U.S. Highlights

  • It was an eventful week across financial markets, with a plethora of economic data, Fed speeches, and political developments keeping investors busy.
  • Domestic economic data was robust and beat expectations. Following on hurricane-induced weakness previously retail sales, housing starts and industrial production get a significant boost from rebuilding efforts in October. Recent data suggests that GDP growth was over 3% in Q3 and is tracking near 3% during Q4 — helping reduce economic slack.
  • Diminishing slack should provide comfort for the Fed to raise rates in December — a view highlighted by several FOMC members this week. The hike is further supported by recent CPI and PPI data which was stronger than expected.

Canadian Highlights

  • Economic indicators this week remained consistent with our view that economic activity is holding at an above trend pace in the second half of 2017.
  • Headline inflation weakened in October as energy prices reversed previous gains. Underlying inflation indicators were little changed. Nevertheless, strong economic activity and rising wage growth all suggest that inflation will trend higher.
  • Downwardly revised estimates of the Canadian neutral policy rate released by the Bank of Canada suggest less room for conventional policy to offset future economic shocks or increases in financial stability risks.

U.S. – Hurricanes Turn from Headwinds to Tailwinds

It was an eventful week across financial markets, with a plethora of economic data, Fed speeches, and political developments keeping investors busy. On the whole, equity markets were largely unchanged from last week’s close (as of time of writing), with robust economic data and potential tax reform reinforcing the Fed’s resolve to raise rates. This has lifted short-term rates somewhat higher, with the yield on the 2-year Treasury note up 7bps since last Friday.

In contrast, yields on longer-term securities have declined since last week. While a pull-back in oil prices from their recent peak was partly to blame, much of the 5bps pare-back in the 10-year Treasury bond yield was related to increased investor demand for safe assets. There was also a sell-off in the junk bond market, lwidening the spread.

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Domestic economic data was in fact quite stellar, with most major releases beating expectations. Importantly, after several weeks of weakness and disruption related to Hurricane Harvey and Irma, data is now firmly showing signs of recovery. After declining during August, retail sales for October continued to rebound. They increased by 0.2% in the month, well above expectations for a flat-print, after an upwardly revised 1.9% surge in September (see Chart 1).

Housing starts too have begun to rebound. After declining during August and September, starts increased by 150 thousand, as previously-delayed projects broke ground. Even more encouraging was the fact that single family starts accounted for much of the gain, surging to match their post-recession peak achieved earlier this year. Additionally, many of the properties that were damaged or destroyed by the storms will need to rebuilt. This trend already appears in permitting data which increased by 72 thousand in October.

Industrial production, hard hit by the recent hurricanes, is is also rebounding strongly. After declining 0.5% in August, as Hurricane Harvey ravaged the Gulf Coast, shutting down refineries and chemical plants, the indicator rebounded sharply. Industrial production was up 0.5% in September and another 0.9% in October. The October surge was largely due to chemicals and petroleum & coal product manufacturing, which surged by 5.8% and 4.0%, respectively (see Chart 2).

Taken together, the recent data indicates that growth in the third quarter was well above 3%, while current tracking suggests that the economy will expand by nearly 3% in last quarter of the year. While the relationship between economic slack and inflation may not be as strong as it had been in the past, most FOMC members believe it still exists. As such, the above potential growth should provide some comfort for the Committee that inflation should over the medium-term converge to the 2% target. On that note, while headline CPI for October decelerated to 2.0% from 2.2% during the previous month as gasoline prices normalized following the hurricanes, core inflation actually accelerated to 1.8% in October (from 1.7%). With unemployment at 4.1% and wage growth seeing signs of firming, inflation should converge and the Fed should hike.

Canada – Growth Holding at an Above-Trend Pace in 17H2

The data flow this week helped reinforce our view that the Canadian economy is expanding at an above trend pace for the fifth, and likely sixth, consecutive quarter.

Manufacturing sales surprised many by rising in September (+0.7% m/m in volume terms). Labor disruptions at an Ontario assembly plant failed to offset a rise in petroleum and coal production in Quebec. As one of the final indicators of third-quarter economic activity, the report is consistent with our call of around 2.0% growth.

With Canada’s housing market increasingly garnering international attention, it was encouraging to see October’s resale home data confirm that activity and prices are on track for a soft landing. National existing home sales rose 0.9% (m/m) in October, marking the third consecutive advance. A rebound in Ontario dominated sales declines elsewhere, while a modest, broad pullback in new listings could act to support price growth in coming months. While national year-on-year home price growth has slowed to its weakest pace since March 2016, regional price trends remain divergent (Chart 1). Home price growth is trending higher in Vancouver and Montreal, lower in the GTA, and sideways in Calgary.

The successive string of well above-trend growth in Canada since mid-2016 has helped to absorb the economic slack that opened up following the 2014 collapse in oil prices. Nevertheless, wage and price pressures have remained subdued. This morning’s data on consumer prices for October was largely uneventful, with the headline index (+1.4% y/y) giving back some of the recent energy-price driven gains. The Bank of Canada’s preferred inflation measures were mixed, although CPI-common rose to its highest rate in sixteen months (Chart 2). Still, there is good reason to believe inflation will trend higher. Wage growth has accelerated alongside strong full-time job gains in recent months. Moreover, a softer Canadian dollar and stable oil prices all suggest that inflation will move toward 2% over the next year.

Rising capacity pressures are consistent with the Bank of Canada moving interest rates higher. However, the risks around the outlook mean that the Bank will remain on hold at least until early next year. But how high can interest rates possibly go? A new research article by Bank Staff this week estimates that the nominal neutral interest rate for Canada is likely within the 2.5% to 3.5% range (prev: 4.5% to 5.5%). The key implications are twofold: a lower neutral rate increases the probability of the Bank hitting its estimated effective lower bound of about -0.5%; and lower rates could exacerbate financial stability concerns by encouraging riskier borrowing behavior.

The Bank is already working to adapt to the risks posed by low rates. In a speech this week, Senior Deputy Governor Carolyn Wilkins highlighted forthcoming changes intended to strengthen the policy framework. In addition to a risk-focused research agenda, next year the Bank will improve its communication and transparency by timing its speeches to better align with fixed announcement dates between MPRs. This is a welcome move by the Bank that should help give both market participants and the average Canadian a better understanding of the policy decisions undertaken.

Canada: Upcoming Key Economic Releases

Canadian Retail Sales – September

Release Date: November 23, 2017
Previous Result: -0.3% m/m, ex-auto: -0.7% m/m
TD Forecast: 0.9% m/m, ex-auto: 1.1% m/m
Consensus: N/A

A rebound in core retail activity and surge in gasoline prices should help drive a 0.9% increase in total retail sales for September. Core retail sales (ex. auto and gasoline) saw one of the largest declines of the post-crisis period in August and such outsized moves tend to correct the following month. Gasoline station receipts will add another source of upside with prices up nearly 5% at the pump due to hurricane effects. Auto sales are likely to see a modest pickup but will be a net drag due to the sizeable increase in sales outside of the dealer’s lot; motor vehicle sales are running over 10% y/y so some moderation should not be seen as overly bearish. This would leave ex-auto sales up 1.1% for their strongest gain since April. Real retail sales should underperform the nominal increase and after negative prints in July and August, are likely to come in largely unchanged for the third quarter as a whole.


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