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The Weekly Bottom Line: A Solid Year In Spite Of Headwinds

U.S. Highlights

  • As widely expected, the Fed hiked rates once more this year. At the same time, the Fed’s dot plot moved lower over the forecast horizon. These changes are consistent with a softer inflation and economic outlook.
  • Data came in broadly positive, with housing starts and home resales both defying weaker market expectations. Consumer spending  remained hot in November, with consumption looking set to advance by a sturdy 4% (annualized) in Q4.
  • The late-year equity market sell off continued this week, with looming risks for a partial government shutdown marking the latest in a series of factors that are likely to weigh on sentiment through the New Year.

Canadian Highlights

  • Christmas came early for economic data watchers this week. A slew of reports showed both the strengths and weaknesses of Canada’s economy.
  • On the weak side, existing home sales pulled back 2.3% in November, falling for a third straight month. Still, the housing market appears to be stabilizing at this lower level with sales to new listings in balanced market territory and quality adjusted prices up 2% from a year ago.
  • On the stronger side, GDP expanded by 0.3% in October. Businesses remain relatively optimistic about the future and note ongoing capacity constraints, which should show up in stronger investment in non-oil-related sectors.

It was a busy data week, but the FOMC meeting was the main event. As widely expected, the Fed hiked rates for the fourth time this year, lifting the upper bound of the fed funds rate to 2.5%. More interesting was that the Fed’s dot plot, which shows members’ expectations for future rate increases, shifted lower in 2019. The median expectation is now for two hikes, down from three previously. The expectation for the longer-run level of the fed funds rate also moved down 25 basis points to 2.75%. Consistent with these changes are a slightly more subdued price outlook and slightly higher unemployment rate, both a sign of a softer economic outlook in the years ahead.

The Fed’s dovish tone with respect to future hikes did little to appease investors. Both U.S. and international equity markets extended their losing streak on the news. It should be noted, however, that the path of interest rates is not set in stone, with the Fed placing a greater emphasis on data-dependency. As Fed Chair Powell put it, from this point on “we’re going to be letting the data speak to us”.

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Speaking of data, this week’s releases continued to confirm several running themes. First, inflation remains near target but has softened lately. The core PCE prince index, the Fed’s preferred measure of inflation, edged up in November, but still fell short of target (Chart 1). Secondly, U.S. consumer spending remains hot. Real spending was up 0.3% in November. With two months in the bag, consumption looks set to advance by close to 4% (annualized) in the final quarter of the year, better than previously expected. This brings our tracking for real GDP for the same quarter up to 2.8% – a deceleration from the third quarter (3.4%), but enough to keep growth at 2.9% for the year.

Third, the housing market remains soft but recent improvements are encouraging. Both housing starts (3.2%) and existing home sales (1.9%) rose in November, besting market expectations. On a less positive note, starts were propped up by the volatile multifamily segment (single-family starts fell for a third straight month), while home resales are still down between 3% and 15% year-on-year across major U.S. regions.

As the sugar high from monetary and fiscal stimulus wears off, we expect growth to slow to a still-healthy 2.5% in 2019. But, several potential potholes lie in the path ahead (see here). The latest spending bill impasse, which could lead to a partial government shutdown, is but one example. Given that shutdowns typically prove to be short-lived, history suggests limited economic impact. However, the hit to market confidence could prove more damaging.

Given expectations for slowing growth and the pronounced late-year selloff in equity markets (Chart 2), the “recession” word has gained traction recently. Our recent look at a broad range of indicators points sees little evidence for this in the economic data. That said, negative expectations have the potential to become self-fulfilling. But for now, the only thing we have to fear is fear itself.

As the year draws to a close, it’s a good time to look back on what was. 2018 was a year of adjustment for the Canadian economy. From new mortgage regulations to trade uncertainty and plummeting oil prices, it was also a year of headwinds. Economic growth downshifted from a lofty 2.9% in 2017 to a still-respectable 2.1% in 2018. Underneath the headline, the drivers also shifted. After years of supporting growth, residential investment subtracted from it in 2018. Fortunately, its negative contribution was offset by a reversal in the contribution from net exports, something we expect to continue over the next year.

The data flow this week echoed these themes. Canadian home sales continued their descent in November, falling 2.3% – a third straight monthly drop. Importantly, the drop in sales was met with fewer listings, leaving the housing market in balanced market territory. Adjusted for quality, home prices across the country were up 2.0% from a year ago. The market appears to be showing signs of stabilization, but at a lower level of activity than the heady pace of the past several years.

Stable is also the word to describe Canada’s inflation backdrop. While headline consumer price growth decelerated to 1.7% in November due to falling oil prices, the Bank of Canada’s core measures have been remarkably steady, hovering in a narrow range between 1.8% and 2.1% over the course of the year. In November, the CPI-common measure marked its 10th month at 1.9%), its longest string of steady growth on record (see Chart 1).

The impact of lower oil prices is likely to be felt more noticeably in Canadian economic data over the remainder of 2018, but the fourth quarter at least started off on a strong foot, with GDP growing by 0.3% m/m in October. Encouragingly, growth was widespread across a majority of both goods and services-producing industries, with the notable exception of construction, which pulled back for a fifth straight month. Even with the strong start to the quarte