Canadian Highlights
- The Fall Economic Statement (FES) was delivered amid a chaotic week for the federal government. Larger deficits and modest stimulus were features, although the FES is unlikely to change the Bank of Canada’s thinking on policy.
- Data on the real economy was mixed, with gains in home sales and starts in November, but flat retail volumes in October and (potentially) November.
- Core inflation was sticky in November, strengthening the case for a patient approach to rate cuts next year.
U.S. Highlights
- The Federal Reserve cut its policy rate by 25 basis points to 4.25-4.5%, as expected. But, updated forecasts showed that FOMC members now expect inflation to be a bit hotter next year, and as a result expect to make only 50 basis points in cuts next year, down from 100 bps in September.
- Economic growth was revised upwards in the third quarter. Real GDP rose 3.1%, up from 2.8% previously.
- There was also good news on the Fed’s preferred inflation gauge. The Core PCE Deflator held steady at 2.8% in year-on-year terms in November, but cooled noticeably on a month-to-month basis.
Canada – Capping the Year Off with a Bang
What a year this week was! The show stealer was Minister Freeland’s surprise resignation the day she was set to deliver the Fall Economic Statement (FES). What’s more, the Canadian dollar fell below the psychological 70 U.S. cents mark (as of writing), weighed down by the prospect of a slower pace of U.S. rate cuts.
Amid the federal government chaos, the FES was tabled (see here). As expected, the Liberals blew through one of their self-imposed fiscal guideposts (FY 2023/24 deficit was $60 billion, a 50% miss relative to the guidepost), but could still hit the other two (declining net debt-to-GDP and a deficit-to-GDP ratio below 1%). Even with one of these guideposts missed, the reality is that Canada’s fiscal position is strong relative to its international peers and the federal government maintains its a AAA rating on its debt.
About $20 billion in net new measures were announced in the update, including $18.4 billion to extend the accelerated investment incentive and immediate expensing measures (under the capital cost allowance rules) that were due to be phased out. These measures have lowered the marginal effective tax rate on investments by 3.1%, on average. The government will also spend $1.3 billion on border security to ease President-elect Trump’s concerns. The GST holiday is slated to cost $1.6 billion, and we envision it offering a marginal lift to economic growth in early 2025, but not enough to significantly move the dial. For the Bank of Canada, there was probably not much in the FES to significantly alter their thinking on monetary policy. However, Canada’s fiscal situation is worse off than what was expected in the spring (Chart 1), offering less space to offset negative economic developments.
On the data front, home sales posted a firm gain in November, and benchmark home prices jumped 0.6% on the month. That’s likely to catch the Bank of Canada’s attention given the upside potential for shelter cost inflation. Homebuilding was also solid last month, with starts climbing 8%. However, they continue to retrench in Ontario, which is the market that can least afford a slowdown given affordability challenges. On the softer side, retail sales volumes were flat in October (and could be again in November), although this followed hefty monthly gains in the prior three months.
November’s inflation report was the marquee release of the week. Overall inflation dipped to 1.9% in November. However, the Bank of Canada’s core inflation measures stalled at 2.7%. Also concerning was a back-up in shorter-term metrics. The 3-month annualized change in core inflation pushed above 3%, and the less volatile 6-month trend points to further upward pressure in 12-month core inflation ahead (Chart 2). These trends are certain to unsettle policymakers and support the Bank of Canada’s position that it will be more patient on future interest rate cuts. We think the Bank will proceed more slowly in 2025, with one 25 bps cut per quarter (see our updated Quarterly Economic Forecast). However, the U.S. tariff threat makes the outlook for the economy, and monetary policy, highly uncertain.
U.S. – Fed Signals a More Cautionary Stance on Rate Cuts Next Year
The Federal Reserve delivered some sour candy to cap off 2024, cutting its policy rate by 25 basis points, but signaling a more moderate pace of cuts next year. This hawkish tilt sent Treasury yields higher, with the 10-year rising from just under 4.4% to briefly over 4.6%. Equity markets took the news hard, with the S&P 500 down roughly 3.5% from pre-meeting levels at time of writing. Part of the weak equity market performance may also have to do with a looming government shutdown. Washington has only a few hours to pass a funding bill into law. Failure to do so will lead to a partial government shutdown. Essential services would continue, but most federal workers wouldn’t receive a paycheck. In addition, some workers would be furloughed until Congress passes new funding. The Bipartisan Policy Center estimates that some 875 thousand federal workers would be furloughed.
The Fed’s quarter point interest rate cut was as expected, but the accompanying Summary of Economic Projections (SEP) raised a few eyebrows. While the median forecasts for economic growth and the unemployment rate were little changed, the outlook for inflation and the policy rate were raised noticeably (Chart 1). Focusing on the year ahead, the median projection now has the Fed Funds Rate ending next year 50 basis points higher than expected in September. This is in tune with a firmer outlook for core inflation. Asked about the more cautious stance on rate cuts, Fed Chair Powell listed several reasons. These included the economy growing at a better pace and inflation coming in a bit hotter than expected recently. Powell also highlighted an elevated uncertainty around the inflation projections – a theme that was visible in the SEP document, with uncertainty and upside risks to core PCE inflation both up noticeably since September. Pressed on how much of the difference could be explained by the evolving data versus potential policy changes from the new Trump administration, the Fed Chair acknowledged that some policymakers did take preliminary steps to incorporate “highly conditional estimates of economic effects of policies into their forecast at this meeting”.
This week’s economic data buttressed several of Powell’s comments. The third estimate of Q3 GDP indicated that the economy grew at an improved pace of 3.1% annualized, up from 2.8% previously. At the same time, the November personal income and spending report indicated that consumer spending should end the year on solid footing. Consumer spending is on track for a solid 3% pace in the fourth quarter of 2024. That is only a small downshift from 3.5% pace in the third quarter. The November report also carried some better news on inflation, with the Fed’s preferred inflation gauge – core PCE – cooling noticeably in November, up a modest 0.1% month-over-month. While the annual pace remained at 2.8%, this latest cooldown helped reverse near-term trends lower (Chart 2).
Overall, with the economy remaining on decent footing and inflation seemingly having resumed its downward path, there is room for further policy normalization next year. But, the potential for major policy changes from the new U.S. administration remains a wildcard.
