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Summary

United States: October Prices Give Fed Ability to Slow Pace of Rate Hikes

• Relief in October inflation gives the FOMC the ability to slow the pace of rate hikes ahead. But make no mistake, the Fed's job of taming inflation remains far from over. We still expect it to raise the federal funds rate 50 bps at its next policy meeting in December, and now look for the policy rate to reach a peak of 5.25% by March, 25 bps more than we previously forecast, due to near-term resilience in spending and labor market strength.
• Next week: Retail Sales (Wed), Industrial Prod. (Wed), Housing Starts/Existing Home Sales (Thu/Fri)

International: Mixed Inflation Trends from Latin America

• This week saw some mixed inflation trends from Latin America. Mexico's October CPI slowed to 8.41% year-over-year and energy prices slowed along with fruit and vegetables prices. However, the core CPI quickened further, and as a result, we fully expect the Bank of Mexico to raise its policy rate by 75 bps points this week. In Brazil, October inflation slowed further to 6.36% year-over-year, with lower taxes and gasoline prices as key drivers of the deceleration in recent months.
• Next week: Japan GDP (Tue), China Retail Sales & Industrial Output (Tue), U.K. CPI (Wed)

Credit Market Insights: Consumer Credit Growth Steadies as Banks Tighten Lending Standards

• Total consumer credit growth moderated in September, increasing by $25 billion in a step down from August’s $30 billion gain. The Fed's quarterly Senior Loan Officer Opinion Survey, which generally covers the third quarter, found that banks have tightened their lending standards over the quarter and demand for most business and consumer loan types weakened.

Topic of the Week: Election Day 2022

• Election Day has come and gone in the United States, and although not every race has been determined, the broad contours of the election outcome have emerged. The most probable outcome appears to be a divided government, with Republicans controlling at least one chamber of Congress and the White House still safely in Democrats' hands.

Full report here.

U.S. Highlights

• Republicans look to have won control of the House in this week’s midterm elections. The Senate race remains too close to call. With Washington more divided, major spending and tax changes are less likely, while some risks increase (i.e., the potential for a government shutdown).
• CPI inflation eased in October, with headline CPI decelerating to 7.7% y/y (from 8.2%) and core CPI cooling to 6.3% y/y (from 6.6%). Shelter costs remained a key contributor to inflation.
• Small business confidence pulled back a bit in October, but job openings remained unchanged near record highs.

Canadian Highlights

• It was a quiet week in Canada data-wise ahead of next week’s flurry of data. The CPI report is expected to show modestly easing inflation, while existing home sales will likely show that the housing market is nearing its bottom.
• Despite significant financial headwinds hitting consumers’ budgets, aggregate spending on debit and credit cards edged slightly higher in September and October after trending lower over the summer months.
• However, rising financial hurdles are leading to higher insolvency filings. Consumer insolvencies are up 22% from a year ago, while filings were up 37% y/y for businesses.

U.S. - Markets Cheer Inflation Easing a Touch

The midterm elections took center stage for much of the week, although markets were most encouraged by good news on the inflation front on Thursday. Republicans look to have won control of the House, capturing an estimated 208 seats thus far (vs. 185 for Democrats), while the Senate remains too close to call. We may need to wait until Georgia’s runoff election on December 6th, to know the final result, depending on races in Arizona and Nevada.

Either way, Washington is looking more divided than it was a week ago, and the chance that new major policy measures get the three required checkmarks – House, Senate and White House – have diminished. Indeed, large scale fiscal spending measures and major tax changes seem unlikely over the next two years. In this vein, the midterms should not have a major impact on economic growth. There are, however, risks that come with a divided Congress. One concerning aspect is the potential for a lack of agreement to fund government programs in the near-to-medium term, which could lead to a government shutdown, or debt-ceiling standoff, which raises the (unlikely) risk of a default on debt or leave other bills unpaid. These issues, which have the potential to significantly disrupt financial markets, as they’ve done in the past, are added risks for a slowing economy in the year ahead.

Inflation was likely top of mind for many voters as they headed to the polls, as it has been taking a sizable bite out of consumers’ wallets this year. The Consumer Price Index (CPI) showed that inflation eased in October, for both headline and core CPI, with the latter decelerating to 6.3% year-on-year (y/y) from 6.6% in the month prior (Chart 1). In month-over-month (m/m) terms, core CPI decelerated meaningfully to 0.3% in October from 0.6% previously. Core goods prices declined 0.4% (m/m) amidst a pullback in several categories such as appliances, apparel and used car prices. Price growth across core services (0.5%) also moderated from last month’s gain of 0.8%, driven by a notable pullback in health care services (-0.6%). However, shelter costs (0.8%) remained a meaningful contributor.

All in all, inflation has eased a bit, in part because of the pullback in core goods prices. However, it remains well above the Fed’s comfort zone, and (without wanting to sound like a broken record) we’re likely to see continued gains in the shelter component over the near term (see here). So, we’re not out of the woods just yet.

As Fed Chair Powell noted recently, the Fed has reached a point where it will dial back the pace of rate hikes, but there’s quite a bit more to be done in raising rates. Underpinning this hawkish tilt is the broad resilience in the labor market. Job openings for instance, have eased a bit, but remain plentiful – a message echoed by the NFIB small business survey (Chart 2). Still, cracks continue to form in some corners of the economy, case in point the tech sector. Layoffs at Meta and Redfin (online real estate broker) amounting to 13% of their workforces added to the string of cuts announced in the tech space this year. Meanwhile, the higher interest environment is expected to continue weighing on the housing market, with weak prints likely to follow in next week’s housing starts and existing home sales reports. Bringing inflation down comes at a cost.

Canada – Economy Still in Excess Demand, but Cooling

It was a quiet week in Canada data-wise, nonetheless the past few days were marked with volatility in financial markets. Midterm elections in the U.S. and turmoil in cryptocurrency markets made waves. Following a selloff on Wednesday, markets surged higher today following the release of U.S. inflation numbers, which showed a larger than-expected slowdown in price growth in October. It's been some time since U.S. inflation surprised to the downside and this news lifted investors' spirits, with hopes that inflationary pressures south of the border are finally starting to ease.

Here in Canada next week's CPI report is expected to show modest improvement on inflation front in October as well. Following a 6.9% year-over-year (y/y) increase in September, headline inflation is expected to have eased to 6.7% last month. However, all eyes will be on core inflation, which has so far remained stubborn. Not helping the cause, both the labour market and spending data have showed renewed resilience in the fall months. Last week's blockbuster employment report showed that after a summer lull, the economy added 100k new jobs in October. Consumer demand too has also shown more life in the past two months. Despite significant financial headwinds hitting consumers' budgets, aggregate spending on debit and credit cards edged slightly higher in September and October after trending lower over the summer months (Chart 1).

No doubt the resilient labour market has been helping to partially mitigate the financial pain that consumers are facing due to high inflation, rising interest rates and thinning wealth cushions. With unemployment near a record low, a tight labour market continues to add upward pressure on wages. The BoC governor Tiff Macklem also discussed labour market imbalances and its implications for inflation in his speech today, stating that "vacancies are elevated, businesses are reporting widespread shortages", and "wage growth has increased and broadened across the economy". However, he also stated that the Bank is seeing early signs of that the labour market is starting to loosen, particularly in interest-rate sensitive sectors, such as manufacturing and construction.

All in all, despite the aggressive monetary tightening, the Canadian economic engine appears to still has some steam left in it. But likely not for long. Monetary policy works with lags, as such we are only starting to see the impact on real economic activity. The full cumulative effect of higher interest rates on consumers will materialize only toward the end of 2023, after significant share of borrowers have been exposed to higher rates either due to mortgage renewals or higher rates on new credit. However, rising financial hurdles are already leading to higher insolvency filings. Consumer insolvencies (which include both bankruptcies and debt-restructuring proposals) are up 22% from a year ago, while filings were up 37% y/y for businesses (Chart 2). Both are rising from low levels, but will likely continue to increase as the labour market cools and higher debt servicing costs extend their reach to a larger number of households.

Consumer price growth in Canada likely ticked higher in October. We expect the annual rate to have risen to 7%, up from 6.9% in September but still down from the 8.1% recent peak in June. Driving the increase was a resurgence in gas and fuel oil prices. These prices, declining for months, had been the main factor pulling overall CPI growth readings lower. At 10.3% in September, food inflation was already the highest it’s been since 1980s—and that momentum likely extended into October. Inflation growth excluding more volatile food and energy products was likely little changed from a 5.4% annual increase in September as weakness tied to home-owning related expenses is offset by strength seen elsewhere.

Still, broader ‘core’ inflation measures—designed to provide a better gauge of underlying inflation trends—have shown some very early signs that the breadth of inflation pressures may be easing. The Bank of Canada’s preferred ‘trim’ and ‘median’ core CPI measures are still very high versus a year ago, but the pace of monthly growth moderated in August and September. By our count, 63% of the CPI basket was still growing at an annual rate above the BoC’s 1% to 3% target range over the three months to September. That’s down from 77% in July. Those green shoots were cited as a key reason for the BoC’s decision to go with a 50 basis point hike in October (below market expectations).

Outside of inflation readings, global supply chain constraints have continued to ease. A variety of shipping indicators have improved. Commodity prices, while still high, are lower than earlier this year. But labour markets are still very tight and consumer demand remains strong. While there are signs that inflation is past its peak in Canada, it will likely take a sustained period of higher interest rates and a weaker economy for price growth to ease fully back to central bank target rates. Our forecast assumes one additional 25 basis point increase in the BoC’s overnight rate in December before it pauses to assess the impact of its rate hikes so far. And risks to that interest rate outlook remain tilted to the upside.

Week ahead data watch:

We expect manufacturing sales declined half a percent in September—in line with early estimates from Statistics Canada. A large drop in petroleum sales was likely price-related, although we expect overall sale volumes to also decline by 0.3% with Statistics Canada noting lower transportation sales.

Housing starts likely slowed but to a still relatively strong 273,000 in October from the 300,000 annualized pace in September. Residential building permit issuance slowed to 258,000 in September from the outsized 307,000 in August.

A jump in U.S. unit auto sales in October is flagging a solid 1% increase in U.S. retail sales. We expect U.S. industrial production edged up 0.1% in October, with higher manufacturing output (+0.4%) offsetting a pullback in utilities output (-1%).

UK NIESR said, today's data confirmed a "production-driven contraction in GDP in Q3. It's expectation GDP growth to be flat in Q4.

However, "given that October PMIs recorded figures below the neutral 50 for both the services and manufacturing sectors, consumer and business confidence is plummeting, and higher-than-expected inflation and interest rates continue to squeeze budgets, the risk of a contraction in GDP in the fourth quarter of this year remains elevated, NIESR said.

"Whether the Chancellor's upcoming Autumn Statement will alleviate or aggravate current recessionary risks will become clearer next week."

Full release here.

Equity markets are on course to end the week on a positive after Thursday's US inflation report gave hope that the great deceleration is well underway.

That inflation report has been some time coming and investors breathed an enormous sigh of relief in response. The reaction to the number looks a little extreme, overdone even, but in fairness, investors have waited a long time for the chance to do that and so much negativity has been priced in during that time.

The fact that equity markets are in the green again today highlights that fact. We could see sentiment cool again in the coming weeks once the dust settles and the narrative changes from inflation has peaked and the Fed will slow its tightening efforts to we need more supportive data to back this up. But this is a fantastic start.

So often in recent months, the market has become bullish in the lead-up to these key releases only to be beaten down again as the reality doesn't live up to the dream. Well, this report delivered on that dream and then some. If it can be backed up by another solid report next month and some decent numbers in between, the Fed will have every excuse to slow down next month and even signal a lower terminal rate early next year.

UK already in recession?

It will come as a surprise to no one that economic data released this morning showed the UK may already be in recession. I mean, at this stage I'm not sure that's even newsworthy enough to make the front pages in the UK.

The Bank of England has been expecting this for some time and when confirmed in a few months, we should have a much better idea of how bad it will be. As we saw from its last forecasts which in a week will be based on old data, the range of viable recessions is quite broad and that's before the new fiscal plans are accounted for.

By the time it's confirmed, at least we'll know what the peak of inflation will be, how bad the winter energy crisis was and how high-interest rates are likely to go. All of which we've had to live without the knowledge of for the last 12 months.

Can oil break $100 again?

It's been quite the volatile week for oil, with Chinese rumours not going away, restrictions and mass testing being undertaken once more and the global economic outlook seemingly changing on a daily basis. There's no such thing as a boring week these days.

Today it's the improvement in economic sentiment on the back of that inflation data alongside a modest relaxation of Chinese quarantine measures that are lifting prices. A press briefing is expected tomorrow which may shed further light but if this is as good as it gets, investors have got way too carried away.

Brent remains in the middle of its $90-$100 range for now but more bullish developments like this, or a further relaxation of Chinese restrictions on Saturday may test the upper end of that.

Gold shines once more

Gold bulls have been waiting for this week for a long time. A week (or so) in which the Fed signalled a potential slowing of rate hikes and the CPI data displayed a significant and broad-based decline. The yellow metal is shining once more and is back at levels not seen in almost three months. It's seeing some resistance around $1,760 now and may see more around $1,780 but at this point, gold bulls may have their sights set on $1,800.

Cryptos weighed down by FTX uncertainty

Even Bitcoin managed a strong recovery rally yesterday alongside the surge in other risk assets. Of course, other risk assets didn't drop 25% in the days preceding the inflation data, nor are they down 3% today. The collapse of FTX and the uncertainty it has brought to the industry has been another damaging blow. How damaging it will be will depend on what further details appear in the coming days but right now, prices remain under pressure and vulnerable to further sharp declines.

• EURUSD broke resistance level 1.0095
• Likely to rise to resistance level 1.0365

EURUSD recently broke the resistance level 1.0095 (which has been reversing the price from the start of September) intersecting with the 61.8% Fibonacci correction of the downward impulse from August.

The breakout of the resistance level 1.0095 led to the subsequent breakout of the resistance trendline of the daily down channel from October.

EURUSD can be expected to rise further toward the next resistance level 1.0365 (multi-month high from August and the forecast price for the completion of the active wave C).

• USDCHF broke support level 0.9735
• Likely to fall to support level 0.9475

USDCHF recently broke the key support level 0.9735 (low of the earlier short-term wave (iv) from the end of September) intersecting with the support trendline of the daily up channel from August.

The breakout of the support level 0.9735 accelerated wave c-wave of the active minor ABC correction 2 from the middle of October.

Given the continuation of the strongly bearish USD sentiment, USDCHF can be expected to fall further toward the next support level 0.9475 (monthly low from September and the target for the completion of the active wave 2).

• AUDCAD broke the resistance level 0.8835
• Likely to rise to resistance level 0.8965

AUDCAD recently broke the resistance level 0.8835 (top of wave (a) from the end of October, former support from September).

The breakout of the resistance level 0.8835 was preceded by the breakout of the resistance trendline of the weekly down channel from April – which accelerated the active impulse wave (c).

AUDCAD can be expected to rise further toward the next resistance level 0.8965 (former double top from September and the forecast price for the completion of the active wave c).

The pound rally gained new momentum on Friday morning, following a respite after the 3% rise in GBPUSD on Thursday. The British currency was supported predominantly by better-than-expected economic data and comments from the Governor of the Bank of England on the intention for further rate hikes.

The UK economy contracted by 0.2% in the third quarter – noticeably less than the forecasted drop of 0.5%. One year ago, growth in the same period diminished to 2.4% after 4.4% in the second quarter and +2.1% expected. For September, the economy contracted by 0.6%, following a decline of 0.1% in August.

Industrial production added 0.2% in September, losing 3.1% y/y. Manufacturing is more challenging, holding on to volumes in September after contracting by a cumulative 2.9% in the previous three months.

Separately, there is an improvement in the balance of foreign trade. The monthly deficit decreased to 15.6bn compared to 17.2bn a month before, 16.1bn a year ago and a peak of 23 in January. However, this is well above ‘normal’ levels from 2013 to 2019, near 12bn. Exports are up 46% y/y, or 11.8bn and imports are up 27% or 11.4bn.

The UK economy has started to contract without surprises, evidenced by earlier labour market figures. So far, it is a softer landing than previously feared.

Nevertheless, it is essential for market participants that the published data shows a less tragic slowdown trajectory and that the decline in commodity prices in recent months is easing the pressure on imports and industry. In this environment, there are more and more reasons for long-term buying of the British pound, which renewed its historic low against the dollar in September. As a result, the GBPUSD is now above 1.1750, having beaten off losses since August.

The rise in the British currency also shows signs of breaking the downtrend as GBPUSD has surpassed previous local highs and has consolidated above the 50-day average. On the technical analysis side, GBPUSD may encounter little resistance up to the 1.20 area by the end of the month, where the bulls will still have to prove their strength.

Yesterday, the US reported headline and core CPI figures well below expectations. Stock markets around the world jumped, and the dollar got weaker as yields fell. The market cut its outlook for rate hikes. Commodities also got a boost. Is this the start of a new trend, or will the move fade? Let's take a look under the headlines to better understand what is going on, and what could be coming.

 The most important takeaway

As pointed out earlier in the week, the data has an important impact on expectations around future Fed policy. Before the release, economists were evenly split on whether the Fed would raise rates by 25bps or 50bps at their next meeting. After the release, the percentage of economists forecasting 25bps jumped to over 85%, with the market moving to price in a lower hike.

Not only that but the market reevaluated its terminal rate for Fed hikes. Before it was estimated that the Fed would hike to slightly above 5.00%. It currently is at 4.00%, meaning more than four 25bps moves until the end of the hiking cycle. Now, that has been repriced to the terminal rate being below 5.00%, so there would be a maximum of 100bps of hikes over the next five months. That is, according to current estimates.

The future trajectory

That could mean a 25bps in December, and then even the possibility of a pause in January. Or just three more quarter-point hikes. That substantially reduced yields on US treasuries, which in turn dragged down the value of the dollar. But, here's the big question: Will this trend be sustained? Because right up until yesterday, inflation was rising. This could be just a short-term correction in a continuing trend - or the CPI figure could be revised with the next release.

Looking closer at the components of CPI, a few things stand out. First was the drop in rent, the largest contributor to the miss of estimates. Rent prices have declined in line with a major slump in the housing market, as higher interest rates have made buying homes more expensive. With house prices slowing down, rents aren't rising.

Getting further into the details

The other two areas where there were unexpected price drops was in apparel and used vehicles. Both of these were driven by tighter financial conditions as Americans have seen their real wages fall for 18 consecutive months. With higher borrowing costs, it's harder for Americans to dip into credit to buy things, as well.

With a stronger dollar, the cost of imported goods has gone down. But with expectations that the Fed won't hike as much, the dollar would get weaker and imported goods would start costing more. We should remember that last quarter's GDP was positive primarily because consumers were buying less imported goods. Such as apparel. If the dollar continues its downward trend, it could bring back core inflation and weigh on this quarter's GDP result.

Although the immediate speakers from the Fed after the data release have hinted at lower rates, the bottom line is that the lower inflation reading depends a lot on interest rates. Over the next month, interest rate expectations might be lower and that could push inflation a little higher and change the evaluation of what will happen at the next Fed meeting. Remember; November CPI figures come out the day before the FOMC in December.