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U.S. Highlights

• The FOMC downshifted its tightening race in December, raising the policy rate by 50-bps, bringing the operating band to 4.25%-4.5%.
• The FOMC’s Summary of Economic Projections showed a less optimistic economic outlook, accompanied by higher inflation. The median consensus on the Fed Funds rate was lifted by 50-bps for 2023, implying a terminal rate of 5.25%.
• November inflation data showed a further softening in price pressures, with core CPI rising 0.2% m/m and the 12-month change falling to 6% y/y. Retail sales for November were weaker than expected (-0.6% m/m), recording its largest monthly decline in 11 months.

Canadian Highlights

• Canadian existing home sales and prices declined again in November, as the market continues to recalibrate to higher interest rates.
• However, housing starts came in at a robust 264.2 thousand units. The pipeline of projects continues to be full, fueled by low supply and the prior run-up in house prices.
• The reading on household balance sheets gave us insight into the Canadian consumer. With house prices dropping, Canadians are less wealthy than at the beginning of the year.

U.S. - Slowing, But Not Stopping

Phew, whatta week! The headlines included further evidence of softening inflation, wanning consumer momentum and the much-anticipated December FOMC interest rate announcement. The Fed met market expectations, increasing the policy rate by “only” 50 basis-points (bps), bringing the upper-bound to 4.5%. That marked a slowdown from the 75-bps pace undertaken at the four prior meetings, but still stands as a historically fast pace of policy adjustment (Chart 1).

Beyond the interest rate announcement, the FOMC also released updated economic projections. Relative to the September assessment, Committee participants now expect growth to be considerably weaker in 2023 (0.5% vs 1.2%) and the unemployment rate slightly higher (4.6% vs. 4.4%). Despite the more downbeat outlook, policymakers view price pressures as having become more entrenched, and upgraded the inflation outlook through 2024. As a result, the FOMC signaled rates are likely to move at least 50-bps higher than previously expected next year – implying a terminal rate of 5.25% – with cuts not beginning until 2024.

In the press conference, Chair Powell struck a somewhat hawkish tone. When asked about the recent easing in financial market conditions, Powell stated that the Committee looks through near-term swings, but emphasized the importance of market conditions aligning to the Fed’s intentions. Moreover, Powell was quick to direct focus to the upward revision to the “dots”, reiterating that the Committee’s view on inflation remains skewed to the upside and thus future projections could still show an even higher terminal rate. Despite this deliberate signaling, market participants still believe that the Fed will begin cutting rates late next year.

Investors current assessment might be somewhat biased by November’s CPI data, which showed a further cooling in inflationary pressures. Core inflation rose by 0.2% m/m – a tick below market expectations – bringing the 12-month change to 6.0%. Core goods prices declined for a second consecutive month, while price growth across services continued to be led by outsized gains in shelter. That said, even after removing its effects, most other service categories continue to show strength. This cuts to the heart of the issue. With goods prices appearing to have rolled over and the shelter component expected to slow in H2’2023, the move down towards 3% inflation by the end of next year is feasible. However, until we see a more meaningful slowdown in hiring activity, leading to a cooling in wage pressures, many labor-intensive service sectors will continue to run hot – preventing inflation from moving back to 2%.

Though the cumulative impact from higher rates hasn’t yet hit hiring intentions, November retail sales showed consumer momentum may be wanning. Sales fell 0.6% m/m – its biggest monthly drop in nearly a year – with notable declines in holiday categories including, electronics, clothing, and sporting goods. As we noted in our Quarterly Economic Forecast, it was unrealistic to assume the recent strength in spending would continue indefinitely. A broader demand adjustment needs to occur over the coming quarters in order to restore price stability. It would appear we are nearing the precipice of that adjustment.

Canada – Housing Drop Hits Household Wealth

It was a volatile week for financial markets, with negative sentiment south of the border pushing Canadian equities and bond yields lower. Canadian economic data didn't help sentiment either as readings on home sales and prices continued to fall (Chart 1). The national household balance sheet data showed another leg down in real estate wealth for Canadians. Though this decline was expected, it encapsulates the impact of the Bank of Canada's historic rate hiking cycle on the finances of Canadians.

Overall activity in the resale market fell again in November, with existing home sales declining 3.3% month-on-month (m/m). At the same time, new property listings also fell 1.3% m/m. With the drop in sales once again outpacing listings, the sales-to-listings ratio is now below the 50% level which defines the midpoint of a balanced market. That is good news for buyers. However, with the month's supply of housing inventory remaining at a very low 4.2 months, supply fundamentals suggest a floor in prices may be coming sooner rather than later. This is the main reason why housing starts – which held at a solid 264.2k annualized units in November – have held up so well amidst this market adjustment.

Speaking of attracting buyers, the like-for-like MLS home price index was down over 1% on the month, putting the peak-to-trough decline at 11.5%. In terms of average house prices, the year-on-year drop now stands at 12%. With the BoC having hiked its policy rate again last week, housing activity is likely to show another decline in December, though a trough is expected to form in early 2023.

The 2022 drop in Canadian housing values is hitting household balance sheets. Canada's national balance sheet accounts for the third quarter of 2022 were released this week and showed that household wealth declined by 2.1% (Chart 2). This marks the second straight quarterly drop in wealth, bringing the total decline to 7.7% over the last six months. In dollar terms, Canadians lost approximately $1.3 trillion in wealth, with the decline in real estate values being the biggest contributor. This has and will have a far-reaching impact on the Canadian economy. When people feel less wealthy, they tend to spend less. No wonder we saw a significant pull-back in consumer spending over the summer.

We will get more insight on the Canadian consumer next week when retail sales data are released. We are expecting a temporary bounce-back in consumer spending during the holiday shopping season given the rise in employment and wages over the last two months. However, we foresee a consumer led drop in spending in the economy through 2023 (See our latest forecast). We will also be watching for CPI next week, which is expected to show a further deceleration on the back of falling gasoline prices in November - a nice reprieve for the constrained Canadian consumer.

Canadian inflation is falling further from its summer peak. CPI growth likely edged down to 6.7% year-over-year. Though that’s still very high, it nevertheless marks another drop below the measure’s 8.1% peak in June. Easing global inflation pressures have been behind much of that deceleration. Gas prices declined again in November, dropping 4% from October. Food prices were likely still running 10% above year-ago levels. And ‘core’ measures of price growth, like the Bank of Canada’s preferred ‘median’ and ‘trim’ measures are still running 5% above year-ago levels. But recent month-over-month price increases have slowed significantly—an early sign that broader inflation pressures are also moderating.

The BoC has pointed to those early signs as a reason that interest rates may not need to rise further following a 50 basis point rate hike last week. The economy is also expected to soften in coming quarters as 400 basis points of interest rate hikes in 2022 cut into household purchasing power, further easing inflation pressures. The advance estimate of October GDP was “essentially unchanged” after a small 0.1% increase in September. We expect little change in the early estimate of November output. Hours worked rose just 0.1% in November. And consumer spending is holding up well for now. Statcan’s early estimate of retail sales was up 1.5% in November and our own tracking of card transactions suggests sales early in the holiday shopping season have been strong. But the outlook for the manufacturing sector is starting to look softer and housing markets continue to retrench.

Week ahead data watch

We expect U.S. personal income to edge up 0.3% in November. Hourly wages rose 0.6% in the month, but hours worked edged lower. U.S. personal spending was likely unchanged in November, given a softening in retail sales (-0.6%). We expect ‘real’ sales (excluding price impacts) to have declined by 0.2%.

Wage growth from the SEPH data will be closely watched given the three-month rolling average hourly earnings were more than a percentage point below LFS in September.
The advance estimate from StatCan showed October retail sales grew by 1.5%. Auto sales ticked higher, and gas station sales likely ticked down on lower gasoline prices. We expect the advance estimate of November sales to remain firm. Our own tracking of card transactions suggests strong November holiday spending and another increase in unit auto sales.

The central bank torch will pass to the Bank of Japan next week. Even though the consensus is for no policy changes, the prospects for the yen have started to improve heading into a potentially stormy year. There’s also a heavy dose of data releases from Canada and the United States. 

BoJ to tighten next year?

Economic developments in Japan have been encouraging lately, raising speculation that the central bank might finally consider an exit from its decade-long stimulus program. Inflation has fired up and is currently running at 3.7%, the Tankan survey suggests business conditions are improving, and the government has unveiled a $200bn spending package to shield consumers and boost wages.

The Bank of Japan will conclude its meeting on Tuesday and despite all this economic progress, it is not expected to adjust policy. While inflation has accelerated, wage growth hasn’t picked up as much speed, so policymakers can argue that inflation dynamics are not self-sustaining yet. With the economy also contracting last quarter, it’s probably too early for any tightening moves.

Nevertheless, it is becoming clear that policy changes are coming, possibly next year. Not only is the economic landscape improving, but Governor Kuroda also opened the door to adjusting yield curve control recently - the strategy that has decimated the yen.

By extension, the stars seem to be aligning for a comeback in the yen. Most of the elements that ravaged the currency this year - widening interest rate differentials, soaring energy prices, and a lack of tourism - have started to reverse.

Looking into next year, the BoJ might start to tighten just as foreign central banks end their own tightening cycles. With recession risks also intensifying in other major economies, rate differentials could continue to compress. Meanwhile, oil prices have declined and tourists are allowed to visit Japan again, helping to boost demand for the currency.

Add everything together and it’s a solid setup for the yen, which might come from behind to be the surprise winner of 2023 as the global economy tips over. One crucial variable will be who will replace Kuroda as BoJ Governor when his term expires in April. If traders get the sense it will be someone more open to raising rates, that could be the catalyst for the comeback.

Deluge of US data

In the world’s largest economy, there’s a barrage of second-tier data releases coming up. The ball will get rolling on Tuesday with housing data for November, which has increased in importance lately as investors view the housing market as a barometer for how much interest rate increases are affecting the economy.

Consumer confidence data for December will hit the markets on Wednesday, before the week concludes with durable goods orders, personal income and spending, and the latest core PCE price index on Friday. New home sales are out on the same day.

The Federal Reserve resorted to shock tactics this week, signaling it will raise rates beyond 5% and keep them there until the end of next year. Even though this message was much more hawkish than market pricing, which currently sees rates ending next year at 4.3%, the dollar fell in the aftermath.

It seems that investors didn’t really ‘buy it’. There’s a sense that the Fed is either bluffing to tighten financial conditions or that a weakening economy next year will force policymakers to renege on their rate promises. Either way, it’s never a good sign when a currency cannot rally on positive news.

The reaction function in the dollar has turned asymmetric lately. Negative developments tend to hurt the reserve currency more than positive developments boost it, something that was on full display this week after the US inflation report and the Fed decision. This dynamic likely reflects how crowded the ‘long dollar’ trade was just a few weeks ago, but it could also be a sign that the tide is turning.

All told, the outlook for the dollar appears neutral, as it is difficult to envision either massive losses or massive gains from here. On the bearish side, US inflation is simmering down and traders clearly don’t believe the Fed will follow through on its rate plans. That said, other major economies are in even worse shape than America, so the world’s reserve currency is unlikely to enter a full-blown downtrend while Europe and China are so fragile.

Canadian data releases

Across the Canadian border, there’s another flurry of data on the menu, starting with retail sales on Tuesday. Then on Wednesday, the latest inflation report will be released, ahead of the monthly GDP print for October on Friday.

Investors will inevitably focus on the inflation prints, as those will be the most crucial for what the Bank of Canada does next. Market pricing suggests the tightening cycle is probably finished already, assigning just a 50% chance for another small rate hike next year.

As for the Canadian dollar, its fate is linked to oil prices and global risk sentiment, so it is difficult to be optimistic heading into a potentially stormy 2023 with stock market valuations still expensive and global economic momentum fading.

In a week dominated by central bank meetings, the end result was a more hawkish impression despite inflation data for November generally surprising to the downside. In the US, the Fed hiked by 50bp as expected, but with 17 out of 19 FOMC members indicating a

Fed funds rate above 5% in 2023 and Chairman Powell saying that the labour market is extremely tight and wage growth high. However, Powell also left a door open for more modest rate hikes in the future, and markets seem to have interpreted the meeting as more or less neutral. Markets were also supported by November inflation data being lower than expected, at just 0.1% m/m for headline CPI and 0.2% m/m for core. However, we note that wage-sensitive components of CPI did not really slow down, and we also see the Fed's message as rather hawkish, pointing to high rates being maintained for long.

The ECB also delivered a 50bp rate hike as expected but with a clear message that rates are going up and that this will not be the last 50bp hike. ECB projections showed inflation exceeding the 2% target even in 2025 and the recession in 2023 being very mild if rates follow pre-meeting market pricing, which also clearly indicates that there is need and room for more hikes than that. ECB President Lagarde did not find much comfort in euro area inflation declining to 10% y/y in November, saying that it will likely rise again in January and February, which we agree with. Markets reacted with a large rise in especially 2 year yields and a stronger EUR, and we have updated our ECB call to expect a peak of 3.25% for the deposit rate in 2023. Much will depend on how inflation and other key variables actually develop over the coming months. PMI data for December rose but remain below 50, so indicating continued but slightly milder decline.

The Bank of England was also part of the 50bp hiking club, but was more dovish in its message than the Fed or the ECB, given the weakening of the British economy. But the Swiss central bank followed the trend with a hawkish message accompanying its 50bp rate hike, saying a bit like the ECB that the recession will be mild and that current monetary policy is not tight enough to bring inflation to target. Intervention to support the CHF is also clearly still a tool they can use to bring price growth down. Finally, Norges Bank was surprisingly hawkish, see the Scandi Update section.

During the coming week, we expect the Bank of Japan to stick to its outlier position as a central bank not tightening monetary policy, as inflation in Japan largely remains an imported phenomenon.

This is the final Weekly Focus in 2022, and over the holidays, we will among other things be keeping an eye on how the Covid situation develops in China, where wide spread contagion could affect supply chains and domestic demand. The US job report for December in the first week of the new year will be important to watch, given the Fed's concern over the labour market.

Weekly Focus will be back on January 6.

We wish a Happy Holiday for all our readers.

Full report in PDF.

BoE raised rates yesterday by 50bp as expected, but speculators look towards the end of the hiking cycle due to recession risk which was highlighted by BoE’s Tenreyro & Dhingra. They said that 3% bank rate is more than enough to bring CPI back to target. In fact, Dhingra warned of a deeper longer recession with higher rates already before. As such, it’s not a surprise to see the pound weakening since yesterday. Notice that the price fell below the wedge, likely stepping into a corrective phase. 1.19-2.0 is support. We talked about this technical reaction a few days before the market turned as you can see on our screenshot of Elliott wave analysis below.

The question is where we go from here? Well, we try to focus on a minimum expectation which in our case is a three-wave drop, ideally wave four. Stocks are already weakening and if this will be the case in the next few sessions we think that pound can very easily make an A-B-C pattern to the south.

Updated analysis

Broken wedge suggests that temporary top is in and that market is making a three wave decline.

Past Elliott Wave expectations

When you see a wedge formation at the end of an extended leg, then you should be aware of a change in trend, especially ahead of important events such as was BoE rate decision this week

Stocks are down substantially this year, even including indices which had a bit of a rally through the last month or so. There has been a split in trend, which is worthy of note. The DJIA moved higher, while the Nasdaq remained relatively steady. In Europe, indices don't concentrate in certain sectors like they do in the US, but a similar trend has emerged when considering certain types of firms.

The Dow Jones consists mostly of lower valuation, so called "value stocks", which have been outperforming. Tech stocks have continued to underperform, even in periods of recovery. This is often attributed to their relatively high valuations, meaning that they are more speculative. The Fed's tightening contributes to reducing interest in higher valuation stocks, and now the Fed is expected to slow its rate hikes. This could be an indication of which sectors/stocks could benefit the most from a Santa Rally.
What are the chances this time?

In order to make an educated guess about whether we can expect a rally this year or not, we need to have a better understanding of why it happens. Which is a bit of a problem, because there isn't much agreement on the causes of the rally. Not only that, but there also isn’t even an agreement on when it happens. Some say it's in the week before Christmas, others say it's the week between Christmas and New Year, and still others say it's both.

So far this month, stocks have been trending higher thanks to an expectation that the Fed won't keep hiking rates so much. Now that they have delivered, the expectation is that US stocks can continue to rise. Across the Atlantic, the situation is a little more complicated, as the UK is expected to fall further into recession. Even if the BOE slowed the pace of hiking, there might not be as much room for optimism. Meanwhile, the ECB threatened to keep raising rates. That is expected, however, since the shared central bank was one of the last to join the hiking movement, so would likely be one of the last to end its tightening cycle.

What can we expect?

Santa rallies happen about 2 out of 3 years, on average gaining about 1.3% over the period from Christmas to the Jan 2 of the next year. It's positive, sure, but not a blow-out growth. Particularly not in the context of the market losing around 17% since the start of the year.

Another difficulty is that the final two weeks of trading for the year see dwindling liquidity as major traders go on holiday. Usually, starting with the final meeting of the Fed, activity starts to drop off, reaching a minimum between Christmas and New Years. That means that volatility tends to increase, with more erratic moves in the markets as relatively small trades can cause bigger moves.

Other factors

In general, markets tend to average higher through December. But in the case of the US in particular, they tend to do even better in an election year. 2018 was a notable exception, as the Fed was tightening though that period.

After stocks performed better in the run-up to the Fed, investors might have some time to digest the results. They could pay more attention to how the market is currently pricing in a terminal rate of 4.85%, but the average of forecasts from the Fed is 5.1%. That could lead to a revaluation of where the Fed could go in the first quarter of next year and let the Grinch into steak the Christmas cheer.

Daily Pivots: (S1) 1.0568; (P) 1.0652; (R1) 1.0711; More...

EUR/USD is staying in consolidation from 1.0733 and intraday bias remains neutral. Further rally is expected as long as 1.0481 resistance turned support holds. Firm break of 61.8% projection of 0.9729 to 1.0481 from 1.0289 at 1.0754 will pave the way to 100% projection at 1.1041. However, firm break of 1.0481 will confirm short term topping and bring deeper fall to 1.0289 support.

In the bigger picture, focus stays on 38.2% retracement of 1.2348 (2021 high) to 0.9534 at 1.0609. Rejection by 1.0609 will suggest that price actions from 0.9534 medium term bottom are developing into a corrective pattern. Thus, medium bearishness is retained for another fall through 0.9534 at a later stage. However, sustained break of 1.0609 will raise the chance of trend reversal and target 61.8% retracement at 1.1273.

Daily Pivots: (S1) 0.9236; (P) 0.9276; (R1) 0.9326; More...

Further decline is still expected in USD/CHF with 0.9378 resistance intact. Fall from 1.0146 would target 61.8% projection of 1.0146 to 0.9355 from 0.9545 at 0.9056. However, break of 0.9378 resistance will indicate short term bottoming and turn bias back to the upside for 0.9545 resistance instead.

In the bigger picture, rise from 0.8756 (2021 low) has completed at 1.0146, well ahead of 1.0342 long term resistance (2016 high). Based on current downside momentum, fall from 1.0146 might be a medium term down trend itself. Sustained break of 61.8% retracement of 0.8756 to 1.0146 at 0.9287 will pave the way to 0.8756. In any case, risk will stay on the downside as long as 0.9545 resistance holds.

Daily Pivots: (S1) 135.97; (P) 137.07; (R1) 138.90; More...

Intraday bias in USD/JPY remains mildly on the upside at this point. Rebound from 133.61 should extend higher to 142.24 resistance. On the downside, however, firm break of 133.61 support and 133.07 medium term fibonacci level will confirm resumption of whole fall from 151.93.

In the bigger picture, price actions from 151.93 medium term could be just a corrective pattern to up trend from 102.58 (2021 low). Strong support from 38.2% retracement of 102.58 to 151.93 at 133.07 and 55 week EMA (now at 131.71) will set the range for such corrective pattern. However, sustained break of 55 week EMA will pave the way to 61.8% retracement at 121.43.

Daily Pivots: (S1) 1.2079; (P) 1.2256; (R1) 1.2355; More...

Intraday bias in GBP/USD remains on the downside for the moment. Fall from 1.2445 short term top should target 55 day EMA (now at 1.1865). Firm break there will target 38.2% retracement of 1.0351 to 1.2445 at 1.1645. For now, risk will stay on the downside as long as 1.2445 resistance holds, in case of recovery.

In the bigger picture, rise from 1.0351 medium term bottom is at least correcting whole down trend from 1.4248 (2021 high). Further rise is expected as long as 1.1644 resistance turned support holds. Next target is 61.8% retracement of 1.4248 to 1.0351 at 1.2759. Sustained break there will pave the way back to 1.4248. This will remain the favored case as long as 55 day EMA (now at 1.1860) holds.