Daily Points

ON DECK FOR TUESDAY, JULY 8

KEY POINTS:

• Global sovereign yields are under upward pressure…
• ...after the RBA delivers a surprise hold...
• ...and markets digest risks to supply chains and inflation from Trump’s letters
• Carney administration is targeting significant reductions to operating spending…
• ...that will still fall well shy of funding defence and infrastructure plans…
• ...and are likely to encounter opposition within Cabinet, by unions and other interests
• The circus to succeed Fed Chair Powell
• Light data: German exports, LatAm inflation, Cdn PMI, NY Fed’s inflation expectations

Sovereign yields are up across most major markets this morning with Australia’s curve leading the way. The catalysts may include a reminder from the RBA that central banks won’t be pushed into easing aggressively. Trump’s tariff letters may also be factoring into market concerns around risks to supply chains and inflation, although in my opinion the main message to be derived from those letters was that he caved again by extending the tariff deadlines to August 1^st for the targeted countries while there is little by way of developments concerning major trading partners like China, Canada, the EU and Mexico. Light data isn’t factoring into the broad market tone. Canada’s government is clearly stinging from direct attacks on its fiscal outlook as noted below.

RBA CLEARLY THOUGHT CUT PRICING WAS GOING TOO FAR

The RBA surprised markets and consensus by holding its cash rate target unchanged at 3.85% with a 6–3 outcome in favour. Only five out of 32 forecasters got the call right while markets were priced for a cut going in. The bias indicated the bank was “cautious about the outlook” but that “it could wait for a little more information to confirm that inflation remains on track to reach 2.5% on a sustainable basis.” That “little more information” could come in the Q2 inflation readings on July 29^th ahead of the next decision on August 12^th. If the underlying readings cooperate, then it could bolster market pricing that shifted a cut to the August meeting.

Regardless, the RBA was clearly uncomfortable with how far markets were going in pricing rate cuts at this juncture. Cumulative pricing into year-end was knocked back from about 75bps to being on the fence between 50bps and 75bps. The rates curve bear flattened as 2s cheapened by about 11bps and the A$ is the star pupil among FX crosses this morning.

CARNEY IN DAMAGE CONTROL OVER DEFICITS

Canada’s Finance Minister Champagne reportedly sent letters to cabinet ministers yesterday indicating plans for a “comprehensive expenditure review” that targets cuts to direct program spending of 7.5% in the next fiscal year beginning April 1^st 2026 and then 10% the next year and 15% in the following fiscal year. Direct program spending is a portion of total program spending that excludes transfers to other governments and persons. In the Fall Economic Statement last December, direct program expenses were targeted at $229B for the recently completed FY25 versus total program spending of $486B.

It’s unclear, however, whether what is being targeted for reduction is the direct program expenses category or the narrower subset called ‘operating expenses’ which excludes transfers other than to governments and persons and includes things like the dental care plan, support for electric vehicle battery manufacturing and major investment tax credits. My hunch is that the letters are targeting just operating expenses excluding these items, but both scenarios will be covered given the absence of any explicit guidance.

If it is total direct program expenses that is being targeted for such reductions, then chart 1 is the relevant one. It uses the last set of numbers published by Ottawa in the December 2024 Fall Economic Statement as the jumping off point from FY26 numbers given we haven’t had a budget and shows targeted reductions that would lower this category of spending by about $66 billion per year by FY29. 

If it is operating expenses being targeted, then chart 2 is the relevant one and the more likely case. It shows that this category of spending would be reduced by about $37B per year by the end of the targeted cuts. There are significant brackets around these estimated impacts because of the uncertainty around an updated starting point and uncertainty around the economic outlook.

These are significant reductions, but the first caveat is that they are mere targets. Perhaps the FinMin is coming in high on the desired percentage reductions partly for optics, and partly while knowing that cabinet ministers will push back on reductions to their empires and fall shy of delivering on the plans. After all, it’s reasonable in my opinion to assume that anyone raised in government is a maximizing bureaucrat that measures their worth on the basis of the size of their budget and the number of staff they have doing their work for them, rather than what they achieve and their departmental productivity. The economist William Niskanen wrote a tonne on this many decades ago.

Reductions of this magnitude are also very likely to involve sharp reductions to the civil service. That’s a good thing in my books, given the bloat that has crept in over the past ten years or so while civil service payrolls ballooned. Chart 3 shows the total number of employees in the civil service across all levels of government in Canada and chart 4 does the same thing for just the Federal civil service. That said, the Carney administration is likely to face stiff opposition from unions that could take varied forms including work to rule campaigns and strikes. It’s tough to see this magnitude of spending cuts being achieved through attrition and spending less on paper clips.

In any event, saving hundreds of billions over a ten year period falls well shy of the amounts the government would need to fund its ambitious target of 5% of NGDP spent on defence and infrastructure by 2035 (chart 5). Somewhere around $1¼ to $1½ trillion is reasonable to assume being spent on these items over the next ten years depending upon how the plan is implemented over time. A few hundred billion in operating spending cuts over a decade would be significant dent, but a) faces implementation risk, and b) is swamped by the desired spending increases on defence and infrastructure. How to fund these items remains focused on bigger deficits for longer and probably taxes. Throughout this year, I’ve warned of large and mounting deficits at pandemic levels on a sustained basis and against more pollyannaish views. I was encouraged to see last Thursday’s piece by the CD Howe Institute (here) to which the Carney administration may well be responding with these letters. 

LIGHT DATA

German exports fell by 1.4% m/m in May (-0.5% consensus) with minor revisions. Imports fell by more (-3.8% m/m, -1.7% consensus) and were revised down to a gain of 2.2% in April (from 3.9% previously). The trade surplus widened but remains in a noisy trend.

Colombia’s inflation reading for June surprised a little lower than expected. CPI was up 0.1% m/m SA (consensus 0.17) and 4.8% y/y (4.9% consensus). Core CPI, however, ebbed a touch to 4.9% (5.1% prior) and was in line with expectations.

Chilean CPI surprised lower than expected (-0.4% m/m, -0.2% consensus) with the year-over-year rate falling to 4.1% in June from 4.4%.

Canada will refresh the Ivey PMI for June (10amET) while the NY Fed’s 1-year inflation expectations reading for June is due out at 11amET.

THE FED CIRCUS

There are no Fed speakers on tap today. Thank heavens for small mercies given the circus that’s being run. The latest likely candidate to undermine Chair Powell’s leadership is Kevin Warsh. To be clear, I respect him for his stance on QE when he resigned from his post due to a difference of opinion with Ben Bernanke on large scale asset purchases, as well as for his stance against tariffs.

I lost some respect for him last evening when he weighed in on current policy by criticizing “bad economic policies” at the Fed while saying there is “plenty of deadwood” at the central bank, that he has sympathy for Trump’s views that the policy rate should be lower and “tariffs are not inflationary.” All of that is debatable, but any serious candidate for Fed Chair shouldn’t be weighing in on current policy in such fashion while overtly currying favour with the administration’s views in a way that should lead markets to question the independence of the three most vocal potential candidates: Warsh, Waller and Bowman. This tactic plays to the thesis there will be a shadow Fed chair challenging Powell until his term is up next Spring and that could create high uncertainty in financial markets.