Weekly market wrap

Fed gets a new chair, takes a pause

Key Takeaways

• The Bank of Canada and Fed held rates steady at their January meetings, as expected¹. After three consecutive rate cuts at the end of 2025, the Fed's pace of easing is likely to slow² as policymakers look for confirmation that inflation continues to cool.
• Kevin Warsh — Federal Reserve Board member from 2006-2011 — was nominated to succeed Jerome Powell as the next Fed chair.
• Warsh likely represents a dovish shift on interest rates versus Chair Powell, though his influence should be tempered by the Fed's structure, which includes the 12-member voting FOMC (Federal Open Market Committee)³.
• The earnings season is off to a solid start for the TSX, while the U.S. is in full swing, as key Magnificent 7 companies released results that beat estimates¹.
• Congress reportedly reached a deal to extend funding for most of the U.S. government, though a partial government shutdown appears likely over the weekend¹.

Bank of Canada, Fed hold rates steady

The Bank of Canada held its policy rate steady at 2.25% for the second consecutive meeting¹. The central bank noted in its statement that CPI ticked up to 2.4% in December, boosted by base-year effects of the Goods and Services Tax and Harmonized Sales Tax holiday that started in December 2024⁶. In addition, BoC commented that the unemployment rate remains elevated at 6.8%⁶. With the policy rate at the low end of BoC's 2.25%-3.25% estimate for neutral rates⁶, headline and core CPI above the 2% target, and unemployment elevated, we expect the bank to remain on hold for the time being. 

The Fed's Open Market Committee (FOMC) concluded its January meeting by maintaining the federal funds target range at 3.5%-3.75%¹. FOMC upgraded its assessment of the economy, noting that activity is expanding at a solid pace, aided by resilient consumer spending and growing business investment³. The statement further reflected the committee's view that, while job gains remain low, the labour market has improved, showing signs of stabilization, though inflation remains elevated³. In our view, this language suggests the Fed is shifting toward a more patient stance after three consecutive rate cuts late last year.

The Fed's preferred inflation gauge — the Personal Consumption Expenditure (PCE) price index — has moderated, aided by cooling services inflation¹. Partially offsetting that progress, goods inflation has risen, in part due to tariffs¹. Overall, inflation remains above the 2% target, and the pace of disinflation has slowed.

We expect tariff-related price pressures to begin fading around midyear. Much of the impact reflects one-time price-level adjustments implemented in mid-2025, meaning the effects should gradually roll out of year-over-year inflation comparisons. The Fed should be able to resume rate cuts once policymakers have more data to confirm that inflation is cooling toward target.

Warsh likely represents dovish shift for Fed

Warsh brings credibility and experience, including a key role during the 2008 financial crisis. While his monetary-policy views have been mixed⁴, we expect Warsh to be more supportive of rate cuts versus Chair Powell. He contends that the U.S. is entering a period of higher productivity — driven by new technologies (including AI) and potential deregulation — which could support faster growth with contained inflation⁴.

Warsh has also been a vocal critic of the Fed's balance sheet as too large⁴. He asserts that the Fed's bond holdings expanded excessively through multiple rounds of quantitative easing⁴. In his view, inflation risks associated with rate cuts (monetary easing) could be mitigated by shrinking the balance sheet (monetary tightening)⁴. Warsh believes this policy mix can support growth, based on his view that low interest rates benefit the economy more than maintaining a large Fed balance sheet⁴. He also views the Fed's approach to inflation forecasting as outdated, advocating for broader perspectives to be considered⁴.

Confirmation process could take time

We expect Warsh to ultimately be confirmed by the Senate, but the process may take time. Republicans hold a narrow 13-11 majority on the Senate Committee on Banking, Housing and Urban Affairs (Senate Banking Committee), which reviews Federal Reserve Board nominees — including the chair — before sending them to the full Senate for final confirmation. Republican committee member Thom Tillis has indicated he will oppose confirmation of any Fed nominees until the DOJ investigation into Jerome Powell around Fed building renovations is resolved.

If Warsh's confirmation extends beyond the end of Powell's term as chair in May 2026, Vice Chair Philip Jefferson would temporarily serve as acting chair. Powell's term on the Fed Board ends in January 2028³, though how long he might remain is unclear. In response to the DOJ investigation, Powell stated that he intends to continue in his role, citing the need for public servants standing firm in the face of threats³.

Fed Chair: outsized but tempered influence

The Fed chair is highly visible with notable influence over monetary policy and communications. However, that influence is intentionally constrained by the Fed's structure, which is designed to preserve independence, including

• Staggered 14-year terms for the seven Board members³;
• Independent board appointments of the 12 regional Federal Reserve Bank presidents to five-year terms³;
• Removal only "for cause," which has never occurred³. "Cause" is not explicitly defined but has historically been interpreted to mean neglect of duty or malfeasance (wrongdoing or misconduct by a public official); and
• Equal votes for all 12 voting members³, who routinely express independent views.

Several Fed officials have recently emphasized the importance of central-bank independence³. While some members may show some deference to the chair, we expect continued diversity of views and data-dependent decisions.

If Fed independence were called into question, markets might react by pricing in uncertainty, potentially lifting intermediate- to long-term yields, steepening the yield curve, and pressuring bond prices.

TSX earnings off to a solid start; U.S. in full swing

Fourth-quarter earnings season is off to a solid start for the TSX, while the U.S. hit its stride this week. Magnificent 7 companies Apple, Meta Platforms (Facebook), Microsoft and Tesla reported results that all beat estimates. The reaction in the companies' stocks was mixed, with Microsoft trading sharply lower due to concerns with robust capital-expenditure spending and slower cloud-computing growth¹.

Fourth-quarter 2025 earnings are expected to rise 12.3% year-over-year for the TSX and 10.1% for the S&P 500¹. Earnings growth is expected to be broad-based as well, with eight of the 11 sectors forecast to report higher earnings¹. We expect expansive earnings growth to help support a broadening of market leadership. Profit growth for both the TSX and S&P is expected to remain robust into 2027¹, shown below.

With valuations elevated relative to history¹, we believe continued earnings growth will be a key element for further stock‑market gains.

U.S. government funding expected to be extended

The short-term funding package that ended the 2025 government shutdown expired on January 30. Congress has reportedly reached a deal to extend funding for most of the government through September 2026¹. However, a partial government shutdown over the weekend appears likely as the package requires approval by the House of Representatives, which is scheduled to return to session on February 2.

Democratic party leaders have indicated that they will not support funding for the Department of Homeland Security (DHS) until the Trump administration agrees to reforms to Immigration and Customs Enforcement (ICE) and Customs and Border Patrol (CBP) immigration-enforcement operations. DHS funding may be excluded from the package pending the outcome of negotiations.

From an economic standpoint, we would expect a short-term slowdown in growth around the shutdown period but a quick recovery in activity in the subsequent weeks and months. In other words, a shutdown would displace or delay spending and economic activity, not eliminate it, in our view.

What this means for investors

1. Fed shifting to more gradual rate-cutting path

The Fed chair announcement does not change our outlook for the Fed to cut rates once or twice this year, targeting 3.0%-3.5% for fed funds. The pace of easing is expected to slow².

With the federal funds target range at 3.5%-3.75%, policy appears close to neutral, in our view. PCE inflation is running at 2.8% annualized, and a neutral policy rate is generally estimated at roughly 0.75%‒1% above inflation for the U.S.⁵

The Fed should be able to resume rate cuts, in our view, assuming price pressures continue to ease. We think a stabilizing labour market — characterized by modest hiring and limited layoffs — should help give policymakers time to confirm that inflation is moving toward the target.

2. Yield advantage of bonds over cash has widened

Cash yields have fallen in recent years alongside BoC rate cuts¹. Purchases of Government of Canada bills by Bank of Canada should help anchor the short end of the yield curve near the policy rate.

By contrast, we expect the 10-year Government of Canada yield to remain largely within the 3.0%-3.5% range this year — still above its average over the past two decades¹. A positive yield curve should help keep intermediate-term bond yields above BoC's policy rate. Resilient growth, persistent budget deficits, and inflation risks typically drive yields higher, making a sustained drop unlikely, in our view.

Some investors may be overweight cash-like investments, including money-market funds, which drew significant inflows amid elevated yields. Consider gradually reinvesting excess cash into either quality bonds that carry more attractive yields or equities aligned with your goals and comfort with risk.

3. Diversification may add value

A backdrop of easing rates, resilient growth and rising earnings should help support equities relative to fixed income, in our view. We favour U.S. large- and mid-cap stocks, where we think leadership should continue to broaden. Developed overseas small- and mid-cap and emerging-market equities may benefit from global economic resilience and lower valuations.

Within fixed income, we think international bonds can add diversification through exposure to different economic and interest-rate cycles, while international high-yield bonds can also enhance income potential.

The bottom line – little change to Fed outlook

In our view, Warsh's nomination likely represents a dovish shift for the Fed chair role, but the impact should be tempered. We continue to expect one or two Fed rate cuts this year, assuming price pressures continue to ease. This interest-rate backdrop, together with resilient growth and rising earnings, helps support the case for diversification and a broadening of equity-market leadership, in our view.

Brian Therien, CFA
Investment Strategy

Weekly market stats

^{Sources: 1. FactSet 2. CME FedWatch 3. U.S. Federal Reserve 4. Hoover Institution 5. Federal Reserve Bank of New York 6. Bank of Canada
Source: FactSet, 01-30-2026. Bonds represented by the Bloomberg Canada Aggregate Bond Index. Past performance does not guarantee future results. *4-day performance ending on Thursday.}
 

The week ahead

Important economic data for the week ahead includes January employment data for Canada and the U.S.