Canada’s inflation report for October will be in the spotlight on last Tuesday after falling below the Bank of Canada’s 2% target for the first time since 2021 in September.

Headline inflation likely edged back to 2% from a smaller annual decline in energy prices (-2.8% vs. -8.3% in September). Meanwhile, food price growth likely held steady (2.8% year-over-year in September). Excluding these two volatile components, we look for consumer price index growth to tick lower to 2.2% from 2.4%.

We expect some upward seasonal price moves in categories like clothing and footwear as well as travel tours. Another component to watch for is property taxes and other special charges as this component is released only in October. Last year, it rose by 4.9% month-over-month, and we expect another large increase this year, given major Canadian cities had tax hikes in 2024.

The BoC‘s preferred median and trim core measures (for a better gauge of where inflation is going rather than where it’s been) both likely ticked higher in October on a three-month rolling average. However, they should remain “below 2 ½%” as referenced in the policy statement from the BoC’s October interest rate cut.

We continue to think that inflation is more likely to drift broadly lower in Canada. With a headline inflation forecast of 2% in October, inflation will have hovered around the 2% target for three consecutive months. The diffusion index has also suggested that the breadth of inflation pressures narrowed recently. Meanwhile, labour markets continue to soften with hiring demand (job openings) slowing and the unemployment rate continuing to edge higher. Given the Canadian economy’s weak momentum, we continue to expect the BoC to cut the overnight rate by an additional 50 basis points in December.

This Week and data watch

Canadian retail sales likely rose 0.4% in September—the same rate as last month. Core sales likely contributed to most of the headline growth, given auto sales and sales at gas stations declined during the month.

We expect housing starts at 256,000 in October, up from 224,000 in September.

Source: RBC Financial Group

There are not many German words that have found their way into international usage. Kindergarten is probably the most prominent one. In recent months, however, ‘Schadenfreude’ and ‘Schuldenbremse’ were clearly added to the list – at least in the financial community.

‘Schadenfreude’ or maybe also ‘cringe’ when looking at the German economy and the major protagonists. It is struggling with first recognising the structural changes and weaknesses of the economy and then with finding solutions. The economy has been in a de facto stagnation for more than four years, industrial production is still some 10% below its pre-pandemic level, international competitiveness has deteriorated, and the growing investment gap of the last decade has become visible in many parts of the economy.

There is no single reason for the collapse of the German government almost two weeks ago, but it is clear that the ‘Schuldenbremse’ played a prominent role, next to growing personal tensions between the leaders of the coalition partners, dropping support in regional elections and opinion polls as well as different views on how tackle the weak economy.

Looking ahead and beyond the upcoming elections in February, the main economic question the next government will have to answer is as simple as it is complicated: how will Germany restore international competitiveness and growth? And the solution, which is as simple as it is complicated, is: Germany will have to go either the Southern European way with structural reforms and (forced) austerity or with structural reforms, investments and somewhat looser fiscal policy.

A reminder – what is the German debt brake?

The German fiscal debt brake, or “Schuldenbremse,” was a political reaction to the financial crisis in 2008 and surging government debt. It was agreed in 2009, when German government debt stood at around 70% of GDP, and became effective in 2010, when government debt was at 80% of GDP. The arguments behind the fiscal debt brake were to anchor sustainable public finances in the Constitution and prevent politicians from engaging in irresponsible fiscal spending. Changes need a two-thirds majority in parliament.

The debt brake restricts structural annual budget deficits to 0.35% of GDP and commits regional state governments to balanced budgets since 2020. Remember that the recently revised European fiscal rules no longer prescribe a certain fiscal deficit when a country has a debt ratio of below 60% of GDP but will instead focus on a sustainable path for public expenditures. Back to the German debt brake, there are provisions for exceptions in cases of natural disasters or severe economic crises, allowing for a temporary suspension of the debt brake, as in the European rules. The war in Ukraine and the pandemic have been valid reasons for exemptions but for the 2025 budget not everyone in the government wanted to opt for another year of special circumstances.

Current state of German public finances

When reading about the current political debate on public finances in Germany, one could get the impression that Germany is close to bankruptcy. The opposite is true. According to the latest forecasts by the European Commission, German government debt has stabilised slightly above 60% of GDP and is expected to stay there until 2026. Germany has by far the lowest government debt ratio of the larger eurozone countries. For example, France currently runs a government debt ratio of 115% of GDP. The expenditure ratio in Germany is currently at 49% of GDP, in France it is at 57% of GDP.

Admittedly, German public finances will be facing more stress over the longer term as a result of demographics. Just think of ageing having a negative impact of government revenues as less people will be at work and at the same time higher government expenditures, for example for pensions and health care. According to European Commission estimates, ageing-related public expenditures in Germany will rise by 2 percentage points over the next decades. However, in the IMF’s estimates of government net debt, Germany’s position will improve over the next five years and is one of the lowest in the eurozone. Debt sustainability is currently not an issue.

No overhaul of the economy without an overhaul of the debt brake?

The government collapsed over personal tensions, disappointing results in the opinion polls and different views on how to get the economy out of its current stagnation and structural weakness. The different economic policy ideas will therefore very likely play an important role at the upcoming elections on 23 February 2025. Differences will mainly occur on how and where to cut expenditures and how to finance or incentivise investments.

Reaching the debt brake during the economic good times of the 2010s was achieved via low interest rate payments and reduced investments. As a result, the economy has fallen behind in important fields like infrastructure, digitalisation and education – often traditional public goods. Of course, it is not only about public investment, as private investment plays a far bigger role. But without public goods and public incentives, there won’t be private sector investments. Currently, the investment gap in Germany is estimated to be some 600bn euro, or some 15% of GDP. Also, add to this another 30bn euro per year, which would be needed to bring German defence spending to the 2% of GDP target. The closing of such a gap will never be achieved by only cutting expenditures. Consequently, any serious effort to fundamentally reform and improve the German economy will have to come with fiscal stimulus. Stimulus that would also benefit the debt-to-GDP ratio as in the German debate very often the denominator is overlooked. Debt ratios can also come down when GDP growth picks up.

Any serious efforts to fundamentally reform and improve the German economy will have to come with fiscal stimulus

Whether the debt brake will be officially changed after the elections remains unclear at present. Interestingly, the CDU has started to make some moves, in our view paving the way for investment-related fiscal stimulus after the elections. As official changes can only be made with a two-thirds majority in parliament, everything will depend on the results for the AfD and the FDP, probably the only two parties left with a very rigid opposition against changes to the debt brake. According to current polls, the two parties together could get some 25% of the votes, with the FDP still at risk of not making it into parliament at all.

In any case, whether there are official changes to the debt brake, following proposals like a golden rule for (defence) investments, a higher structural deficit or a longer exemption period for the sake of infrastructure investments, or whether any new government would opt for other tools, doesn’t matter. Fiscal stimulus is here to come. Other financing tools could still include the so-called Sondervermögen (special purpose vehicles). Contrary to public belief, the Constitutional Court didn’t prohibit these vehicles but only ruled against shifting money from one to the other. A special purpose vehicle to finance an infrastructure and digitalisation modernisation programme could be possible.

Taking the 600bn euro investment gap as a starting point, this would mean more than 1.5% GDP additional fiscal stimulus over the next ten years.

When any next government has to decide on the future path for the economy, there are simply two options: structural reforms and investment via austerity or structural reforms via investment and looser fiscal policies. In all honesty, it's not a difficult choice. And with looser fiscal policy and a reform and investment agenda, it could be time for Europe to dust off another German word often used: Leitmotiv.

Week in Review: Soft Landing in Jeopardy?

A week that promised much is drawing to a somber close. Following two action packed weeks, last week which included US CPI and PPI data was muted in comparison. However, the week was not a waste by any means and provided some valuable insights while at the same time raising some key questions.

The biggest takeaway for last week is, whether or not a soft landing is still on the cards?

An uptick in PPI coupled with rising US Yields and stubborn CPI data have brought the question back to the fore.

In Q3, the chance of a soft-landing went up from 40% to 42%. At the same time, the likelihood of a recession dropped from 30% to 28%, and the chance of stagflation went down from 28% to 27%. The highest probability is for a soft-landing, meaning there’s a greater chance of steady growth over the next year.

The chances for different growth scenarios stayed mostly the same as last quarter. However, the election results have added uncertainty to the economic outlook, which might lead to changes in these chances going forward.

Given the comments by Fed Chair Powell and the history of the Fed, another monetary policy pivot in early 2025 is unlikely. Powell has made it clear that the Fed will gauge the impact of Government policy before making any decisions, which will mean a Q1 or potentially Q2 pivot remains unlikely as markets come to terms with a Trump return to the White House.

Taking into account all of the above however, market participants do not seem fazed by Fed Chair Powell’s comments. The probabilities and implied rates for 2025 remain muted with less rate cuts the base case, as market participants continue to see increased inflation in the new year. The impact of this continues to be felt by the US Dollar and US Yields in particular both of which have enjoyed bullish weeks.

Markets are now pricing in around 72 bps of rate cuts through December 2025, down from 77 bps on Wednesday. This was down to a rise in US PPI and strong retail sales and NY Fed manufacturing data. Adding fuel to this were some announcements by President elect Trump where he touted some key foreign policy positions to known China Hawks. This will no doubt exacerbate concerns of a more aggressive stance toward China and increase trade war concerns.

Moving forward, these developments might be more important than the pricing of the December meeting where the likelihood of a cut still remains above the 60% mark.

Source: LSEG (click to enlarge)

The surprise of the week came from US Indices with the SPX and Nasdaq 100 giving back the majority of its post election gains. The SPX and Nasdaq 100 are 2.03% and 3.17% down for last week at the time of writing.

The biggest winner of the week was the crypto space with Bitcoin (BTC/USD) roaring to fresh ATH highs around the $93k handle. Markets remain optimistic that President Trump will follow through on his pro-crypto stance with various opinions floating around.

Commodity markets came under strain again last week with rising yields and the DXY pushing Gold down to lows around $2536/oz, as much as 5% down for last week. Oil pisces also struggled to gain any favor as OPEC downgraded their forecasts for a fourth consecutive month. Brent was down around 3% for the week at the time of writing.

All in all a confusing week, one that is likely to keep markets guessing heading into a busy festive season.

The Week Ahead: Muted Week in APAC, PMI Data Rules

Asia Pacific Markets

This week in the Asia Pacific region will see a slowdown with a surprise meeting called by the Bank of Japan (BoJ) likely to be a highlight.

Japan’s data is likely to show that things are slowly getting back to normal after some temporary disruptions. This should lead to better PMI figures. The manufacturing PMI might stay below average, but the services PMI should improve thanks to temporary tax cuts and rising incomes.

Exports are expected to grow by 1.7% compared to last year, following a 1.7% fall in September, while imports might drop by 4.5% due to lower global commodity prices. Inflation is predicted to decrease to 2.3% compared to last year, mainly because of a high base from last year. However, monthly growth should rise to 0.6%, helped by the end of energy subsidies and strong price increases in services.

The surprise may come on Monday however, per a Reuters report BoJ Governor Ueda will deliver a speech and hold a news conference in Nagoya on Monday, the BOJ said, an event (which wasn’t previously scheduled) that will be closely watched by markets for hints on whether it might raise interest rates next month. The comments by Ueda could spark volatility in Yen pairs following a bout of weakness in recent weeks.

In China, data is thin this week. The loan prime rates will be announced on Wednesday, where no change is expected after the People’s Bank of China has so far held rates unchanged this month.

In Australia the highlight of the week will be the RBA minutes scheduled to be released Tuesday. The report could shed some light on the recent RBA meeting and provide insight into rate policy moving forward.

Europe + UK + US

In developed markets, the Euro Area returns with high impact data and more specifically PMI numbers. This is crucial for the Euro Area as growth is now the primary source of concern for the region given the struggle by its manufacturing powerhouse, Germany. The Euro having lost so much ground in recent weeks to the greenback in particular could face renewed selling pressure if a lackluster PMI print is revealed.

In the UK, Q3 GDP showed the UK economy slowed to 0.1% with the economy in September shrinking by -0.1%. This makes the upcoming CPI data even more important and intriguing with the services inflation print in focus once more.

At the start of October, household energy bills went up by about 10%, which means overall inflation might go above 2% again. However, the Bank of England is more concerned with inflation in services which could rise toward 5% once more. ‘Core Services’ inflation is expected to drop significantly from 4.8% to 4.3%. This small detail probably won’t lead to a rate cut in December, but it suggests that the BoE might cut rates more sharply than the 2-3 cuts currently expected over the next few years.

In the US this week markets enjoy a pause on the data front with one high impact release on the agenda. The S&P PMI report will be released on Thursday which should not have a huge impact.

The next important updates will be the core personal consumer spending figures and the crucial November jobs report, coming out in two and three weeks, respectively.

Chart of the Week

Last week’s focus remains the US Dollar Index (DXY), which has run into multi-month resistance around 107.00 handle. The DXY has been having an effect across global markets together with US Yields and thus my intrigue into where we could head next.

The DXY chart below and you can see the pink box where price is currently hovering which is a key area of resistance that the index has to navigate. Friday saw a significant pullback in the European session, but US Data later in the day provided USD bulls with renewed impetus.

A break above the 107.00 handle may find resistance at 107.97 with a break above this level bringing 109.52 into focus.

Looking at the downside and immediate support rests around 105.63 before the 105.00 handle and the red box on the chart around 104.50 come into focus.

The DXY has been driving price action in all Dollar denominated instruments and this could continue in the week.

US Dollar Index Daily Chart – November 15, 2024

Source:TradingView.Com (click to enlarge)

Key Levels to Consider:

Support

105.63

105.00

104.50

Resistance

107.00

107.97

109.52

Source: ACTIONFOREX

Retail sales rose 0.4% month-on-month (m/m) in October, down from the upwardly revised September 2024 gain of 0.8%, but ahead of the consensus forecast calling for an increase of 0.3% m/m.

Trade in the auto sector rose 1.6% m/m, as the decline at automotive parts and accessory stores (-2.0%) was more than offset by the large increase at motor vehicle dealers (+1.9%).

Sales at gasoline stations rose 0.1 % m/m in October, driven by higher volumes as gas prices fell on the month. The building materials and equipment category rose by 0.5% m/m.

Sales in the “control group”, which excludes the volatile components above (i.e., gasoline, autos and building supplies) and is used in the estimate of personal consumption expenditures (PCE), fell 0.1% m/m, a sizeable deceleration from the upwardly revised 1.2% monthly gain in September.

Modest gains were recorded at non-store retailers (0.3% m/m) and department stores (0.2% m/m).

Sizeable declines were recorded by miscellaneous stores (-1.6% m/m), sporting goods, hobby, book, & music stores (-1.1% m/m), and health & personal care stores (-1.1% m/m).

Food services & drinking places – the only services category in the retail sales report – rose 0.7% m/m. September’s data was also revised up to 1.2% (previously 1.0%).

Key Implications

Retail sales were higher than expected in October due to an outsized uptick in motor vehicle sales, however if motor vehicles are excluded then retails sales were flat on the month. Nevertheless, the 3-month average for retail sales rose from 0.2% in September to 0.6% in October on the back of material upward revisions to the prior month’s data. It’s possible that Hurricane Milton may have distorted sales readings last month, although clean-up and recovery efforts may lead to higher readings in the months ahead.

U.S. consumption remains healthy on aggregate, supported by a stable labor market and solid real income gains. Our tracking currently puts fourth quarter annualized consumption growth above 3% and only slightly below the third quarter’s strong reading. While we currently expect the Federal Reserve to cut by 25 basis points in December, risks surrounding a potential pause to end the year have risen, with markets pricing in roughly 40% odds of that outcome as of the time of writing.

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