. The key five-year rate jumped almost 30 bps this week to just above the 3% threshold, a level it has not seen since August.

The divergent expectations for the Fed and the BoC are finally making more of a mark on currencies. The Canadian dollar benefitted heavily this week from the combo of healthy domestic economic data and growing expectations of Fed rate cuts. The suddenly revived loonie rose by nearly 1% for the second week in row, hitting 72.2 cents on Friday (or $1.385/US$), the strongest level in over two months. Somehow, this leaves the currency on track for an appreciation of almost 4% since the end of last year, albeit from weak levels.

The less-dovish view on the Bank of Canada did not majorly interfere with the rally in equities. Supported by a wave of solid Q4 bank earnings, and a near record-high for the S&P 500, the TSX reached a new high before retreating Friday. This still leaves the index up 27% since the start of the year—that’s on course for its second-best year since 1999 (topped only by a 30.7% rebound in 2009). Not bad for an economy that was expected to struggle mightily this year amid the trade trauma.

Policy Contributing Writer Douglas Porter is Chief Economist for BMO.