U.S. – Canada Policy Gap Widens as Fed Maintains Rates

On May 7th, the Federal Reserve announced that it will maintain the target policy range for the federal funds rate at 4.25% to 4.50%, citing persistent economic uncertainty. This decision comes as the Fed awaits the conclusion of the current 90-day pause on new tariffs, maintaining a cautious approach amid evolving global trade tensions.

This marks the third consecutive meeting since December 2024 where the Fed has left interest rates unchanged, highlighting its cautious approach in light of persistent trade and economic uncertainty. Meanwhile, the divergence between U.S. and Canadian monetary policy continues to widen. The Bank of Canada’s overnight rate remains at 2.75%, creating a 175 basis point gap relative to the Fed’s target range—a spread that could grow further according to current market forecasts. As the chart below shows, similar divergences have occurred in the past—most notably in the early 1990s and early 2000s—often reflecting differences in inflation trends, labour market strength, or the severity of economic slowdowns across the two countries. Today, the spread reflects differing economic realities: the Fed is holding rates higher to manage core inflation and robust consumer demand, while the Bank of Canada is confronting slower growth and a more fragile economic backdrop. This policy divergence may continue to shape currency trends and influence cross-border investment flows in the months ahead.

Source: FRED: Data from 01/01/1960 – 05/07/2025 and Statistics Canada:

Data from 01/01/1960 – 04/29/2025

Despite elevated interest rates, the U.S. labour market remains impressively resilient. In April, the unemployment rate held steady at 4.2%, which remains low by historical standards and signals underlying strength in the economy. Non-farm payrolls rose by 177,000 jobs, with gains concentrated in healthcare, transportation and warehousing, financial activities, and social assistance. Federal government employment, by contrast, saw a decline. Meanwhile, inflation continued to ease, with the Consumer Price Index falling to 2.4% in March from 2.8% in February—further evidence that the economy is navigating high rates with surprising stability.

Source: FRED: Data from 01/01/1960 – 04/29/2025

Adding to the current uncertainty is the temporary 90-day pause on the implementation of new tariffs, which began in mid-March. While this pause offers a temporary relief, several sectors remain excluded from the suspension, including steel and aluminum. These sectors continue to face higher import costs, putting pressure on margins and raising concerns about future inflation. The tariff pause is scheduled to end in mid-June, and any decision to resume or extend the measures will likely influence the Fed’s next steps.

Looking ahead, market expectations for interest rate cuts have shifted noticeably. According to Bloomberg’s World Interest Rate Probability (WIRP) model, the probability of a rate cut at the Fed’s next meeting on June 18 stands at just 29.3%, reflecting tempered expectations as the Fed balances slowing inflation against lingering trade risks. In contrast, Canada’s WIRP assigns a 52.8% probability of a rate cut at the Bank of Canada’s June 4 meeting, reinforcing the narrative of a growing transborder policy gap that could shape both economic performance and investment strategy moving forward

World Interest Rate Probability - Source: Bloomberg - May 7, 2025

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