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U.S. Review

Harvey and Irma Push Up Inflation and Retail Sales

• Higher gasoline prices and replacing storm-damaged property put upward pressure on the CPI and retail sales in September. Core CPI came in softer than expected, which does little to clarify the underlying inflation trend the Fed is seeking.
• Small business owners were hit by the storms as well, but small business optimism remains strong despite contending with increasing difficulty finding qualified workers. JOLTS data in August confirmed that demand for labor is strong and September's slip in payrolls is likely to reverse easily.

Hurricanes Cloud Data Takeaways

Interpreting the hurricane-impacted string of data releases over the next few months is nuanced but not impossible. Most of the economy was on solid footing before the storms and large swings in the data are very likely to prove transitory. The large drop in payrolls in September will likely reverse in October, as we know the labor market is strong and demand will warrant the creation of more jobs. One area that is less obvious is the inflation data. Continued misses in gauges of price changes for much of this year has been vexing, especially because underlying fundamentals should support greater inflation pressure than has actually played out. Hurricane Harvey's aim at the Gulf Coast certainly pushed up prices, though we know the effect is transitory. The problem for the FOMC is trying to flush out the underlying inflation pressure from the transitory effects. As inflation did not show much sign of acceleration before the storms, basing decisions on incoming inflation data in the months ahead is quite tricky.

August JOLTS data show demand for labor was solid before the storms, suggesting the decline in September should reverse rather easily. Openings remained at their record highs, though that did little to entice workers to leave their current positions. The quit rate held in its 2.1-2.2 percent range that it has bounced between each month this year, leaving 2.2 percent as cycle high.

Many small businesses are finding it difficult to find qualified workers, according to the September NFIB survey also released this week. Among respondents attempting to hire, 86 percent said there were few or no qualified applicants. The problem is most acute for manufacturers and construction firms. Overall small business optimism slipped in September, partially reflecting the impact from the storms. Optimism still remains near cycle high.

Producer prices in September pointed to firming inflation. Energy prices contributed to a sizable 0.4 percent rise in producer prices on the month. The volatile trade component helped push services prices up 0.4 percent, and higher energy costs also helped boost prices for transportation on the month. Though construction costs were little changed in September, they will likely continue on the recent upward trend as rebuilding from the hurricanes get underway. Although not the Fed's primary inflation gauge, the PPI has firmed over the year and is behaving in a way supportive of the Fed's inflation objectives. Headline PPI is up 2.6 percent while core PPI, which excludes food and energy, is up 2.2 percent.

The storms pushed up consumer prices, particularly at the gas pump, as expected. Headline CPI rose 0.5 percent on the month, though core inflation rose 0.1 percent, which was below the consensus of 0.2 percent. The softer showing in the core did little to give the Fed clarity on the underlying inflation trend.

Retail sales received a large boost from storm-related purchases. Replacing cars and paying more at the pump pushed retail sales up 1.6 percent on the month. Control group sales were up a solid 0.4 percent which suggests the strong showing in September was not only because of hurricanes, as it excludes autos and gas as well as food services and building materials.

U.S. Outlook

Industrial Production • Tuesday

Output at the nation's factories, mines and utilities fell 0.9 percent in August after Hurricane Harvey hit the Gulf Coast. The storm was estimated to have reduced the monthly change in industrial production by about three-quarters of a percentage point. In the manufacturing sector, a rise in durables output was not enough to offset outages at refineries, chemical plants and plastics factories. At the same time, mild weather weighed heavily on utilities output.

With Irma making landfall two weeks later, we expect to see another drop in September. Power outages in Florida will have weighed on utilities output, while the ISM supplier delivery index suggests production disruptions continued last month. We look for industrial production to have declined 0.6 percent in September but expect a substantial rebound in October.

Previous: -0.9% Wells Fargo: -0.6% Consensus: 0.3% (Month-over-Month)

Housing Starts • Wednesday

Housing starts edged down in August amid further weakness in the multi-family segment. Single family starts, however, continued their upward trend and are up nearly 9 percent year-to-date.

We expect starts to have fallen slightly to a 1.17 million annualized pace in September after hurricanes Harvey and Irma hit Texas and Florida, two of the largest and fastest-growing housing markets this year. Low mortgage rates and strong permitting activity— particularly in the multifamily segment, where permits were up 20 percent last month—suggest that the damage will be relatively contained in September. That said, overall new construction is likely to remain weak between now and the end of the year, as repair efforts divert labor and materials and delay new construction.

Previous: 1.18 Million Wells Fargo: 1.17 Million Consensus: 1.18 Million

Leading Economic Index • Thursday

The Leading Economic Index is expected to show another gain in September, suggesting the economy will continue to expand in the coming months. The pace, however, looks likely to slow a bit due to disruptions stemming from the recent storms.

Leading indicators of the labor market, including jobless claims and the average workweek deteriorated last month and are expected to pull the index lower. Higher stock prices in September, however, as well as relatively easy credit conditions implied by the Leading Credit Index and interest rate spread, should be enough to offset the dip. Along with a boost from the ISM manufacturing report's new orders index, we look for the LEI to have risen 0.2 percent last month.

Previous: 0.4% Wells Fargo: 0.2% Consensus: 0.1% (Month-over-Month)

Global Review

Global Growth Appears to Have Been Solid in Q3

• Real GDP growth in Singapore, an important bellwether for global economic growth, strengthened to a three-year high in the third quarter. It appears that the British economy continued to expand at a modest pace in Q3, and real GDP growth in the Eurozone remained solid.
• On balance, global economic growth appears to have strengthened recently. However, the modest downshift in economic momentum that appears to be underway in China is a reminder that the global economy is not exactly "booming" yet either.

Global Growth Appears to Have Been Solid in Q3

As usual, Singapore this week was the first country to release GDP data from the just-completed quarter. As shown on the graph on the front page, the year-over-year rate of real GDP growth in the Lion City picked up from 2.9 percent in Q2-2017 to 4.6 percent in the third quarter, the strongest year-over-year rate of growth in more than three years. The preliminary supply-side disaggregation that was released showed that the pick-up in the overall rate of real GDP growth was driven largely by acceleration in the manufacturing sector. A breakdown of the quarterly GDP data into its underlying demand-side components is not yet available, but the strength in the manufacturing sector is consistent with monthly data indicating that export growth was solid in the third quarter. The small economy of Singapore is not that important in terms of global economy growth. However, the extensive trade ties that Singapore has with many other economies make it an important bellwether for the state of global economic growth.

The United Kingdom has not yet released GDP data for third quarter, but a widely respected think tank in that country estimates that real GDP grew 0.4 percent (not annualized) in the July-to-September period relative to the second quarter (top chart). The think tank's estimate, which has had a good track record over the years, is in line with our own estimate of Q3 GDP growth. In general, the British economy has decelerated somewhat this year, but growth remains positive. Data released this week showed that British industrial production (IP) grew for the fifth consecutive month in August, giving credence to estimates that U.K. real GDP growth remained positive in the third quarter.

Speaking of the industrial sector, IP in the Eurozone rose 1.4 percent in August relative to the previous month. Data released earlier had shown that German IP jumped 2.6 percent during the month, but the outturn for the overall euro area was still much stronger than most analysts had expected. As shown in the middle chart, there is a clear upturn in Eurozone IP growth that is underway this year. As we have written previously, we expect the economic expansion in the Eurozone to remain intact for the foreseeable future and we look for the ECB to take further steps in coming months to dial back its degree of monetary policy accommodation.

In contrast to the modest acceleration we are seeing in some other major economies, recent economic data out of China suggest that economic growth in the world's second-largest economy may have downshifted a tad in Q3. Export growth in China has softened a bit in recent months as did import growth (bottom chart). The latter would be consistent with some deceleration in domestic demand in China. On balance, it appears that global economic growth has strengthened recently. However, the modest downshift in economic momentum that appears to be underway in China is a reminder that the global economy is not exactly "booming" yet either.

Global Outlook

Germany ZEW • Tuesday

The German and Eurozone economies have been steadily, and slowly, improving. Consequently, there is renewed speculation that the ECB is considering the need to start taking measures to unwind the monetary expansion implemented over the past several years.

On Tuesday markets are expected to get information on the ZEW current situation and expectations indices for both Germany and the Eurozone for the month of October. These indices have been, in general, on an upward trajectory during the past several years with the current situation index hitting 87.9 in September in Germany and 31.7 in the Eurozone.

Meanwhile, the expectation index has been very volatile, both in Germany and in the Eurozone but improved in September. A further improvement in these indices would cement the view that the region is continuing to improve.

Previous: 87.9 Consensus: 88.5

China Q3 GDP • Wednesday

Our forecast for the Chinese economy calls for a further slowdown in the coming years. However, the result for the second quarter was a bit stronger than what markets had expected, up 6.9 percent on a year-earlier basis.

On Wednesday, the markets will have an opportunity to gauge the staying power of the Chinese economy again, especially if they can keep the growth rate steady at the 6.9 percent rate they recorded during the second quarter.

Although we have seen some improvement in the Chinese PMI manufacturing index, the improvement has not mimicked the strong improvement we have seen in the United States and in the Eurozone and thus we are still calling for Chinese economic growth to slowly weaken. We expect a rate of growth of 6.7 percent during the third quarter of the year.

Previous: 6.9% Wells Fargo: 6.7% Consensus: 6.8% (Year-over-Year)

Brazil Economic Activity • Wednesday

The Brazilian economy has been slowly coming out of its worst recession in history lately. However, the monthly economic activity numbers, which are a proxy for the behavior of GDP, have not been consistent with a sustained recovery, up one month, down the next.

On Wednesday the Brazilian economic activity index for August will hit the wire and it will be nice to see some stability from this index. The July year-over-year number was 1.4 percent while the monthover- month print was also positive, up 0.4 percent. That is, a repeat of July's performance with both the year-over-year as well as the monthly number would help cement expectations of a sustained recovery for the Brazilian economy. Still, we are not expecting the economy to recover at a fast pace even after two years of dismal economic activity. The political crisis in the country is still lingering and a full recovery will take a relatively long time.

Previous: 0.4% Consensus: -0.3% (Month-over-Month)

Point of View

Interest Rate Watch

A Cautious Climb.

Our outlook for interest rates projects a cautious climb in rates as the Fed adjusts policy towards a perceived normalization of both the funds rate and the Fed's balance sheet. However, normalization from a stance of administered, below market equilibrium interest rates will be anything but normal. As interest rates are a price for credit, the challenge in the markets will be a movement from policy set to market determined interest rates. We are cautious on the transition.

Steady Domestic Demand—at Low Rates

As illustrated by the top graph, domestic real final sales, at the current FOMC determined low interest rates has been very steady in recent years. Consumer spending has been solid and housing starts have improved over recent years. However, we are aware that light vehicles sales as well as housing will be sensitive to a rising interest rate path.

Crossing the Streams: From Negative to Positive Real Rates

Over the next two years, short-term interest rates should cross into positive territory (middle graph) and will be there for the first time for a sustained basis since 2007. There are two issues. First, decisions made at negative real rates that now must be refinanced at positive rates will be challenged. Second, as the FOMC pursues its intended policy, investors will quickly judge that the total return of some past investments made at lower rates will quickly negative total returns.

Our Outlook: Rising Rates with Caution

Over the next two years we do see that interest rates will rise modestly. However, over the past four years we have been below consensus on the extent of any interest rate rise and we were right. For 2017, for example, we anticipated that the 10-year rate would be up 2.5 percent, below the 2.7 percent Blue Chip Consensus.

If interest rates were to rise as much as the FOMC intends, we believe economic growth would be damped and possibly lead to a recession on the basis of our published work. Therefore, the FOMC will likely limit its rate increases.

Credit Market Insights

Consumer Credit Slows in August

Consumer credit rose $13.3 billion, representing a modest pullback from July. Consumer credit is up just 4.2 percent year over year, down from a 5.7 percent rise in the prior month. Revolving credit remains just below its pre-recession peak, climbing 7.0 percent year over year in August, while non-revolving credit, up just 3.2 percent year over year, currently sits at a record high. The limited rise in personal consumption for August likely translated into the slowdown of consumer borrowing for the month. Our expectation is for consumer credit to gradually grow.

Although consumer credit slowed in August, it remained elevated as a percentage of disposable income. At 26.1 percent, consumer credit currently represents its largest share of disposable income since the start of the series in 1960. Commercial banks continue to hold the largest share of consumer credit, followed closely by the federal government. Financial companies and credit unions largely round out the remaining portion of the consumer credit pie.

The federal government holds

approximately 40 percent of all nonrevolving credit, which includes student loans and mortgages, up from holding just 15 percent in 2010. We expect the growth of this share to persist as educational costs continue to rise.

Consumer credit is expected to expand as strong consumer confidence remains at elevated levels.

Topic of the Week

Past Storms Offer Little Clues for CRE Spending

Every hurricane affects the national construction numbers differently. Major storms affected two large commercial real estate markets this year, Harvey in Texas and Irma in Florida. Estimates already put the storms among the most costly on record.

Reviewing past data on value of construction put in place following Andrew in 1992, Katrina in 2005 and Sandy in 2012 bears little fruit. Construction values stumbled slightly in the months following Andrew but returned to trend rather quickly. It took slightly longer after Sandy and values rose uninterrupted after Katrina. That does not mean it will this time, however.

Andrew was an incredibly powerful and destructive storm, but damage was limited to South Florida. Katrina was certainly catastrophic, but it bore down on the Gulf Coast as its economy was already shrinking, and the rest of the country was enjoying a real estate boom. Sandy was likely the most relatable to Irma and Harvey, as it hit a very active real estate market in New York City and it affected a large chunk of the eastern seaboard. Still, rebuilding after Sandy took place later than expected which makes comparing that weather event with this one iffy at best.

Fixed investment in structures from the GDP tables also behaved differently in quarters following the past major storms, offering us little clues for coming months. The fact that Harvey affected some energy infrastructure puts its impact on fixed structure investment closer in line with Katrina's aftermath. However, fixed structures investment continued uninterrupted in 2005.

There was a ramp up in construction costs about six months after Hurricane Andrew in 1992. Similarly sized bumps followed Katrina in 2005 and Sandy in 2012, but those occurred about a year later. Regardless, the recent storms are highly likely to cause a run up in costs in coming months. Construction labor is already in short supply, which has led to higher construction costs even before the hurricanes arrived.

U.S. Highlights

• Global stock markets this week rose to new highs in a number of regions, shrugging off elevated geopolitical tensions and the threat of a massive shake-up in global supply chains for the umpteenth week in a row.
• Retail sales rebounded strongly in September, helped by Hurricane-related rebuilding efforts. Looking ahead, we anticipate that consumer spending should pick up to a 3% annualized pace in the fourth quarter.
• Core consumer price growth disappointed in September, holding steady at a 1.7% y/y pace. Core measures of inflation have remained below target for much of the recovery even though economic slack has largely diminished. Persistently weak inflation makes us a little less certain about a December rate hike by the Fed.

Canadian Highlights

• It was a relatively quiet week in Canadian markets, with the loonie, oil, and equities all trading up as of late Friday morning.
• On the data front, it was all about housing. Led by a dip in Toronto, starts slowed slightly in September after two months of strong activity. On the other side of the coin, resale activity ticked up for a second month in a row, on broad cross-country strength.
• The near-term stabilization of housing activity is welcome after this summer's readjustment in the important GTA market. However, we are not out of the woods yet, with a number of factors, including rising rates and regulatory changes likely to generate further medium-term headwinds.

U.S. - Hurricane Recovery Efforts Bolster Consumer Spending

Global stock markets this week rose to new highs in a number of regions, shrugging off elevated geopolitical tensions and the threat of a massive shake-up in global supply chains for the umpteenth week in a row. It seems that nothing can derail the slow melt-up; not gradually rising interest rates, North Korean tensions, populist movements in Europe, or policy uncertainty emanating from the U.S. administration. Perhaps with low interest rates stimulating investor risk appetite this should be expected, but one can't help but wonder what may happen to asset prices as global interest rates rise further off extraordinary low levels.

To some extent, rising asset prices fairly represent the state of the U.S. and global economy. Economic indicators for the third quarter continue to show a Hurricane-battered but resilient U.S. economy. This morning's retail sales report for September recorded a 1.6% increase on the month, lifted by strong auto sales (18.5 million units), and building and material supply sales (Chart 1). Although the strength in these two categories likely reflected rebuilding efforts after Hurricanes Harvey and Irma, strong growth in other spending categories provides some underlying support to U.S. consumer spending heading into the fourth quarter. All told, we anticipate that rising incomes and strong job growth are supportive of a strong handoff to fourth quarter spending, with consumption expected to accelerate to a 3% annualized pace from 2% in the third quarter.

But, not all news on the U.S. economy was positive this week. The inflation report for September was disappointing. Headline inflation ticked up to a 2.2% y/y pace from a 1.9% pace in August, bolstered again by the Hurricane-related increase in gasoline prices that is expected to reverse in the months ahead. Most disappointing was core inflation, a measure that strips out volatile food and energy prices, which held at 1.7% y/y despite an expectation for a small uptick to 1.8%, with month-on-month prices rising a meagre 0.1% (or 1.2% annualized) rate.

This latest in a string of disappointing inflation readings will surely add fuel to the ongoing inflation puzzle debate going on in the Federal Reserve as evidenced by the minutes from its September meeting released this week. Core measures of inflation, including the Fed's preferred core PCE deflator metric, have held below the 2% target for much of the recovery from the Great Recession even though economic slack has largely diminished (Chart 2). Fed officials remain somewhat divided on the topic. Some Committee members favor maintaining a highly accommodative monetary policy environment until wages and inflation show a persistent move higher, while others attribute much of the weakness to more temporary forces that do not warrant a pause in interest rate normalization. All told, we continue to anticipate that the Fed will raise rates this December, but the ongoing weakness in inflation makes us a little less certain about this call.

Taken together, above-trend economic growth in the U.S. and other regions are helping support asset prices. However, as the IMF pointed out this week, risks to the global economic recovery remain skewed to the downside. An unforeseen shock can easily derail the recovery, sending risk asset prices down with it.

Canada - Housing Steadies, For Now

The shortened week was fairly light on the data front, with the releases focused on Canadian housing markets. Starting with new housing activity, September saw a modest pullback in housing starts, to 217k units. This was above market expectations, and comes on the back of two months of solid activity (Chart 1). The slowdown, such as it was, can be put down to Ontario, and the closely-watched Toronto market in particular, which saw a 18k drop in starts. Even with this softness, the third quarter saw Ontario starts at their second highest point in five years - the high point being the red hot pace recorded in the first quarter of the year.

In contrast to the starts data, the resale housing market saw a further tick-up in activity in September, with home sales up 2.1% month-on-month (Chart 2). It was a generally encouraging report, with healthy activity reported across the country. To focus on Toronto again, activity continued to rebound, but remains a far cry from the frenzy seen early in the year, and the sales-to-listings ratio, at 46%, suggests a relatively balanced market - a far cry from its peak of 94% in January. For the time being at least, Canadian real estate activity looks to have regained its footing - a welcome change after the volatility of this past summer. That said, we are not out of the woods just yet as a number of signs suggest that a slowing of activity may be on the horizon.

First, it remains likely that the Bank of Canada will hike its policy interest rate again this fall, most likely in December. In the grand scheme of things, while not overly aggressive, the 75bp of hikes over the second half of the year will work to reduce affordability and moderate demand. Second, looking a bit further out, OSFI may extend recent "B20" regulations to cover all mortgage lending. What this means is that all borrowers will need to show their ability to service a mortgage at the Bank of Canada's posted rate (generally about 2 percentage points higher than typically contracted mortgage rates). Currently this requirement only applies to those with low down payments and those who are taking out mortgages with terms of less than five years. The high level of the posted rate makes this change particularly impactful: a further 25bp increase in rates will have an impact, to be sure, but adding 200bp to the rate for approval purposes is likely to result in a more significant reduction of mortgage approval sizes, all else equal. And, while there remains a lot of uncertainty around the path of interest rates, OSFI has so far shown no signs of backing down on this change.

Finally, for housing starts there is the simple matter of market dynamics. That multi-unit construction is the bulk of housing activity in Canada means that to a large extent, housing starts reflect earlier market conditions - condo pre-sales typically occur well in advance of construction. This implies that any slowing in presale activity in Ontario over the late spring and summer's adjustment period is not likely to make itself felt in starts activity (let alone measures of ongoing construction activity) for some time to come. On balance then, it seems likely that as we move into 2018, housing activity is likely to moderate.

Canada: Upcoming Key Economic Releases

Canadian Manufacturing Sales - August

Release Date: October 18
Previous Result: -2.6% m/m
TD Forecast: -0.1% m/m
Consensus: NA

Manufacturing sales are expected to post their third consecutive decline in August, with nominal sales forecast to edge lower by 0.1% m/m. After a sharp decline in output caused by retooling shutdowns, factory shipments of motor vehicles should post a partial rebound in August. However, this report will not capture ongoing labour disputes, which will constrain any further recovery in September. Outside of the transportation sector, the weak export data and a broad decline in hours worked argue towards a downbeat report, though rising petroleum prices will help to support nominal refinery sales. Real manufacturing sales should underperform the nominal print due to higher factory prices.

Canadian Consumer Price Index - September

Release date: October 20
August Result: 0.1% m/m, 1.4% y/y
TD Forecast: 0.3% m/m, 1.7% y/y
Consensus: NA

TD looks for a 0.3% m/m increase in the September CPI, lifting the headline inflation rate to 1.7% y/y vs 1.4% y/y in August. Energy prices should be a net boost on higher gasoline prices, while food prices are at risk of downward pressures in light of the rapid appreciation seen in CAD. Other sources of downside include apparel - sensitive to currency fluctuations - along with telephone services, the latter which has plunged in the prior two months. On the upside, we expect to see continued strength in shelter prices from lagged effects from increases in the new housing price index. The fundamental story remains sound with labour market slack dissipating and wage pressures picking up, allowing core inflation measures to stabilize or firm further in this report. The Bank's three measures averaged a 1.5% y/y pace in August; a move higher toward 2% would strengthen confidence that the output gap is approaching is closure, which we set estimate is by yearend.

Canadian Retail Sales - August

Release Date: October 20
Previous Result: 0.4% m/m, ex-auto: 0.2% m/m
TD Forecast: 0.5%, ex-auto: 0.4% m/m
Consensus: NA

Retail sales are forecast to rise by 0.5% m/m in August, led by another increase in motor vehicle spending. This would leave ex-auto sales up 0.4% on the month, with gasoline station receipts expected to make a positive contribution due to Hurricane Harvey's impact on prices. August saw the unemployment rate reach a post-crisis low while consumer confidence rose to record highs, both of which should support increased consumer spending. Core retail sales will also benefit from a recent pickup in wage growth, which has accelerated from early-2017 lows, though unseasonably cool weather may have a negative impact. Due to rising consumer prices, we look for real retail sales to underperform the nominal print with a more modest increase, consistent with a moderation in household spending growth from Q2.

Fed policy uncertainty increased three folds after the CPI miss.

Just as the dollar was picking up some momentum, it got hammered back to reality as the doggedly unexceptional CPI prints continues to haunt the dollar bulls.

When it comes to gauging inflation, it could be time to throw the textbook theory out the window as despite unemployment falling there's little sign of inflationary pressures flaring up. Also, the Fed's preferred inflation measure, the core PCE index, has consistently fallen short of its target rate of 2 percent, so its either time to update the old Phillips Curve or finally conclude that the influence of technology on lower prices will likely persist for the foreseeable future.

Either way, the monthly rituals surrounding these inflation prints are adding more confusion rather than clarity regarding monetary policy. Perhaps we've become too accustomed to knowing that when it comes to inflation, the Feds are the only game in town.But I'm sure if you asked most traders why the Feds have set a 2 % inflation target, besides a lot of blank stares, the likely response would be " it is because it is".

The clear example of how confusion within the Fed inflation mandates distorts dollar conviction sentiments can analyse market behaviour. After last weeks boisterous average hourly earnings print USD conviction soared to +2.5 on a scale +/- 3 but then dropped to -1.5 post CPI. These position Flip Flops add an unwanted element of disorder that could be quickly ironed out by a decisive Fed

The week ahead could be pivotal on numerous levels

The British Pound

The Brexit drama should escalate, as May is expected to touch on the topic of a transition deal at the EU leaders' summit. But from the EU perspective, this is likely to be a case of " show me the money "and EU leader will continue to baulk at any proposal until a divorce check is signed. This scenario does not portend well for the Pound next week

The Euro

The Spanish Referendum is now inconsequential to currency markets, But the Australian election on Sunday could provide some fodder especially if the far-right Austrian Freedom party has a stronger showing than expected. The right-wing Freedom party is expected to form a coalition partnership, but a stronger appearance could ruffle a few EU leaders feathers. By all accounts, range trade mentality should remain the order of the day.

Tax Reform

Tax reform passage will struggle given the fragile GOP majority as the lack of support from both McCain and Corker's could be the ultimate nail in the coffin. But given Trump's current approval ratings, unless the Republicans can move this reform through the Senate quickly, there's no guarantee they will have a sitting majority after the midterm election.

The Ultimate Game of Thrones

Without a doubt, traders went into the US CPI and retail sales data with one thing on their mind, who is the next Fed Chair.

One of the exciting candidates that are churning the rumour mill is Stanford Economist John Taylor who is the most hawkish among the perceived frontrunners.

Much of the initial market debate centred around the "Taylor Rule" an interest rate forecasting model invented and perfected by Dr Taylor which estimates Fed Funds~3.75% vs 1.25 % presently. The market was a bit shell-shocked initially until a flurry of Google searches discovered that his recent on the record comments better align his views with the current Feds gradual pace of normalisation. None the less he does present a more hawkish alternative to the current front-runner Powell and Warsh who currently sit atop the bookie boards at 45% and 25% respectively

Regional sentiment:

New Zealand Dollar

The New Zealand election upheaval should be settled Monday when the NZ First board will meet to decide whether to support either Labour or National in government. Once again politically driven mean reversion trades prove to be a significant risk-reward, even more so when the USD has failed to gain any real traction over the last six weeks.

China

Let not lose sight of the 19th Communist Party Congress kicks off in China which is expected to produce a deluge of headline risk. Last week the RMB complex was arguably one of the primary drivers in regional USD dollar sentiment so local traders will have eyes focused and ears to the ground on headline risk.

Last but not least we have the China data dump to deal with throughout the week as CPI, GDP, retail sales and industrial production will provide some good food for thought.

Australian Dollar

Other then Fed speak, and unlikely hawkish shift at the Fed Helm USD should continue to suffer at the expense of high beta FX. The Aussie dollar finished the week on a positive tone and appeared poised to extend gains next week.

Global Political Uncertainty in Driving Seat

The US dollar is trading lower on Friday after the consumer price index (CPI) and the preferred inflation metric the core CPI came slightly under expectations. Fed speakers had been divided in their comments leading up to the release. Doves thought it was a mistake to keep raising rates with low inflation. Hawks urged that waiting could be a bigger mistake and that inflation will eventually catch up. The disappointing data has not taken the December rate hike off the table, with the data between now and the date of the meeting to provide the final say.

The CME FedWatch tool is showing a decrease in the probabilities for a December US interest rate hike. The calculation is done using the prices of Fed funds target rates futures and it stands at 82.9 percent. One week ago it was 87.8 percent, but also worth mentioning a month ago the odds were below 50 percent for a lift at the end of the year.

The USD regained some of the ground lost after the CPI release with the comments from US President Trump that refused to certify the Iran nuclear deal but has not officially terminated the deal and solutions can still be achieved. Political uncertainty remains a critical factor as the US faces an uphill battle in the fourth quarter and alongside Brexit the European Union has to deal with the situation in Catalonia.

The EUR/USD lost 0.07 percent on Friday and will post a 0.75 percent weekly gain. The single currency advanced versus the dollar after the US consumer price index (CPI) disappointed and will put pressure on the U.S. Federal Reserve as the December Federal Open Market Committee (FOMC) still has a rate hike priced in by the market. Statements from US President Donald Trump about Iran's nuclear deal that could involve new sanctions changed the direction of the pair on Friday.

Earlier at the end of the week the European Central Bank (ECB) president had said that the European Union continues to enjoy a firm and broad based economic expansion. European data this week supported that view as industrial production jumped 1.4 percent in the region. Germany and Italy surprised by beating estimates. German inflation remains low at 0.1 percent as for all the work of the ECB the pull of deflation is too hard to shake off.

Final CPI for the European Union will be released on Tuesday, October 17 at 5:00. Inflation is expected to have remained steady at 1.5 percent. An improvement over that will be seen as a positive by the market specially after the US data underperformed on Friday.

The GBP/USD rose 0.21 percent on Friday. Cable has been reacting to different Brexit scenarios. Rumours of a softer breakup after both sides admitted being at a deadlock saw the pound rise. The currency rose 1.72 percent on a weekly basis as the chief negotiator for the EU Michael Barnier confirmed that he will not recommend the talks move to the next phase until the deadlock is resolved. A harder Brexit was implied but rumours about a way to transition the UK out of the EU with members discussing several options on October 19–20.

The biggest issue that is keeping negotiations from moving forward are the UK's financial obligations to the EU. While the conservative party has said that no deal is better than a bad deal the market disagrees with that assessment as exiting the EU without a deal would mean higher levels of uncertainty making asset valuations harder.

The dollar was falling on Friday after a lukewarm CPI data release. The U.S. Federal Reserve has been supportive of the USD with two rate hikes, but low inflation has always made it questionable if there will be a third one.

Market events to watch this week:

Monday, October 16

• 5:45pm NZD CPI q/q
• 8:30pm AUD Monetary Policy Meeting Minutes

Tuesday, October 17

• Tentative GBP BOE Gov Carney Speaks
• 4:30am GBP CPI y/y

Wednesday, October 18

• 4:30am GBP Average Earnings Index 3m/y
• 8:30am USD Building Permits
• 10:30am USD Crude Oil Inventories
• 8:30pm AUD Employment Change
• 10:00pm CNY GDP q/y
• 10:00pm CNY Industrial Production y/y

Thursday, October 19

• 4:30am GBP Retail Sales m/m
• 8:30am USD Unemployment Claims

Friday, October 20

• 8:30am CAD CPI m/m
• 8:30am CAD Core Retail Sales m/m
• 7:15pm USD Fed Chair Yellen Speaks

*All times EDT

The Canadian dollar was lower against its US counterpart on Friday. The loonie had appreciated versus the dollar all week and after the release of a disappointing US inflation data it rose even higher, but US NAFTA proposals it reversed course. The US tabled an idea a higher regional content for autos to be part of the free tariff access. Current North American content requirement is 62.5 percent and the US wants to increase that to 85 percent (with 50 percent of that being US content). Negotiations have been tense after the US also proposed a five year term for the updated NAFTA, to which both Canada and Mexico had already objected.

House resale numbers in Canada rose 2.1 percent in September pointing to a more stable market after drops in building permits and new home sales earlier in the week. Permits dropped 5.5 percent and the New House Price Index (NHPI) underperformed with a 0.1 percent gain.

The CAD managed to print a 0.40 percent gain on a weekly basis versus the USD. Oil prices rose as Chinese demand showed signs of an increase, tensions rising between the United States and Iran threatening a return to sanctions, and Iraq unrest could lead to limited supplies out of the Kurdish regions as troops are mobilizing after the vote for independence in late September.

The USD/CAD lost 0.38 percent in the last five trading days. The USD recovered some ground on Friday after the Trump administration comments on NAFTA send the CAD lower. The currency pair is trading at 1.2481 as Canadian fundamentals appear stronger in the short term. Soft inflation dealt a strong blow to the greenback as it will give further ammunition to the doves within the Federal Open Market Committee (FOMC). The U.S. Federal Reserve is still anticipated to hike the Fed funds rate by 25 basis points in December, but there has to be some improvement in economic data.

The US dollar traded lower on Friday after the consumer price index (CPI) and the preferred inflation metric the core CPI came slightly under expectations. Fed speakers had been divided in their comments leading up to the release. Doves thought it was a mistake to keep raising rates with low inflation. Hawks urged that waiting could be a bigger mistake and that inflation will eventually catch up. The disappointing data has not taken the December rate hike off the table, with the data between now and the date of the meeting to provide the final say.

The CME FedWatch tool is showing a decrease in the probabilities for a December US interest rate hike. The calculation is done using the prices of Fed funds target rates futures and it stands at 82.9 percent. One week ago it was 87.8 percent, but also worth mentioning a month ago the odds were below 50 percent for a lift at the end of the year.

Canadian data will be scarce with the main events the release of inflation data and retail sales on Friday, October 20 at 8:30 am EDT.

Market events to watch this week:

Monday, October 16

• 5:45pm NZD CPI q/q
• 8:30pm AUD Monetary Policy Meeting Minutes

Tuesday, October 17

• Tentative GBP BOE Gov Carney Speaks
• 4:30am GBP CPI y/y

Wednesday, October 18

• 4:30am GBP Average Earnings Index 3m/y
• 8:30am USD Building Permits
• 10:30am USD Crude Oil Inventories
• 8:30pm AUD Employment Change
• 10:00pm CNY GDP q/y
• 10:00pm CNY Industrial Production y/y

Thursday, October 19

• 4:30am GBP Retail Sales m/m
• 8:30am USD Unemployment Claims

Friday, October 20

• 8:30am CAD CPI m/m
• 8:30am CAD Core Retail Sales m/m
• 7:15pm USD Fed Chair Yellen Speaks

*All times EDT

Next week's economic releases, which includes UK inflation figures, can determine the future path of monetary policy for major economies, while political events, such China's five-yearly Communist Party Congress commencing on Wednesday, perhaps have the capacity to steer developments for the years to come.

Chinese Party Congress, Japanese trade data and elections further ahead and Australian employment to be closely watched

Data on producer as well as on consumer prices for the month of September will be released out of China on Monday. Expectations are for the producer price index (PPI) to grow by 6.3% year-on-year, at the same pace as in the preceding month. According to analysts' estimates, the consumer price index will rise by 1.6% on an annual basis, below August's 1.8%. Among other releases attracting attention in China, are figures on urban investment, industrial output and retail sales (all for the month of September), as well as third quarter GDP figures, to be released on Thursday. Analysts' forecasts are projecting an annual growth rate of 6.8% during the quarter. The respective figure during the second (as well as the first) quarter of the year stood at 6.9%, with the official growth target for 2017 being "around 6.5%". In the background will be China's Communist Party Congress taking place in Beijing and beginning on Wednesday, October 18. This political meeting takes place once every five years and has a mandate of considering and approving new policies, as well as appointing to certain positions those individuals who will lead China over the next five years.

Transitioning from the world's second largest economy to the next in line, September Japanese trade data out on Thursday will definitely be eyed. Exports and imports are expected to rise by double digits though at a smaller pace relative to August (but only slightly so in the case of imports). Of course, speculation regarding the outcome of general elections taking place in the nation on October 22 will be on the rise. Should the Japanese Prime Minister Shinzo Abe come out strong, then it is expected that we'll have a continuation of Abenomics with a reflationary economic agenda remaining on the table. This is also seen as increasing the odds for the Bank of Japan to maintain its ultra-loose monetary policy, something which supports the dollar/yen moving higher over the medium- to longer-term given the divergent monetary policies in the US and Japan.

Relating to the Antipodean currencies, the releases gathering most attention in Australia will be Thursday's employment data (number of positions added to the economy, unemployment rate and participation rate) for the month of September. Last month's upbeat employment report allowed the aussie to move higher relative to the greenback. Out of New Zealand, third quarter inflation figures to be released on Tuesday will be in focus. The bi-weekly milk auction, which tends to affect the kiwi as New Zealand is a major dairy exporter, will also be taking place on the same day.

Eurozone inflation, ZEW survey and producer prices out of Germany - UK data supporting the case for a hike?

Final inflation figures for the month of September to be released on Tuesday will be attracting attention in the eurozone, especially after reports this week that the European Central Bank could decide to proceed with a reduction of its monthly asset purchases (currently amounting to 60 billion euros per month) by around half as it completes its monetary policy meeting on October 26. On a monthly and annual basis, inflation is expected to show growth by 0.4% and 1.5% respectively, with August's equivalent figures being released at 0.3% and 1.5%. The core measures of inflation will also be eyed. Also out on Tuesday, will be the ZEW survey gauging economic sentiment for the month of October in Germany, eurozone's (as well as Europe's) largest economy. September producer price data released on Friday will also be on the look-out in Germany.

Expected to be of most importance out of the UK will be Tuesday's inflation figures for the month of September, August employment statistics out on Wednesday and Thursday's September retail sales. Month-on-month, the consumer price index (CPI) is anticipated to grow by 0.3% (August's figure stood at 0.6%) and year-on-year by 3.0% (August's equivalent came in at 2.9%). The Bank of England's inflation target stands at 2%. It will be interesting to see whether the numbers would support the case for an interest rate hike to be delivered by the BoE, something which would support a stronger British currency. The central bank will be completing its next meeting on monetary policy on November 2.

US industrial production, housing starts and existing home sales - manufacturing & retail sales as well as inflation dominating attention in Canada

Out of the US, industrial production figures to be released on Tuesday, housing starts on Wednesday and existing home sales on Friday, all pertaining to the month of September, would probably be the releases having the capacity to move forex markets the most. It is important to note that the effect of hurricanes could have distorted the aforementioned economic releases. Other themes which have been recurring and driving sentiment either in favor or against the US currency, such as who the next Fed chair would be (with a Yellen reappointment not to be ruled out), the US-North Korea spat and President Trump's plans on tax reform, might reappear as well.

Canada will see the release of manufacturing sales on Wednesday as well as inflation and retail sales data on Friday. In terms of inflation, the CPI measures utilized by the Bank of Canada will be in focus as well. It remains to be seen whether the data will negatively or positively affect the Bank of Canada's appetite for additional interest rate hikes after the ones delivered in July and September which brought the central bank's benchmark rate to 1%. The BoC will be completing its next meeting on October 25.

This weekend's International Monetary Fund and World Bank meeting of central bankers and finance ministers would be also generating interest (the IMF this week upgraded its growth outlook for the US, China, Japan and the eurozone relative to its previous forecasts in July), with Federal Reserve Chair Janet Yellen (talking on Sunday) being among the notable speakers. Yellen will also be participating in a lecture titled "Monetary Policy Since the Financial Crisis" on Friday.

Week beginning 16 October 2017

• The dark side of the lift in Consumer Sentiment.
• RBA: RBA minutes, Assistant Governors Ellis & Bullock speak.
• Australia: employment, Westpac-MI Leading Index.
• NZ: CPI.
• China: 19th National Congress, PBoC Governor Zhou speaks, GDP, CPI.
• Euro Area: European Council, ECB President Draghi speaks.
• US: Fed Chair Yellen speaks, housing starts & permits, existing home sales.
• Key economic & financial forecasts.

Information contained in this report was current as at 13 October 2017.

The Dark Side of the Lift in Consumer Sentiment

This week we saw a strong lift in the Consumer Sentiment Index.

The Westpac Melbourne Institute Index of Consumer Sentiment rose 3.6% to 101.4 in October from 97.9 in September.

It is the first time since November last year that optimists have outnumbered pessimists and represents the highest level of the Index since October last year.

Consistent reports of an improving global economy may have been a factor behind this lift in confidence. It is also likely that concerns about rising interest rates associated with over-heated housing markets have eased.

Ongoing improvements in the labour market are also boosting confidence. Confidence showed stronger gains amongst those employed as tradies, 'paraprofessionals' (typically in the health and education sectors), or labourers. The rise in confidence was particularly strong for 'trade' workers, up 22% in the month, suggesting the continued strength in residential building was a positive factor.

This is not a great surprise. The recent report from the ABS shows that of the net 320,000 jobs added over the year to August nearly a third (105,000) were added in the construction sector. We expect this will be about as good as it gets for construction workers. The downturn in residential construction activity is expected to bite through 2018.

Overall, confidence is still not particularly strong, with views on family finances a clear weak spot. Whereas the overall Index is down 1% on a year ago, respondents' assessments of their own finances relative to a year ago have fallen by 6.1%.

This is a particularly significant point. Recall that the Reserve Bank consistently refers to this component of the Index as a reliable indicator of spending patterns.

The logic is persuasive. Consumers are more likely to base their spending decisions on their current income capacity rather than necessarily expectations around the overall economic outlook where they may not necessarily be a beneficiary.

During the week I noticed reports that US consumers are particularly pessimistic about: living from 'paycheck' to 'paycheck'; never being able to get out of debt; and never being able to afford to retire. Fortunately, Australia's pension and superannuation system provides households with much more comfort around the retirement issue but I suspect Australians would be similarly concerned about the first two issues.

That 6.1% fall over the year in "finances relative to a year ago" is quite significant. In previous years (to October) the comparable movements have been: -2.4% (2016); 4.3% (2015); flat (2014); 6.2% (2013); 1.2% (2012); -12.9% (2011); flat (2010); 21% (2009); -24% (2008).

The big fall in 2011 was associated with the 200 basis points of mortgage rate increases from October 2009 while the fall in 2008 was in response to the collapse of Lehman and the onset of the GFC. The fall in 2017 is therefore by far the largest annual fall in this component outside unusual extraordinary events since the GFC. This move is likely to be associated with some of the factors that are most likely behind the reports from the US: weak wages growth and excessive levels of household debt. It is for these reasons that we are cautious about prospects for consumer spending and, although the overall Index lifted strongly, the concerns about the consumer must still remain. It is certainly true that other parts (with the exception of housing) were solid in the survey.

The 'economic conditions, next 12 months' sub-index posted the strongest gain, rising 7.1% to a four year high. Some of this likely stems from consistent coverage of the continuing improvement in the global economy with, in particular, improved confidence in the US growth outlook. Longer term economic prospects showed a more muted rise. The 'economic outlook over the next 5 years' sub-index rose just 1.4%.

Consumers were more positive about making major purchases, the 'time to buy a major household item' sub-index rose 3.5% in October after a 2.1% lift in September. However, the sub-index remains well below its long run average (down 2.9% over the year), suggesting that the sluggish spending evident through most of 2017 is likely to extend into year-end.

Expectations for the labour market continue to improve. The Westpac Melbourne Institute Unemployment Expectations Index fell 3.3% to 129.2 in October, marking the lowest reading since June 2011 (recall that lower reads mean more consumers expect unemployment to fall in the year ahead). The move is broadly based with expectations improving across all the major states. So, as in the US survey, households may be becoming less anxious about actually losing their jobs but concerned about the size of that 'paycheck'.

Consumer views around housing remained downbeat. The 'time to buy a dwelling' index dipped 0.2% to 95.1, well below the long run average of 120. State indexes continue to vary widely, ranging from very weak reads in NSW (77) and Vic (88) to a strongly positive result in WA (135.4).

Consumer expectations for house prices also softened in the month. The Westpac-Melbourne Institute Index of House Price Expectations dipped 1% to 140.5. The index still shows positive price expectations nationally although the state breakdown showed a sharp 8% decline in New South Wales (to the lowest level since June last year) partially offset by stronger price expectations in Queensland and Western Australia. Evidence that house price expectations in the over-heated Sydney market are cooling is likely to be encouraging for policymakers.

We contend that the key to the interest rate outlook remains the consumer and the housing market. While we have seen a boost in consumer confidence, most of the strength is centred on the one year economic outlook. Respondents remain concerned about their own finances despite an expectation that the economy overall will improve.

Furthermore, the survey continues to point to an easing in sentiment in the housing markets in the major states. Interest rate increases aimed at cooling over-heated housing markets appear to be becoming unnecessary as macro prudential policy tools and the slowdown in foreign activity are achieving the same purpose.

The Week that Was

This week saw the release of our October Market Outlook. In addition to our latest assessment of conditions in Australia; New Zealand; the global economy and FX markets, key themes investigated this month include: Australian employment trends by industry and state, highlighting the narrow focus of job creation; the housing sector's loss of momentum, focusing on the role played by policy and foreign buyers; and the construction sector, where the balance between mining, non-mining and residential investment activity is shifting. Overseas, ahead of it beginning on 18 October, we look forward to the 19th National Congress in China.

On the data front, sentiment was the focus in Australia this week. We also received an update on housing finance and, from the RBA, the latest Financial Stability Review.

The Westpac-MI Consumer Sentiment survey provided a very interesting update this month. The headline index rose 3.6% to 101.4, the first outcome above the 100 optimist/pessimist divide since November last year. Economic expectations for the coming year jumped 7% and the 5-year view also improved. Unsurprisingly, unemployment expectations fell further, posting their lowest read since June 2011 as consumers became more optimistic over job prospects. However, despite all of the above and an abating of concern over recent interest rate increases, family finance expectations are still circa 5pts below their longrun average level, both relative to a year ago and for the year ahead. This is also true of the 'time to buy a major household item' series, implying that growth in retail spending is likely to remain subdued irrespective of the lift in overall confidence. On housing, house price expectations remain elevated versus history, but 'time to buy a dwelling' is holding some 25pts below average. By state, the 'cost' of affordability is clearly evident, with very weak results reported for NSW and Vic.

Also, housing finance data came in a little above expectations in August. Investor finance continued to hold up despite the impact of macro-prudential measures, likely in part because of refinancing activity. The investor result also likely signals that the recent loss of momentum in capital city markets (particularly Sydney) has come as a result of a pullback by foreign buyers. Lending for purchases of newly built dwellings continue to show strength (23%yr) as more buildings are completed and made available for occupancy. First home buyer approvals have also continued to strengthen, up 40%yr.

On the business sector, the September NAB business survey was positive overall; however, a concern for the outlook is that conditions are uneven across the economy. The sectors that are supporting conditions at above average levels are construction and related industries, including manufacturing. Elsewhere, weakness is clearly evident, particularly in the retail sector which is being affected by: weak wages; household debt; rising energy costs; housing affordability and the peak in housing investment activity. These results fit with our concerns regarding the outlook. We anticipate that consumption growth will struggle to accelerate as housing investment turns down. That will restrict 2018 growth to a below trend outcome. A positive for the interim is that the employment index from the NAB survey suggests the current strong pace of employment growth will be sustained through year end.

From the RBA, as is typically the case, there were no surprises in the October Financial Stability Review. Excessive risk taking globally supported by historically low interest rates was cited as a key global risk, as was debt in China. Meanwhile for Australia, "household balance sheets and the housing market remain a core area of interest". On this front, it was emphasised that policy actions have brought greater resilience to the sector. The overall health of the financial sector and the Australian economy was regarded as strong. Worthy of a read are the special topic boxes on: risks in international housing markets; and Australian households' investment property exposures.

Offshore this week, it was relatively quiet. The FOMC September meeting minutes franked expectations of a December rate hike, but also clearly emphasised that the Committee is uneasy over the inflation outlook. This is a topic we cover in depth in the October Market Outlook. The take home is that, while the structural health of the economy has improved materially, slack remains in the labour market. Further context on this labour market slack was provided this week in Northern Exposure. In short, while hiring and job openings are elevated, so too is churn in and out of the labour market. In combination with historically weak participation of prime-aged workers, this trend implies that many US workers are struggling to find permanent employment and thus the household income they desire. This is likely to keep a lid on wage pressures and see consumer price inflation remain a little below the FOMC's 2.0%yr medium-term target. We remain confident in our view that the FOMC will only hike twice more in this cycle following the December 2017 decision - likely in June and December 2018.

Chart of the week: Job creation & losses year to Aug 2017

In the edition of our October Market Outlook, we provide an update on Australian employment trends by industry and by state. Total annual employment growth has accelerated to a well above trend 2.75%. Interestingly, the hiring surge has been narrowly focused with household services the key driver, followed by construction. The current relatively narrow job upswing contrasts with the broad based strength evident in 2015/16 and is symptomatic of the broader uneven economic expansion.

Through the last year the net balance of sectors expanding vs. those contracting was +1, highlighting just how narrow the current expansion is. Compare that to the 2015/2016 peak in employment growth of 3%yr when the net balance was +4 and it held this level for a year.

New Zealand: Week ahead & Data Wrap

Signs of life

There is growing evidence that the slowdown in the housing market over the last year is weighing on household spending decisions. We wouldn't be surprised to see a brief revival in house prices over the next few months. But the outlook for the next couple of years remains subdued, in the absence of a substantial fall in interest rates.

Retail spending on debit and credit cards rose just 0.1% in September, less than we and the market expected. That continued a string on several months where card spending has been flat or even lower. A fall in petrol prices over this year could explain some of the slowdown in spending, but there's little sign that households are taking advantage of their fuel savings to spend more elsewhere. Spending on clothing and durable goods has flatlined, and the rise in hospitality spending (which includes international tourists) has slowed.

Consumer spending in New Zealand tends to have a strong link with the housing market, reflecting the fact that housing makes up a very high proportion of household wealth. The slowdown in spending in recent months is consistent with the cooling in house prices over the last year. Prices are down slightly from their peaks in Auckland and Christchurch, and are rising at a slower pace than before in other regions.

We believe the rise in mortgage rates over the last year has been a significant factor in the housing slowdown. Over much of 2015 and 2016, fixed-term mortgage rates were steadily declining, which incrementally added more fuel to the housing market. But from late 2016, mortgage rates ceased falling and began to rise - not by huge amounts, but the change of direction was enough to take the heat out of the housing market.

The latest round of restrictions on loan-to-value ratios, which were targeted at property investors, are also likely to have been a factor in the early stage of the slowdown. But the experience both here and overseas suggests that the impact of lending restrictions is short-lived; the current slowdown has lasted for longer than could be explained by LVR restrictions alone. Caution ahead of the 23 September election may also have been a factor, to the extent that investors feared the possible introduction of a capital gains tax for investment properties.

A key question for the economic outlook is whether the slowdown in house prices will persist. We wouldn't be surprised to see a brief rebound in house prices over the next few months. The most recent moves in mortgage rates have been down - again, not by a large amount, but the change of direction is notable. The banking system is now striking a better balance between deposits and loans than it was a year ago, reducing the pressure for banks to lift lending and deposit rates.

The election uncertainty factor remains, as the coalition talks between the main parties drag on. (The latest indication is that a decision could be announced as late as the end of next week.) But the NZ First Party, which is being courted by both the National and Labour Parties, does not favour a capital gains tax, so that policy is unlikely to make it into the mix when the next Government is formed.

There have in fact been some tentative signs of life in house prices already. The REINZ house price index rose 1% in September, the second monthly increase in a row. The stabilisation in prices has been supported by a sharp drop in new listings in recent months - property owners don't sell into a falling market if they don't have to. As a result, the stock of unsold homes has actually started falling again, which has alleviated the downward pressure on prices. However, housing turnover remains very subdued, with the number of sales falling to a six-year low. That doesn't augur well for a sustained lift in prices.

Unless the Reserve Bank reduces the OCR, there is a limit to how far mortgage rates can fall in the short run. Over a longer timeframe we would expect fixed mortgage rates to rise in anticipation of OCR hikes and in response to rising global interest rates. Consequently, beyond a short-term fillip, we expect house prices to remain subdued in coming years. And consequently, we would expect consumer spending growth to be more subdued than it has been in previous years - more in line with the pace of income growth.

A slowdown in spending growth in turn implies that there is even less risk of the economy overheating. Inflation has picked up from its lows over the last two years - we expect next Tuesday's CPI release to show inflation close to the Reserve Banks' 2% target midpoint in the September quarter. But with growth expected to be subdued from here, inflation is unlikely to threaten the top end of the inflation target. And that means the Official Cash Rate can remain low for a long time.

Data Previews

Aus Sep Westpac-MI Leading Index

Oct 18, Last: -0.19%

• The Leading Index has swung sharply in recent months from well above trend to back below trend, the six month annualised growth rate holding at 0.19% below trend in August. The turnaround mainly reflects swings in Australia's commodity prices and to a lesser extent a shift to a rising yield curve implying tightening financial conditions.
• The Sep read will again see a mixed bag of updates: the ASX200 down -0.6% vs -0.1% last month, US industrial production contracting 0.9% vs a 0.4% gain last month, and commodity prices holding flat in AUD terms but consumer sentiment and consumer unemployment expectations showing solid improvements, dwelling approvals up 0.4% vs -1.2% last month, and the yield spread widening slightly.

Aus Sep Labour Force, employment '000

Oct 19, Last: 54.2k WBC f/c: 25k

Mkt f/c: 15k, Range: -10k to 32k

• Total employment rose 54.2k in August compared the market's for +20k. Full-time employment bounced 54.2k following a -19.9k correction in Jul. In the year fulltime employment has gained 251.2k/3.0%yr. Part-time employment rose 14.1k following a 49.1k bounce in Jul. In the year to Aug, part-time employment lifted 74.5k/2.0%yr.
• By state, NSW, Vic and Qld were driving the strength with total employment gaining 12.9k, 18.6k and 16.7k respectively.
• The leading indicator including our preferred Jobs Index all point to ongoing robust demand for labour. We are also looking for annual growth in employment to overshoot the Index through late 2017 and into early 2018 as it rebounds from an undershoot during late 2016 early 2017.
• Our forecast 25k rise in employment will lift the annual rate to 3.1%yr from 2.7%yr.

Aus Sep Labour Force, unemployment %

Oct 19, Last: 5.6% WBC f/c: 5.6%

Mkt f/c: 5.6%, Range: 5.4% to 5.7%

• Despite the strong gain in employment, the Aug release printed a flat unemployment rate of 5.6% (5.60% at two decimal places) due to a 0.2ppt gain in the participation rate driving a solid rise the labour force.
• In Aug, the gain in participation came from a lift in both male and female participation but the gains from females have been somewhat greater and females do appear to be on a more solid uptrend. Males, by contrast, look more like they have found some stability in participation. By state, the strongest gains in female participation were in Qld but they are also improving in NSW while Vic continues to hold a very high level of female participation.
• In Sep, we are looking for a flat participation rate of 65.3% which will generate a 30.5k gain in the labour force which, with rounding, will leave the unemployment rate at 5.6%.

NZ Q3 CPI

Oct 17, Last: 0.0%, Westpac f/c: 0.5%, Mkt f/c: 0.5%

• We expect a 0.5% rise in the Consumer Price Index for the September quarter, lifting the annual inflation rate to 1.9%.
• Food prices rose for the quarter, while fuel prices fell. The strong New Zealand dollar was a disinflationary force over the first half of this year, but we expect its influence to have waned in the September quarter.
• We expect inflation to exceed the Reserve Bank's forecast for the quarter. However, with economic growth and house prices falling short of the RBNZ's forecasts, we think that interest rates will need to remain low for even longer than the market expects.

China Q3 GDP

Oct 19, last 6.9%, WBC 6.8%

• In the June quarter, Chinese GDP recorded a third consecutive upside surprise, with annual growth of 6.9%. Versus authorities' 2017 target of "around 6.5%yr", the six months to June was certainly a strong start.
• Come the September quarter, this momentum has endured. The PMIs continue to report robust momentum across both the manufacturing and services sector, with broad-based support from domestic and external demand.
• Looking forward, the key downside risk to growth is that subdued employment growth caps momentum in household spending. In the near term, it is unlikely to be significant. However, should household incomes not grow in a robust fashion, it could become a bigger cause for concern. In 2018, investment is also likely to be providing less support.

The rate plunged after the United States data were sent to the public and has erased the earlier gains. USD/CHF is trading in the red and is pressuring a dynamic support after the false breakout above a dynamic resistance. Remains to see what will happen till the end of the day because the rate may squeeze a little after the impressive drop.

Unfortunately, the greenback has taken a hit from the United States data, which has disappointed in the afternoon, failing to come in line with expectations.

The US Retail Sales have increased only by 1.6% in September versus a 0.1% drop in August, less versus the 1.7% estimate, while the Core Retail Sales surged by 1.0%, more versus the 0.9% estimate and versus the 0.5% growth in the former reading period. Moreover, the CPI increased only by 0.5%, less compared to the 0.6% estimate, the Core CPI disappointed as well because has increased only by 0.1%, less versus the 0.2% estimate.

You can see that the rate failed to stay above the UML and now is pressuring the WL2 of the former ascending pitchfork. I've said in the previous reports that the rate could come down to retest the second warning line (WL2) after the false breakout above the median line (ml) of the ascending pitchfork and above the 0.9787 static resistance.

Only a valid breakdown below the WL2 will confirm a further drop in the upcoming period, while a rejection will signal a potential bullish momentum.

The EUR/JPY dropped and resumed the yesterday's minor drop. You can see that is the rate is pressuring the downside line of the Rising Wedge and looks determined to breakdown from this chart pattern. I've said that a valid breakdown from this pattern will signal another leg lower in the upcoming period, the first downside target will be at the upper median line (UML) of the major ascending pitchfork.

EUR/CHF decreased after a little today, but looks undecided at this moment. The bulls seem exhausted and could lose significant territory in the upcoming days. I've said in the previous report that a rejection from the WL5 and from the upper median line (uml) will send the rate tumbling. A minor drop is expected if will really fail to close on the mentioned resistance levels.