Financial Market Weekly

Transcription

1 Financial Market Weekly Abbreviated format this week. 19 JUNE 2015 CHRISTOPHER S. RUPKEY, CFA MANAGING DIRECTOR CHIEF FINANCIAL ECONOMIST ECONOMIC RESEARCH OFFICE (NEW YORK) (212) The Bank of Tokyo-Mitsubishi UFJ, Ltd. A member of MUFG, a global financial group YELLEN TELLS US NOT YET The Fed met this week. Nothing happened. At the start of her press conference on Wednesday, Yellen said, The Committee continues to judge that the first increase in the federal funds rate will be appropriate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. At our meeting that ended today, the Committee Fed votes for first rate-hike still in September Fed funds rate 0.75 at end of 2015 means liftoff from 0.25 in September, 25 bps more in December June 2015 FOMC "median" forecasts 0.75% end of % end of % end of % longer run Eurodollar futures % % % % % Long run concluded that these conditions have not yet been achieved. The more they talk about it, the less we understand what the holdup is. For liftoff. Liftoff which is still sometime in 2015 we guess with 6 months left to go. John Williams, Yellen s research director when she was President of the San Francisco Fed, during the subprime mortgage crisis, told reporters on Friday that he thought they would raise rates twice in 2015, which means September and then December we assume. 100 bps per year normalization speed. We hope he s right. He is the current head of the San Francisco Fed. Fed Chair Yellen did not sound like a rate hike was coming soon at the press conference this week. Certainly, her words should have been a little more suggestive of the possibility if they were thinking of %

2 raising rates next meeting: July She said a while back that every meeting after April s was a live one, but the July meeting has no scheduled press conference, so it does not seem very likely. She needs to explain the first rate hike. The regularly scheduled press conferences are March, June, September, and December every year. The confusion on the timing of the first hike comes from their own central tendency forecasts (that throw out the top and bottom three extreme forecast views) that say at the end of 2015 the Fed funds rate will be 0.75% (median) at the same time the unemployment rate will be %. Does this mean if the current 5.5% unemployment rate drops to 5.3%, two-tenths, the data dependent Fed will raise rates to 0.75%? There does not appear to be any room between the goal line and current economic conditions right now for Yellen to even talk about the forecasts constructively. The forecasts that represent the Federal Open Market Rate hikes? Well, it's a judgment that the Committee is--will have to make and as I've said previously as we've said in this statement, it will depend on a wide range of data and not on any simple indicators. So I can't provide you--it would be wrong for me to provide you a roadmap that said something as simple as if the unemployment rate declines to X that then the labor market will have improved enough for us to begin to raise policy. Obviously, we have to look at the pace of job creation. We have to look at what's happening to labor force participation, to part-time employment for economic reasons, to job openings, to the pace of quits, to wage inflation, and other indicators of the state of the labor market. Yellen June 17, 2015 Committee s views. The economy is too close. Too close to full employment. The unemployment rate could drop two-tenths to 5.3% in the next monthly employment situation report due out Thursday, July 2. The current inflation rate is not relevant because it responds to current economic conditions with too much of a lag to guide policy, to guide the timing for the liftoff certainly. The focus should be on the unemployment rate. The level of unemployment today, drives inflation in the future. Unfortunately, Yellen responded to a reporter s question that it was not just the unemployment rate, although she may have given more of her Fed Individual Forecasts own personal view as opposed to Fed funds rate by year-end representing the wishes of the full Votes 2015 End 2016 End 2017 End 2015 End 2016 End 2017 End committee. There are five of seventeen who want the Fed funds rate at 1% at the end of the year. Four regional Feds want to raise rates now, including the only two women-led regional Federal Reserve Districts, Kansas City s George and Cleveland s Mester; the other two districts are Philadelphia and Dallas. Interesting politics right now at the Fed with Yellen not attending the Kansas City Fed s famous annual Economic Symposium at Jackson Hole this year where previous Federal Reserve Chairmen have used the Median Symposium to give a heads up on a new Meeting Jun 2015 Jun 2015 Jun 2015 Mar 2015 Mar 2015 Mar 2015 direction for Fed policy ahead of the September FOMC meetings. For 2015, it could have been an opportunity to say September will be the liftoff meeting. This year the topic will be Inflation Dynamics and Monetary Policy. It will take place August 27-29, The September Fed meeting with a press conference is the 16-17th. 2

3 There seems to be a difference of opinion about where the economy is in the business cycle. The dots forecasts of the 17 committee members forecasts for year-end Fed funds rates show three distinct camps with six months left to go in Five, Five, and Five. Five say the Fed funds rate should be 0.5% at the December 15-16, 2015 FOMC meeting. Five say 0.75% at the end of the year, and five others say an even faster/steeper liftoff of 1.0% at the end of this year. Only 2 of 17 join with IMF Managing Director Lagarde in thinking liftoff should be postponed to The difference of opinion on where the economy is in the business cycle gets harder to understand as the end of the is hard to see looking in the rear view mirror, it ended so long ago in June Consumer confidence has fully recovered. The Michigan Survey of consumer sentiment index was 94.6 in June. And the Mar 2001 start Nov 2001 ends U. Michigan Survey Consumer Sentiment Sep 2005 Hurricane Katrina Mar 2003 Iraq War 2003 disinflation era housing bubble average 90.4 Dec 2007 start Aug 2007 Global funding crisis Sep 2008 Lehman Aug 2011 S&P USA Fiscal Cliff June Federal Govt shutdown reading exceeds the 90.4 average of the housing bubble economy years from when all was well. Confidence is back and consumer spending makes the economy go. Happy consumers bought 17.7 million cars & light trucks in May The difference of opinion on the economy extends to the top of the Fed. Fed Chair Yellen s comments that business investment was subpar were particularly striking in her Economic Outlook speech late on Friday afternoon, May 22, At the end of the speech, talking about longer-run growth prospects, she wondered could investment spending be the cause of relatively weak productivity growth (just substitute the word GDP for productivity here). She said, Firms slashed their capital expenditures during the, and as I Business investment on R&D in real GDP accounts ($ blns) The 2001 Recession The Great Recession Q R&D up 9.1% YOY to $281.6 bln 2001 Recession and The Great Recession The effect on R&D was the same

4 noted earlier, the increases in investment during the recovery have been modest. In particular, investment in research and development (R&D) has been relatively weak. We are unsure of the figures she has cited because real GDP spending on R&D graphed here seems to be accelerating, having risen 9.1% in the year ending Q to $281.6 billion. This seems to be another example of Fed officials being too downbeat in their assessments of current economic conditions. It isn t just Fed officials that are pessimistic about the economy s prospects. It s the market as well. 5.0 % Eurodollar future yields Dec 2017 Where 3-mo Libor will be at the end 4.5 of 2017 (month-end, percent %) Aug 2011 S&P cuts USA to AA+ Markets don't see eye-to-eye with Fed gradual rate hikes May 2013 Bernanke taper "in the next few meetings" July 2014 Crude oil $100 bbl Jan 2015 ECB QE Dec 2017 median Fed funds rate forecast 3.0% June 19, % Eurodollar futures yields do not even match the Fed s slow path for normalization of interest rates, 100 bps per year Bernanke-style. December 2015 Eurodollar futures closed Friday, June 19 at 0.55% which is consistent with just one rate hike this year at the final December 2015 Fed meeting. And the market does not see the Fed raising rates that quickly in the future either, which is a bit of a puzzle, given what has happened historically following s; yields rise as the economy continues to grow, if for no other reason than greater credit demand. December 2017 Eurodollar futures closed this week at 1.995% where the median forecast of 17 Fed officials calls for 3.0%. The market is coming up 100 bps short. The Fed is behind the curve, and market yields are even further behind the Fed s curve In conclusion, we are still studying the Fed statement and forecasts from this week s meeting and Yellen s press conference. What it means for the interest rate outlook in the longer run. Near term, we do think the Fed will raise rates at the September meeting. Our focus is on the unemployment rate. The Fed did not move down its estimate for what full employment is. In June they say the full employment What are we waiting for? So let me say to my mind the most important positive is that it--i believe a decision to raise rates would signify very clearly that the U.S. economy has made great progress in recovering from the trauma of the financial crisis and that we're in a different place. I think, hopefully, that would be something would be confidence-inducing for many households and businesses. Yellen unemployment rate is %, the same as they thought in March. The closer unemployment falls to this level, the Fed has to raise rates. It is in the all college economics textbooks that the Fed funds rate should be at normal levels when the economy reaches full employment. Fed policy remains hundreds of basis points behind the curve. 4

5 Analyst Certification The views expressed in this report accurately reflect the personal views of Christopher S. Rupkey, the primary analyst responsible for this report, about the subject securities or issuers referred to herein, and no part of such analyst's compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed herein. The information herein is provided for information purposes only, and is not to be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. Neither this nor any other communication prepared by The Bank of Tokyo-Mitsubishi UFJ, Ltd. (collectively with its various offices and affiliates, "BTMU") or should be construed as investment advice, a recommendation to enter into a particular transaction or pursue a particular strategy, or any statement as to the likelihood that a particular transaction or strategy will be effective in light of your business objectives or operations. Before entering into any particular transaction, you are advised to obtain such independent financial, legal, accounting and other advice as may be appropriate under the circumstances. In any event, any decision to enter into a transaction will be yours alone, not based on information prepared or provided by BTMU. BTMU hereby disclaims any responsibility to you concerning the characterization or identification of terms, conditions, and legal or accounting or other issues or risks that may arise in connection with any particular transaction or business strategy. While BTMU believes that any relevant factual statements herein and any assumptions on which information herein are based, are in each case accurate, BTMU makes no representation or warranty regarding such accuracy and shall not be responsible for any inaccuracy in such statements or assumptions. Note that BTMU may have issued, and may in the future issue, other reports that are inconsistent with or that reach conclusions different from the information set forth herein. Such other reports, if any, reflect the different assumptions, views and/or analytical methods of the analysts who prepared them, and BTMU is under no obligation to ensure that such other reports are brought to your attention. Copyright 2015 Bank of Tokyo-Mitsubishi UFJ All Rights Reserved The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of MUFG or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor MUFG guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor MUFG shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information. About MUFG Union Bank and MUFG Americas Holdings Corporation MUFG Union Bank, N.A., is a full-service bank with offices across the United States. We provide a wide spectrum of corporate, commercial, retail banking and wealth management solutions to meet the needs of customers. The bank also offers an extensive portfolio of value-added solutions for customers, including investment banking, personal trust, capital markets, global treasury management, transaction banking and other services. With assets of $106.7 billion (USD), as of March 31, 2014, the bank has strong capital reserves, credit ratings and capital ratios relative to peer banks. MUFG Union Bank is a proud member of the Mitsubishi UFJ Financial Group (NYSE: MTU), one of the world s largest financial organizations with total assets of approximately 258 trillion (JPY) or $2.5 trillion (USD) as of March 31, MUFG Americas Holdings Corporation, the financial holding company and MUFG Union Bank, N.A., have corporate headquarters in New York City. 5