Canada is weeks away from receiving the federal budget, which is creating a lot of interest from market participants. In this episode, Ian and Ali spend time discussing why this budget will look different than those in prior years. The introduction of the new framework, coupled with expectations of fiscal stimulus, make this a key event for markets. The show begins with Ali discussing the reasons for the changes to the framework, while Ian discusses why markets are so hyper-focused on how the budget will be financed. The pair spend some time talking about whether the Bank can ease rates after the budget has been released, focusing on the impact to the economy from the elevated fiscal spend. The show concludes with Ian discussing why markets are reluctant to price-in more from the Bank, while Ali opines on what a Blue Jays World Series win will do the economy!
Intro: Relative to the current run rate of issuance, we need financial requirements between 25 to 40 billion. I would say that 80 to 85% of that is likely to come in bills. Of that residual, I think you will get some increase in coupon supply.
Ian Pollick: Happy Friday everybody and welcome back to another episode of Curve Your Enthusiasm. Listen, we have a lot to talk about and there's this one big important thing ahead of us and it's not just the Bank of Canada rate decision next week or the week thereafter. It is the budget on November 4th. And to talk about that I'm joined today by Ali Jaffery in our CIBC Economics department. Ali, how goes?
Ali Jaffery: Good man, how are you?
Ian Pollick: I'm okay. I want to start off talking about the information we got a couple weeks ago on the compositional change of the budget. You know, I was in Europe seeing a bunch of clients when this news dropped and at first it was not entirely obvious why the government has changed both the timing as well as the way in which the budget is presented. So let's just talk about that. And I think to be very specific, we're now moving into a world where there's going to be an operating budget. There's going to be a capital budget. Maybe just walk us through how you're thinking about this and why did they do that?
Ali Jaffery: Sure, so I think that it's kind of just a circumstances for the timing. You know, the government was formed after the, you know, the typical period of the budget. There was a summer recess. And, you know, and then to go back and to reset the normal fiscal calendar, I think was going to be challenging given the circumstances that we're in. And plus there are some advantages of doing a budget before the actual fiscal year begins because people don't really appreciate that there's a difference between the budget which is kind of a conceptual fiscal document that lays out the priorities of the government and uses kind of an accrual accounting approach to lay out the government's finances and expenditure plan and that's different from the actual appropriation cycle in Canada, which begins in February and March with this document called the main estimates that lays out the appropriations by different government departments. And then there's these other supplementary windows called supplementary estimates A, B and C that where the government actually then adds on what was agreed to in the budget or was passed in the budget. So it doesn't come in that the main window for the appropriations process. It creates some better alignment with the appropriation cycle. Now, I don't think that that was a big necessarily priority for the new administration, but it just, this is, I think, a more pragmatic approach. It solves that problem of aligning with the appropriations cycle, provides firms and businesses and also government departments with clarity provinces as well. So think that's part of the motivation for the shift in timing. But I still think that the fiscal updates that you'll see in the spring will be substantial. They'll kind of be like mini budgets. So it's just kind of a shift in timing rather than a real material shift in style. Now, the other part you alluded to, new capital budgeting framework. The government has announced that they're going to distinguish different types of identifying that spending or tax expenditures that are related to stimulate investment, either directly or indirectly. And then everything else that isn't considered related to capital spending or capital investment will be day-to-day or operational spending. I think the point there is to signal to the market and firms more widely in Canada and globally that this government is focused on a pro-growth agenda. So even though it's going to run deficits, it's the intention is really to stimulate growth. The UK has done something similar to that-
Ian Pollick: Yeah, you're boring to invest. Like that's the whole message you're trying to send.
Ali Jaffery: Yes. Yeah, exactly. So will that work? I'm not sure. I understand why they're doing that, but it's to kind of give a sense that, this is intended to stimulate growth as opposed to be just normal government spending or for social policy purposes.
Ian Pollick: Okay, so let me ask you this. Let's get some very basics out of the way. You know, usually when we get a budget, it is in the spring, it is for the upcoming fiscal year, sometimes that fiscal year has started. Obviously this budget's a bit different. We are, you know, well through the current fiscal year, 25/26. And so when we get this budget on November 4th, are we getting a budget for the balance of the current fiscal year and as well as 26/27?
Ali Jaffery: I think we're definitely getting for the balance of the fiscal year, be kind of an accounting of what we've seen also of what's been announced. And then plus some of the next fiscal year until we get to the spring or whenever they want to do the fiscal update. So it's kind of a little bit of both. This is where I think we where we are. And then once we get to the spring, we get a proper reset of the entire cycle. We say, OK, this is where we are, how we've done relative to the budget we announced about six months ago. This is where we think we're going to go till the end of the next fiscal year. And really, our understanding of fiscal years will be closely tied to calendar years as the government announces fall budget. So this year will be a bridge year till that new regime, which will really will get more clarity probably in six months or by the spring.
Ian Pollick: Okay, and so I think a lot of the there's a bit of confusion in terms of what you were saying earlier, or this is going to be a budget that's going to show some capital deepening, a rebuild of the capital stock on the public sector, the private sector. But we also heard Carney talk about an austerity and an investment budget. Is it fair to say that the austerity comes through the operating budget, which will probably show a balance over the forecast horizon, and that's where the fiscal anchor is maintained. And then the spending comes on the capital side. Is that the best way to think about it?
Ali Jaffery: Yeah, I think so. what they've said and they laid that out in their campaign platform as well, where they wanted to book around, you know, $13 billion in government efficiency and savings. And also there was, you know, a line item there for fines and fees being increased. So altogether, I think it was around $15 billion in savings that they wanted to achieve over a four year period. So and that will be concentrated on that operating side, as you mentioned. So they're doing these two things in tandem, you trying to stimulate private investment and also contribute through public investment, but then also cut back. That cut cutting back is, you know, it seems to be primarily focused on government back office operational spending. So you'll, think what you're going to end up seeing is, and I'm hearing this from the whispers already here in the beautiful city of Ottawa, you know, government departments possibly being merged. Different offices being moved here and their senior officials not being replaced as they retire. And that's a process that they're going to pursue, I think, quite aggressively. And you'll see more of that laid out in the budget. So it's just kind of reducing the overall operational footprint of the federal government, but at the same time, increasing spending on defense, infrastructure, housing, the main priorities that they've been talking about for quite some time.
Ian Pollick: And so, you know, it's not lost to me that as we go into CPI next week, you know, one of the things we're looking for is the reciprocal tariffs are kind of going to impact those core measures. But those reciprocal tariffs were a line item for revenue in kind of the original liberal platform. And so in theory, that would live in the operating budget. But to the degree that on a go for basis, we don't really have these reciprocal tariffs. Where's the plug coming from? You know, that was a sizable number. It was like 10 billion or something.
Ali Jaffery: Yeah, it was pretty mature. think it was, I think maybe 20... It was a large number book for this year. I think what's gonna happen is they're gonna have to pare back some of their spending objectives. And you've kind of seen that where they've, you know, they talked a lot about infrastructure early on as a means of rewiring our economy, supporting inter, you know, inter provincial trade. And they've announced a few, they just announced something fairly modest for the city of Toronto, but infrastructure really, they haven't laid out the details of that because that's very expensive. So I think they're gonna pare back spending on that, because they've been compelled to spend on defense, they're gonna do a little bit on housing. So I think they're just gonna have to be more careful about the price tag of some of major initiatives because they're not gonna be able to book that revenue for this year. And that's the thing that in the outer years though, I think they'll pursue those objectives, but probably possibly more carefully instead of, you know, using government spending, they might use kind of off budget loans to achieve some of that. But that that they're only hamstringed in terms of, you know, counter and tariff revenue just for this fiscal year. And then, you know, I think in the future years, they'll have more space to pursue those objectives.
Ian Pollick: Okay, so let's get to the nitty-gritty. When we think about the actual level of the deficit. You remember that originally, I believe that when the liberal platform was costed in the election, you were looking at a 25/26 deficit around 60 to 65 billion. We've seen different measures since then. You have the CD Howe that is closer to 100. You have the PBO that's closer to 70. In my own kind of math, I get closer to that 90 to 100 level. So what are you thinking about it? What is CIBC's official view on this?
Ali Jaffery: Well, we're thinking somewhere in the range of 80 to 95 billion. So not far from what you're thinking and also with, guess, with the CD Howe's thinking. So our sense is that the baseline, given the weaker economic outlook, has been revised higher, you know, to around 65 billion alone. So given the spending and the weaker revenue that's already in the system, you already kind of have a budget or budget deficit of around minus 60 to minus 70 billion and then the measures that the government has announced or have cost and is likely to announce, we think that adds up to 20 billion to 25 billion. So you get closer to that 80 to 95 billion deficit range. So you're looking at anywhere from 2.5% of GDP to close to 3% of GDP as a deficit for this year.
Ian Pollick: And so I think the other question here is, when we look at how we're breaking to some of the consensus, and just meeting with investors, my sense is that markets are thinking somewhere between 70 to 80 is likely the status quo here. It's on the revenue side, right? Like it's not like there's a bunch of additional fiscal measures that are being surprised. Now, one thing I have heard from a variety of accounts is this idea that will there be a GST consumption tax increase to help provide a little bit more revenue? Have you thought about some of those types of measures that move in the opposite direction?
Ali Jaffery: Yeah. I think it's very unlikely. There'd be a pretty significant negative sentiment shock from that. It also, you know, that would be a modest drag on growth as well, likely. and, you know, I haven't heard anything in the city, even, you know, resembling anything close to that. So I would put that as a very, very low probability.
Ian Pollick: Alright, amen.
Ali Jaffery: And so let me kind of turn the tables here. So what are markets thinking about this budget in terms of how it impacts the path of the BOC?
Ian Pollick: Listen, I think that markets rightly are looking at this budget as a very spendy budget, one that has the ability to provide a decent outlook to the economy over the medium term, not right away. I think people recognize when you look at the channels that stimulus is really coming in, you don't really see that cash hitting the economy right away. But that being said, the bank has been suggesting that they are very short term in nature when they think about the policy path, but that converges back to the medium term over time and therefore, by definition, when you get to the January NPR, it's gonna have a overall forecast compared to the October NPR because it will incorporate these fiscal changes. And so I think the idea here is now, if I had to think about where the distribution is of expectations for October. I'd say 25% of accounts are firmly in yes, they are cutting in October. I think 50% think that the cycle is done. And then that remainder 25 think that there's probably another cut, but at a more gentle pace of like once a quarter and with a terminal between two to two and a quarter. And so I do think though that there is a risk that if we're wrong on CPI, for example, and the downward push from reciprocal tariffs being dropped doesn't impact core measures. If the business outlook survey, in particular the leaders pulse index shows some optimism, then if they didn't go in October, I think people are looking at the budget is saying, well, now the budget's so big that this probably means the cycle is done. I mean, how do you think about that? Do you agree with this assessment that the window is closing even if you got data that didn't slam dunk October that the bank would feel compelled to do something before that new information is delivered?
Ali Jaffery: I think that the bank recognizes that the economy is weak. They've kind of changed their tune in the last several meetings about the risk to inflation being balanced, even though, you know, inflation is, you know, a little bit higher than what they would like. They can explain that by some kind of idiosyncratic forces related to the exchange rate related to different sectors. So I think that they recognize that the economy needs more support. Is fiscal policy a significant deterrent to the BLC? I think unlikely. The reason being that sure, you're going to have a big deficit, but it doesn't necessarily mean that that's going to provide a material amount of stimulus to the economy. So it will take time for that to feed through. think the fiscal impulse from this budget, we don't know the details obviously of everything, but of the big pieces we know, I think you know, my guess is that this will be a fiscal impulse around half a percent to one percent on the level of GDP over a period of, you four to seven quarters. And the defense spending part has a significant component related to boosting salaries of existing soldiers or employees of the Department of Defense. So that's not really going to spill over significantly in the rest of the economy. Other parts are about, you know, building infrastructure in Canada to support the military again. You know, that's really not going to generate substantial spillovers either. So I think the bank's going to see all of that, be patient, but recognize that, you we do need a little bit more support. So I don't see a lot of obstacles to October and it would just be weird for them to cut in September and then be very data dependent again and see all of that, know, typically-
Ian Pollick: I agree. Let's just talk about the elephant in the room, right? Like you guys in CIBC Economics, you were looking for a pretty decent employment number. We got that employment number, but you were right for the wrong reasons. had nothing to do with youth unemployment. Maybe it was some lagged impact of the way that productivity was working with final domestic demand in Q2 and so there was some understating of job losses because of the rise in population. But the point is, is you got a very big number and it was all in private sector full time, public sector full time. How is the bank looking at this unemployment number? Because I think that the three month average is pretty crappy. It's the lowest since 2021. But talk to me about how, if you were sitting on the governing council, what would you be talking about with respect to the employment report?
Ali Jaffery: So I think they'd be thinking about exactly as you mentioned, they'd be looking at the three month average, you know, in terms of the job gains, you know, which is around minus 15K, not very good at all. But they'd put more weight on the employment rate, is still very low around two percentage points below probably what equivalent of full employment, a jobless rate that's very elevated at 7%, the prime age, which I really care about, I think a sense is really the pulse of the economy, which is still elevated at a 6 % unemployment rate, it's not a good labor market. Even if you had whatever it was, 60,000 jobs gained, that's coming off after a minus 65. So there's a lot of measurement error also in the LFS, particularly with population shifting. And we see the population numbers in the LFS, at least the adult ones, don't necessarily align very well with the quarterly population estimates, which are bit more credible. They're not worried about that large employment gain number for the for you know one month and they see a broader labor market picture that is weak and an economy that definitely needs more support so I think October is a go and I would not be surprised it's not our house call but if they're contemplating you know further cuts in the future given if they see weak data and I think there's a higher probability of that than most are thinking about. So actually, let's kind of turn back to the budget for a moment. One of the questions I'm hearing all the time from clients is what are our expectations around the composition of issuance and supply?
Ian Pollick: I mean, this is a great question. And I think what you have seen, particularly in 2025, is this idea that fiscal expansion just means more bond supply and that bond supply creates this very big term premium and yield curve. And that's one of the reasons why you've likely seen curves steepen over and above what you would normally expect from just macro curve mechanics. And so when I take a step back and I look at the overall picture of Canadian supply, remember that Canada has been the fastest growing bond market in percentage terms in the G7 this year. When I look at the amount outstanding across the curve, it's not lost on me that 10 year plus issuance is running relatively high. Obviously, it's a bit lower than peak COVID, but compared to pre pandemic, you you're still in that 30 to 35 % range. At the same time, when you look at the size of the bill stock, the bill stock looks relatively low. And unlike other jurisdictions, a lot of people forget that Canada tends to run a 50-50 program in terms of proportion of bills to bonds. Now, that proportion on the bill side is running a little bit lower this year. I think that the bill stock was calibrated such that it could absorb any big swings in financial requirements. And so I would say that if we are talking about a deficit of 100 billion just to have a round number. Relative to the current run rate of issuance, we need financial requirements between 25 to 40 billion. I would say that 80 to 85 % of that is likely to come in bills. Of that residual, I think you will get some increase in coupon supply, but you're talking about 10 to 15 billion in that world. So in 10 year equivalents, you're talking really about three auctions, and that's going to be distributed across the curve. So it's just not a huge amount of supply. And I think that we have to also remember that there is a liability-led growth in the balance sheet that the bank needs assets and they have talked about buying bills in the fourth quarter we are in the fourth quarter and so you know it's a very elegant design to increase the short-end supply knowing that in net terms the Bank of Canada is going to be purchasing bonds in the bills in the primary market and such that you're not gonna get this over saturation of short end even if you're relying on it. And so we tend to think that the bottom line is that you don't get a huge amount of coupon issuance. I think that some of the curves like 5s30s and 10s30s look too steep on the expectation of supply. And then most of it actually comes to the bills market.
Ali Jaffery: And so how do you the market is going to react to all that? And so what does it mean for financial conditions?
Ian Pollick: I do think that in longer term interest rates, you'll likely see some support. I think it shows itself most acutely in asset swap spreads. I think that there's some reason to be somewhat bullish 10 year spreads, 30 year spreads relative to the curve. That would argue for trades like 10s30s swap spread curve steepening or 5s30s swap spread curve steepening. But you know, where I see the most benefit are in areas where boring rates in the economy just aren't located. You know, you still have most of boring rates that are sub five years There's a lot of mortgage originations that are still in the two and three year range And so that doesn't actually do a lot and I think that's the rub here, right? The rub to all this is like you can make the case that you have this big deficit footprint. And when you think about the channels by which our star has declined structurally in Canada, it's really come from these other components, not necessarily just trend productivity. so that is just your savings and investment balance is not in balance. And if you're talking about a budget that is looking for more capital deepening, I do worry that, you know, this is the case where real interest rates need to rise to entice savings back into the system to equalize the need for investment. And that's not gonna do a whole lot for five-year bond yields, and therefore it's not gonna do a whole lot for mortgages. And so I guess the question I have for you is, you know, when you think about this narrative in the market and that narrative is early cutters become early hikers and that gives no semblance to the non-inflationary growth room across markets. How do you think about hiring boring rates, hurting housing, but those higher boring rates being a function of bringing savings back into the system to funnel investment? Like that's a natural tension, isn't it?
Ali Jaffery: No. It is, it is. And that's a good view. but that's, think the balance of saving investment here, it's more of a structural thing, a structural development. Whereas when we look at kind of the broad range of the economy, it's telling us that, you know, we're in disequilibrium relative to our level of potential. And so I think there's a justification, strong justification, you know, to bring rates into in a more accommodative position to allow the labor market to move back into full employment to keep inflation around target and bring GDP back to potential. So is it a big challenge now, the saving investment imbalance? I'm not sure if we need to address that sort of thing right now.
Ian Pollick: Not today.
Ali Jaffery: Yeah, not today. And there's a lot of frictions in this because like, there's also this sectoral change going on where we had, you know, you 2000 to 2010, you know, it was a strong investment in national resources, and particularly the energy sector. That has faded off a lot since 2015, since the oil price crash. And we've had legislation that's pushed the other way. So I think there's a lot of other structural forces that have kind of put that part on hold and causing a lot of that. But right now, the here and now is telling us that we need rates to go, I think, into more supportive position. And so I guess to bring it home and a question to you is, you know, the market doesn't see that, you know, you know, they're not pricing in more of a risk that the bank goes below two and a quarter, even though, you know, we see a strong argument that that could be the case. So why is the market thinking the way it is?
Ian Pollick: Honestly, I do think it's partly a function of the fact that there was expectations at the last cut in the September meeting that you get more forceful forward guidance and you didn't. And so I think there is a lot of confusion over what that policy path looks like. Now I agree with you. I think it looks super weird to go through an easing cycle, pause for six months, stop out of the pause, deliver a cut, go back on pause, get a budget, maybe cut later. I think it's a super weird profile. It's just largely inconsistent with their reaction function. But I do think that you're in an environment where going below the lower end of the neutral range requires a very large burden of proof that isn't as automatic as it is when you're in that range. And you're seeing it across the world, right? In the early cutters like New Zealand, Europe, Canada, markets are treating these dynamics effectively homogeneously. And so I think that when I look at what's priced into the curve, you basically have Hikes price in the latter part of 26 and 27. You reach terminals sometime in the middle of 2026. But you're very, very close to that two and a quarter level. I think you dip a few basis points below it. I think you're going to need to see some external shock to really get the market moving. Let's say USMCA risks in early 2026. But I also think that there is an expectation that I believe is crazy that when the bank goes to two and a quarter, they'll tell you they're done. And that's just not how this this governing council works. And so I do think it'll correct itself. But I think that's how we got there. You know, my question for you, just to end the episode, because we're a bit long in the tooth, people want to enjoy their weekend. Have you run any math around what it means for the Canadian economy when the Blue Jays win the World Series?
Ali Jaffery: Yeah, think that we're going to totally unwind the effects of the tariffs. So let's go, Jays.
Ian Pollick: Okay, let's go Jays. With that said, we hope everyone has a great weekend and remember there are no bonds harmed in the making of this podcast.
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