ECONOMIC & FIXED INCOME COMMENT- Fiscal Policy in Focus

As 2025 draws to a close, the global economy remains confronted with a difficult landscape marked by trade tensions, uneven but moderate growth, and rising concerns surrounding inflation and government deficits. Looking towards 2026, many of these issues are expected to continue to prevail, with the OECD forecasting a modest slowdown in global growth from 3.2% in 2025 to 2.9% in 2026.

In 2025, several major central banks implemented interest rate cuts at the fastest rate and most substantial magnitude since the financial crisis, executing 32 interest rate cuts totalling 850 basis points. Looking ahead to 2026, many central banks are anticipated to pause their monetary policy initiatives.

The global economic landscape is shifting away from an era characterized by monetary dominance toward fiscal dominance, with governments becoming increasingly inclined to run elevated deficits to meet structural spending needs and political objectives.

Fiscal policies in major developed economies, especially in the United States and Canada, are expected to emphasize economic growth through intentional expansionary measures. Moving forward, the focus will shift towards industrial policies aimed at reinforcing critical sectors like infrastructure, defence, and manufacturing, while government funding will increasingly support the private sector with long-term investment opportunities.

The Canadian economy expanded 2.6% (y/y) in Q3, recovering from 1.8% in Q2, although growth momentum moderated at the start of Q4. The Canadian economy is expected to avoid a technical recession in 2025, but ongoing economic challenges are anticipated to extend into the first half of 2026, with overall growth forecast to expand 1.3% in 2026.

The Canadian government has implemented policies designed to diversify trade relationships and reduce interprovincial barriers, but restoring business confidence will be crucial. The outlook for growth will be closely tied to the outcome of CUSMA negotiations with the U.S. administration, and we are cautiously optimistic that the negotiations will lead to increased stability and clarity.

The U.S. economy witnessed its strongest growth in two years, expanding 4.3% (y/y) in Q3, with momentum expected to moderate in Q4. As we look toward 2026, the U.S. economy is set to gain from three significant growth tailwinds:

1. Increased infrastructure spending and fiscal stimulus (including tax cuts and deregulation from the One Big Beautiful Bill Act)

2. Swift adoption of artificial intelligence technologies

3. Consistent consumer demand

   
   

Recent government initiatives are set to support infrastructure projects, AI integration is improving efficiency and fostering innovation, and consumer spending remains robust. Overall, the U.S. economy is expected to expand 2.3% for 2026.

The Bank of Canada (BoC) maintained its policy rate at 2.25%, with the Governing Council reiterating that the current policy rate is appropriate for keeping inflation near the 2% target while supporting growth. Moving forward, the BoC will focus on monitoring export growth and its effects on business investment, employment, and consumer spending.

Currently, economists are forecasting three possible scenarios for the BoC in 2026:

1. An extended hold at 2.25%

   • Inflation remains close enough to target

   • Growth stays soft (~1-1.5%) but not recessionary

   • Trade uncertainty doesn't produce a major shock

2. An early/mid-year rate cut in the event of notable economic weakness

   • Canadian domestic demand softens more than expected

   • Labour market slack rises, and inflation drifts below target

   • Trade disruption hits growth harder than expected

3. A late-year hike if the economy shows resilience and inflation remains a challenge

   • Inflation proves "sticky"

   • Wages or demand rebound faster than expected

We believe the BoC may need to uphold its easing bias, which could involve one more rate cut in early 2026, lowering the policy rate to 2.0%.

The Federal Reserve lowered the Fed funds rate to 3.75%, and it is anticipated that the Fed will likely pause any rate adjustments early in 2026 before considering one or two rate cuts later in the year following the appointment of a new Fed Chair.

Overall, Government of Canada 10-year bond yields are expected to remain within a defined range of 2.75% and 3.50%. We anticipate a continued steepening of the yield curve and favour Canadian bonds, particularly in the short to intermediate segments, due to their attractive yields and potential for capital appreciation if economic growth does not meet expectations.