Tiff Macklem Can’t Save Canada, and He Knows it.

Trapped between a sinking Loonie, rising bond yields, and a $500B debt wall, the Bank of Canada has no good moves left.

On the Loonie Hour, we often joke that Tiff Macklem, Governor of the Bank of Canada, is the Squirmer. This stems from his waffling during COVID, a waiflike appearance, and our predilection for making fun of important people in the financial and political world. It is called the Loonie Hour after all. Now, however, Governor Macklem might be feeling shifty for a whole set of different reasons.

Canada faces a productivity emergency, and now that the Federal government has finally slowed immigration and population growth is negative, there is nothing left to paper over naive and self-defeating industrial policy. Setting aside the fact that Canada is in a technical recession, growth is weak and will stay weak.

At the same time, core inflation is falling. The latter is, of course, related to weaker growth but also because of a normalizing housing market and, yes, fewer immigrants. With headline inflation, the BOC’s stated mandate, now within its target range, interest rates for this new Canada should be lower.

In other words, Canada’s Output Gap is negative. In layman's terms, the economy is operating below its potential, which means there is spare capacity in the form of idle workers, underutilized factories, and weak business investment. In that environment, demand is the problem. Consumers and businesses aren’t spending enough to absorb the economy’s productive capacity, which puts downward pressure on prices and wages and left unchecked, this can become self-reinforcing. Not good.

Central banks generally respond by cutting interest rates to make borrowing cheaper, which encourages businesses to invest and consumers to spend. The goal is to stimulate demand enough to close the gap between what the economy is producing and what it is capable of producing. The logic is symmetric: a positive output gap — where the economy is running hot above potential — calls for rate hikes to cool demand and contain inflation.

Unfortunately, cutting rates is just a short-term fix; it can’t address structural productivity problems or attract private capital that left because of a growing regulatory burden. It has the added complication of weakening a currency. For Canada, and the BOC, that’s a problem because the Loonie is already plumbing depths not seen in years.

So to recap, Canada’s growth is weak, and its output gap is deeply negative, and to address this the BOC almost certainly wants to cut rates to relax financial conditions and stimulate some growth. But it can’t because Canadian can’t stomach a much weaker currency. At the same time, bond yields are rising.

The Global Bond Market is Tightening for the BOC

At IceCap, we have long argued that global risk is synchronized. So even if the federal government rediscovered some measure of fiscal prudence, government bond yields are still set to rise. This is a tightening of financial conditions, and means that mortgage rates rise. Although variable and short-term rates are dictated by the BOC’s Overnight Target Rate, longer-term rates are determined by longer-duration bonds. This means mortgage rates (grey line) and other credit facilities will become more expensive as they follow bond yields higher (red line).

A Debt Wall is Coming

More trouble for the BOC and for Canada is the massive debt wall that the Federal government is facing. Yes, the BOC is mandated to act independently, but they know the data, and they are not stupid. There is more than 500 billion worth of bonds that must be refinanced over the next three years.

Interest Payments Set to Soar

As bond yields grind higher, more and more of the government’s revenue will be allocated to servicing the debt. Presently, the Federal government already pays more interest than it transfers to provinces for healthcare, and it is fair to say this will rise significantly, far outstripping the almost comically optimistic forecasts. Provinces too will have to reckon with higher interest rates. This is another reason they would be happy to see lower rates, even at the front end of the curve. It would give the Federal government some reprieve as it refinances the debt.

Governor Macklem finds himself in an unenviable position — one with no clean exit. The case for cutting rates is straightforward: growth is weak, the output gap is deeply negative, inflation is within target, and the economy needs relief. Under any conventional playbook, the Bank of Canada should be cutting aggressively.

But it can’t. Not really. The Loonie is already under significant pressure, and further rate cuts risk sending it lower still — importing inflation through a weaker currency at precisely the moment Canada can least afford it. The Bank is caught between the economy it needs to stimulate and the currency it cannot afford to sacrifice.

And here is the cruel irony: even if the Bank threads that needle perfectly, it may not matter. The part of the interest rate complex that actually drives mortgages, business loans, and government refinancing costs — longer-term bond yields — is not set in Ottawa. It is set by global capital markets, and those markets are tightening regardless of what Tiff Macklem does or doesn’t do.

The result is a central bank that wants to ease, but rates are heading higher due to forces entirely outside its control. Add a federal debt wall of over $500 billion requiring refinancing in the next three years — at yields considerably higher than when that debt was issued — and the interest burden alone threatens to crowd out everything else the government might want to do.

The Squirmer has good reason to squirm. There is no good option here — only the question of which bad option does the least damage.

~rd