Market Brief: Markets Retreat as Threat Environment Worsens

Markets are dressed in red for all the wrong reasons this morning. Most major currencies are down against the dollar on a month- and year-to-date basis as increasingly-hawkish policy expectations intersect with safe-haven demand ahead of a likely shutdown of the US federal government. Ten-year Treasury yields are holding near a six-month high at 4.54 percent, North American equity futures are pointing to renewed losses at the open, and many measures of expected volatility remain elevated.

The Federal Reserve’s preferred inflation measure continued its moderation in November, slightly depressing rate expectations for next year. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index rising 0.1 percent from the prior month, undershooting market forecasts for a 0.2 percent increase. On a year-over-year basis, core price growth rose 2.8 percent, aligning with economist estimates as unfavourable base effects played havoc with the annual comparison. The overall personal consumption expenditures index climbed 0.1 percent relative to the prior month, and was up 2.4 percent from a year ago, slightly above the 2.3-percent consensus estimate. Personal income rose a slower-than-anticipated 0.3 percent month-over-month, and inflation-adjusted household spending climbed at the same pace. The savings rate, which can offer a preview of future spending capacity, fell to 4.4 percent from 4.5 percent, continuing its long decline as consumers tapped borrowing products to support spending.

This won't provide much yield relief, given that a hastily-constructed funding bill was defeated in the US House of Representatives last night, putting the government on course toward a holiday shutdown. Thirty-eight Republicans joined their Democratic counterparts in voting down a Trump-endorsed measure that would have suspended the debt ceiling for two years, and with all three sides (old-school Republicans, Trump Republicans, and Democrats) remaining far apart on the major issues, a deal looks distinctly improbable ahead of the deadline. A shutdown is likely to cost the American economy billions, add to the disruption already roiling fixed-income markets, and bolster flows into safe-haven Treasuries, along with the US dollar.

Across the pond, the euro is holding firm after Trump posted a note on his social media platform saying “I told the European Union that they must make up their tremendous deficit with the United States by the large scale purchase of oil and gas. Otherwise it is TARIFFS all the way!!!”. Markets have long expected this, and the president’s elect’s demand shouldn’t be difficult to satisfy: although there has been some softness in recent months as West African prices have fallen, US crude oil exports to Europe have grown substantially since the shale revolution drove a surge in American output, and natural gas shipments have exploded since the invasion of Ukraine. Traders suspect that a high-profile press conference and a “deal” between Trump and EU policymakers will be enough to offset any damage to cross-Atlantic trade.

Here in Canada, retail sales increased less than expected in October, and an advance estimate showed overall receipts flatlining in November, suggesting that underlying economic momentum is fading once again. Data released by Statistics Canada this morning showed sales rising 0.6 percent on a month-over-month basis in October, modestly below the 0.7 consensus forecast. Sales at auto and parts dealers rose 2 percent, while gas station receipts fell -0.5 percent, and the food and beverage sector saw a -0.7 percent retreat.

Tough sledding is ahead for the Canadian dollar. With a confluence of negative factors—high household indebtedness, soft consumption, weak business investment, and increasingly-strident trade threats from the incoming US president—offering a number of persuasive reasons to short the currency, it is difficult to see a sustained rally taking place until well beyond January. Options markets—which function more like the insurance industry than the Macroeconomic Entertainment Complex—are priced for a modest recovery in the loonie over the year ahead, but tail risk protection is also being offered at a substantial premium, suggesting that traders are preparing for a series of volatility shocks.

Please note: I may send a note if something interesting happens in markets in the interim, but will try to give your inboxes some relief over the next week or two, with the Morning Market Brief returning on January 2. Thank you for your kind support and feedback over the last year, have a wonderful holiday season, and have a happy, healthy, and prosperous 2025.

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