USD/CAD

U.S. retail sales rebounded sharply in October as purchases of motor vehicles and building materials surged, but data for the prior two months was revised lower and the underlying trend suggested that consumer spending was probably slowing down.

Still, the report on Thursday from the Commerce Department showed broad gains in sales ahead of the holiday shopping season, which bodes well for consumer spending and the overall economy as the fourth quarter gets under way.

Retail sales increased 0.8% last month. Retail sales in September slipped 0.1% instead of rising 0.1% and sales in August were also weaker than previously thought.

The market had forecast retail sales increasing 0.5% in October. Sales rose 4.6% from a year ago.

Excluding automobiles, gasoline, building materials and food services, retail sales increased 0.3% last month. These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product.

Data for September was revised lower to show core retail sales rising 0.3% instead of gaining 0.5% as previously reported. Core retail sales fell 0.2% in August rather than being unchanged.

Strong domestic demand and a tightening labor market support views that the Federal Reserve will increase interest rates in December for the fourth time this year. The U.S. central bank last Thursday kept rates unchanged, but said data "indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate."

Next week, the Federal Reserve will end its seventh regular FOMC meeting of the year. It is widely expected that the committee will keep the target range for the federal funds rate at an unchanged 2.00% to 2.25%, while reiterating the outlook for another 25bp move in December. Newly appointed Vice Chair Richard Clarida said as recently as last Thursday, i.e. right before the start of the blackout period, that “even after our most recent policy decision to raise the range for the federal funds rate by 0.25 percentage point, monetary policy remains accommodative, and I believe some further gradual adjustment in the policy rate range will likely be appropriate.” Moreover, he added that “with the economy now operating at or close to mandate-consistent levels for inflation and unemployment, the risks that monetary policy must balance are now more symmetric and less skewed to the downside.” Neither the recent stock market volatility nor President Trump’s repeated comments have thus affected the Fed’s underlying policy view. This should be indicated by the statement reiterating its main policy outlook: “The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2% objective over the medium term. Risks to the economic outlook appear roughly balanced.”

Rather than making any immediate policy changes, the Fed will likely use the meeting to discuss the size and composition its balance sheet should have after the normalization is completed. According to the minutes of the August 1 FOMC meeting, Fed Chair Jerome Powell suggested that such a discussion of operating frameworks would likely resume in the fall. Previously, the committee had said that it wanted the smallest balance sheet that is consistent with a good monetary policy. At some point, that general statement will need to be translated into a target size for excess reserves; we expect a ballpark range of USD 500 bn to USD 750 bn, compared to the current level of USD 1.7 tn and a maximum level of USD 2.7 tn, which was hit in 2014. With regard to the composition, the Fed has suggested before that it ultimately targets a Treasury-only balance sheet, which means that all MBS and agency debt holdings would be wound down. This is likely to be confirmed. A circumstance that is adding some urgency to the topic is the fact that the effective fed funds rate continues to push against the interest paid on excess reserves. Unless the situation changes by the December meeting, it seems likely that the Fed will once again raise the interest paid on excess reserves by less than the target range in order to push the effective fed funds rate back to the middle of the band.

The Canadian economy added jobs in October with a surge in full-time hiring, and the unemployment rate dipped to a 40-year low, underpinning expectations that the Bank of Canada would keep raising interest rates.

Statistics Canada said on Friday that 11.2k jobs were created and the unemployment rate fell to 5.8% for the first time since July. The market had forecast a gain of 10k positions and for the jobless rate to remain at 5.9%.

The Bank of Canada on Tuesday reiterated that more interest rate hikes would be needed to achieve its inflation target and that now was the ideal time to remove monetary stimulus, given how well the economy was doing. Market expectations of an interest rate hike on December 5, as reflected in the overnight index swaps market, dipped to 28.43% from 30.29%.

Although full-time jobs rose by 33.9k compared to a loss of 22.6k part-time positions, the labor participation rate dropped to 65.2%, its lowest since October 1998.

The average year-over-year wage growth of permanent employees - a figure closely watched by the Bank of Canada - fell to just 1.9%, the lowest since the 1.7% recorded in August 2017.

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