Market Commentary – November

Hurricanes Turn from Headwinds to Tailwinds

It was an eventful week across financial markets, with a plethora of economic data, Fed speeches, and political developments keeping investors busy. On the whole, equity markets were largely unchanged from last week’s close (as of time of writing), with robust economic data and potential tax reform reinforcing the Fed’s resolve to raise rates. This has lifted short-term rates somewhat higher, with the yield on the 2-year Treasury note up 7bps since last Friday.

In contrast, yields on longer-term securities have declined since last week. While a pull-back in oil prices from their recent peak was partly to blame, much of the 5bps pare-back in the 10-year Treasury bond yield was related to increased investor demand for safe assets. There was also a sell-off in the junk bond market, lwidening the spread.

Domestic economic data was in fact quite stellar, with most major releases beating expectations. Importantly, after several weeks of weakness and disruption related to Hurricane Harvey and Irma, data is now firmly showing signs of recovery. After declining during August, retail sales for October continued to rebound. They increased by 0.2% in the month, well above expectations for a flat-print, after an upwardly revised 1.9% surge in September (see Chart 1).

Housing starts too have begun to rebound. After declining during August and September, starts increased by 150 thousand, as previously-delayed projects broke ground.  Even more encouraging was the fact that single family starts accounted for much of the gain, surging to match their post-recession peak achieved earlier this year. Additionally, many of the properties that were damaged or destroyed by the storms will need to rebuilt. This trend already appears in permitting data which increased by 72 thousand in October.

Industrial production, hard hit by the recent hurricanes, is is also rebounding strongly. After declining 0.5% in August, as Hurricane Harvey ravaged the Gulf Coast, shutting down refineries and chemical plants, the indicator rebounded sharply. Industrial production was up 0.5% in September and another 0.9% in October. The October surge was largely due to chemicals and petroleum & coal product manufacturing, which surged by 5.8% and 4.0%, respectively (see Chart 2).

Taken together, the recent data indicates that growth in the third quarter was well above 3%, while current tracking suggests that the economy will expand by nearly 3% in last quarter of the year. While the relationship between economic slack and inflation may not be as strong as it had been in the past, most FOMC members believe it still exists. As such, the above potential growth should provide some comfort for the Committee that inflation should over the medium-term converge to the 2% target. On that note, while headline CPI for October decelerated to 2.0% from 2.2% during the previous month as gasoline prices normalized following the hurricanes, core inflation actually accelerated to 1.8% in October (from 1.7%). With unemployment at 4.1% and wage growth seeing signs of firming, inflation should converge and the Fed should hike.

Michael Dolega, Senior Economist | 416-983-0500

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