USD/JPY

U.S. homebuilding rose in October amid a rebound in multi-family housing projects, but construction of single-family homes fell for a second straight month, suggesting the housing market remained mired in weakness as mortgage rates march higher.

Other details of the report published by the Commerce Department on Tuesday were also soft. Building permits declined last month and homebuilding completions were the fewest in a year. Housing starts increased 1.5% to a seasonally adjusted annual rate of 1.228 million units last month.

Building permits fell 0.6% to a rate of 1.263 million units in October. The market had forecast housing starts rising to a 1.225 million-unit pace last month.

The struggling housing market is in stark contrast with the broader economy, which has enjoyed two straight quarters of robust growth and an unemployment rate at a near 49-year low of 3.7%. Prolonged housing weakness, together with a relentless sell-off on the stock market could stoke fears over the durability of the economy's strength.

In addition to rising borrowing costs, the housing market is also being squeezed by land and labor shortages, which have led to tight inventories and more expensive homes. Many workers are being priced out of the market as wage growth has lagged.

Tuesday's data also suggested that housing supply is likely to remain tight in the near term. Homebuilding completions in October fell 3.3% to a rate of 1.111 million units, the lowest level since September 2017.

Realtors estimate that housing starts and completion rates need to be in a range of 1.5 million to 1.6 million units per month to plug the inventory gap.

The stock of housing under construction rose 0.5% to a more than 11-year high of 1.137 million units last month. But the multi-family homes segment made up just over half of housing inventory under construction last month.

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.

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