By Douglas Porter

September 12, 2025

After a lengthy spell on the sidelines, both the Federal Reserve and the Bank of Canada are expected to resume cutting rates at next Wednesday’s decisions. A suddenly darker employment picture is the primary driver for both, overriding somewhat sticky core inflation, and looking past rollicking equity markets.

The Fed’s decision is widely viewed as more of a slam-dunk, as the debate has gravitated from “if” to “how much”, with some small chance of a repeat of last September’s 50 bp slice. The Bank’s decision is a little less clear-cut, with the added complication of the CPI report landing just one day earlier. Still, in both cases, we expect a low-drama 25 bp trim, but with plenty of questions on what comes next.

Financial markets have certainly already cast their vote, with the expected rate cuts re-firing up the bullish parade. All major averages hit fresh all-time highs this week, led by the AI-fueled strength in mega tech. After lagging briefly, the Nasdaq has since revived and is now up a crackling 25% from year-ago levels, double the increase in the venerable Dow over the same period. Meantime, the once-laggard and mostly low-tech TSX has kept pace with the Nasdaq, boosted by gold and a mining mega-merger this week (some may call it high Teck).

The sustained upswing in equities is especially remarkable given that we are now knee-deep in the most challenging month of the year for stocks. The prospect of lower rates is providing a powerful tailwind, with investors apparently comfortable in the view that growth will cool just enough to prompt Fed easing, without tipping over into an outright downturn. Treasuries seem a little less certain on the latter issue. Brushing away wider fiscal concerns, long-term yields have cascaded lower in recent weeks amid the chillier growth backdrop. Even with a modest back-up on Friday, 10-year yields were holding just a bit above the 4% threshold, flirting with the lowest levels of the year and down from 4.5% as recently as mid-July.

Sidebar on the fiscal backdrop for yields: The U.S. budget deficit narrowed slightly in August from year-earlier levels, but was still weighty at $345 billion. This left the cumulative shortfall in the first 11 months of the fiscal year at a towering $1.97 trillion, up from $1.89 trillion in the year-ago period. With September usually printing modest surpluses, the final deficit is likely to be a tad lower, but still around 6.2% of GDP. That’s even with the helping hand of rapidly rising tariff receipts, which pushed above $30 billion last month to alone account for nearly 9% of government revenues, up from 1.6% for all of last year. Put another way, tariff revenues totalled $165 billion in the first 11 months of the fiscal year, up $95 billion from a year ago. Very roughly, half of this increase has been driven by the so-called emergency tariffs; if they were struck down, it would make a mark on government finances, but catastrophe? No.

True, monetary policy can’t ‘fix’ the trade war, but it can set the conditions for the rest of the economy to prosper.

The case for cuts was strengthened by two developments on the jobs front this week. First, the previously unremarkable benchmark revisions to the establishment survey revealed a hefty 911,000 downgrade to payroll gains in the year to March 2025. In a stroke, more than half of the previously estimated job growth vanished, leaving a very different context for the economy. Earlier this year, the Fed’s press release consistently described job market conditions as “solid”—doubtful that word would still apply given that average payroll gains to March will now be clipped down to 70,000. And, in the more current environment, initial jobless claims lurched to a four-year high of 263,000 in the latest week (though bumped by a spike in Texas).

The key inflation reports ultimately did not move the needle much for the Fed, with producer prices notably cooler than expected, but consumer prices a bit on the warm side. The yearly core CPI pace of 3.1% barely held steady, but the 3-month annualized rate firmed to 3.6%. To these eyes, what’s remarkable is that it’s not really a tariff story, as core goods have only bumped up to a 1.4% y/y clip—stronger than normal, but hardly a major source of pressure. Instead, services ex-shelter and groceries are proving to be surprisingly persistent. In turn, consumer inflation expectations are also sticky, with the latest University of Michigan survey reporting that the five-year outlook firmed again to 3.9% (from 3.5% last month and an average of 3.0% last year).

While we expect the Fed to deliver a low-drama 25 bp rate cut, there of course will be some drama around the vote. For starters, we’re still not certain exactly who will be voting, as the Administration is attempting to block Governor Cook from participating with a late appeal. Moreover, there is a strong possibility that at least one official, and perhaps as many as three, will vote for a more aggressive 50 bp cut. Perhaps more important than this particular decision is what happens next. We have been leaning to a steady stream of 25 bp slices every other FOMC meeting until the end of 2026. It’s pretty clear that the world will not unfold in such a neat and tidy way, with the risks now leaning to “earlier and deeper”.

The Bank of Canada’s decision is not a foregone conclusion, although most believe that the pronounced weakness in employment in recent months and the heavy drop in Q2 GDP have weighed the scales to a 25 bp cut next week. There was really no major new news on the domestic front for the Bank to chew on this week. While the unveiling of five new “nation-building projects” was intriguing, the reality is that these were all already on the books and unlikely to move the macro needle. Next week’s calendar is much heavier, as the Bank will get a raft of new info in the days prior to the rate decision, highlighted by Tuesday’s CPI, but also including home sales and starts for August.

It’s noteworthy that while the Bank’s preferred measures of core inflation have been stuck around 3% for months now, and likely stayed there in August, the official commentary suggests that underlying inflation is “around 2½%”. This may be a nod to the old tried-and-true core CPI of ex food & energy & indirect taxes, which is at precisely 2.5% (vs. 3.1% stateside). Besides their own dedicated measures of core running a bit hot, there’s the added frustration of grocery prices chugging along at 3.4% y/y and now even gasoline prices are working against them. In recent days, pump prices have somehow climbed above year-ago levels nationally, even with the consumer carbon tax having been axed and world oil prices down about 10% y/y. While the Bank typically looks past swings in gasoline, it’s no help to inflation expectations with pump prices suddenly flaring for no obvious reason.

Despite that curveball, we expect the Bank to trim rates and keep the door open for more. Our call stands at a total of three cuts, taking the overnight rate down to 2.0%. The stickiness of core CPI is the strongest argument against a more aggressive rate cut campaign and may even prompt the Bank to move in staggered steps. But bigger picture, with the jobless rate pushing above 7% and the housing market listing sideways, there’s a good case for the Bank to bring rates to the low end of their neutral range (officially 2.25%-to-3.25%), or even a bit below. True, monetary policy can’t ‘fix’ the trade war, but it can set the conditions for the rest of the economy to prosper.

Policy Contributing Writer Douglas Porter is Chief Economist for BMO.