2018 Economic Outlook 3Q Update

Transcription

1 2018 Economic Outlook 3Q Update The Sky Is Still the Limit And the U.S. Economy Is Closer Craig Dismuke Chief Economist, Vining Sparks Dudley Carter Economist, Vining Sparks

2 Jan 29 Feb 3 Feb 8 Feb 13 Feb 18 Feb 23 Feb 28 Mar 5 Mar 10 Mar 15 Mar 20 Mar 25 Mar 30 Apr 4 Apr 9 Apr 14 Apr 19 Apr 24 Apr 29 May 4 May 9 May 14 May 19 May 24 May 29 Jun 3 Jun 8 Jun 13 Jun 18 Jun 23 Jun 28 Atlanta Fed GDPNow Forecast Weak Q1 Growth Fades as Expected As was expected, 2Q growth estimates reflect a rebound in consumer activity from the disappointing 1Q pace that could lead to one of the strongest quarters for the economy since the Great Recession Q Projections and Actual 2Q Projections % Actual Sources: Federal Reserve Bank of Atlanta, Vining Sparks

3 MoM Consumer Spending Thaws Out After a disappointing December, January, and February; core retail sales have bounced back solidly. Through May, they point to personal consumption rising near 2.5% in 2Q. 2.00% Core Retail Sales - MoM QoQ Tracking (SAAR) 1.50% (Excluding Gas and Building Materials) 1.00% 0.50% 0.00% 3 12% 10% 8% 6% 4% 2% 0% -0.50% -1.00% Sources: Census Bureau, BEA, Vining Sparks

4 Labor Market Continues to Look Strong Except for subdued wage growth and questions around participation levels, almost every indicator is signaling that U.S. labor market is becoming increasingly tight Sources: BLS, Vining Sparks Avg Payroll Growth: k k k k Fed s Long Run Range U-3 Unemployment Rate Unemployed Persons (6.564MM) per Open Position (6.638MM) 4 4.0% 0.99x

5 Business Confidence Remains Strong While business spending on equipment has leveled off in recent months, leading indicators support the story that businesses will be a positive contributor to growth in 2H NFIB Small Business Optimism Index Sources: NFIB, Vining Sparks

6 Monthly Trade Deficit, $Billions Trade Deficit Shrinks on Strong Exports The trade deficit hit a 19-month low in May on strength in exports of aircraft and soybeans. The boost from beans is likely to be a transitory tailwind for 2Q growth Monthly Trade Deficit , ,000 Soybean Exports 95 U.S. Dollar 4, , ,000 1, Jan Feb Mar Apr May Jun Sources: Census Bureau, Vining Sparks

7 Fiscal Stimulus Added to Tailwinds Washington agreed to lift spending caps, increasing defense spending by 24% and non-defense spending by 29% over the next two years. This will be another deficit-financed boost to GDP. 15% Government Expenditures by Category (QoQ, SAAR) Total Federal Employees, Monthly 2,820 10% 5% Defense: +$165 Billion ($80B in 18 / $85B in 19) Non-Defense: +$131 Billion ($63 B in 18 / $68 B in 19) Disaster Relief: +$84.4 Billion Total Government Including State and Local Federal Non-Defense Federal Defense 2,800 2,780 2, ,000 10,000 New Defense Orders, Monthly $MM 7 0% Federal Construction Spending, Monthly $MM 24,000-5% GDP Impact: Projected +0.5% +0.4% ,000 20,000 18, Sources: BEA, BLS, Census Bureau, Vining Sparks

8 Inflation Mildly Returns to Target Three separate measures of wage growth showed traction in late January. While the average hourly earnings data were likely distorted by the weather, inflation fears gripped investors Core CPI Inflation YoY 10-Year TIPS Breakeven Inflation % Core PCE Inflation YoY Year TIPS Breakeven Inflation Sources: BLS, Bloomberg, BEA, Vining Sparks

9 Fed Forecast is Slightly Less Gradual The Fed hiked for a seventh time this cycle, taking the target overnight range to 1.75% to 2.00%. In addition, they steepened their projected path through 2019 in response to labor market strength. Fed Funds Target Range X Rate Increase June 2017 SEP September 2017 SEP December 2017 SEP March 2018 SEP June 2018 SEP Median Rate Projection, June SEP Sources: Federal Reserve, Bloomberg, Vining Sparks YE Target Rate 2019 YE Target Rate 2020 YE Target Rate Longer Run

10 Longer Treasury Yields Range-Bound Longer Treasury yields were range-bound in 2Q as the effects of resurgent U.S. growth were tempered by uncertainty around growth and politics outside of the U.S. and concerns of a possible trade war. Italian Political 3.15 Drama Began 10-Year Treasury Yield 3.05 Investigate High Yield 2.9% Hourly Earnings YoY Tax Reform Follow Through, Central Bank Speculation J F M A M J Sources: Bloomberg, Vining Sparks Hot January CPI Gov t Raised Spending Caps Metals Tariffs Announced Fed Hike Initial China Tariffs Announcement Strong April U.S. Retail Sales Commodity Rally, European Supply Another $100B of 1,300 Chinese Chinese Imports? Imports Listed Potentially Subject to Tariffs Oil Prices Sank 7% In Five Days Current Expansion Became The Second Longest In Modern History Autos for Tariffs Metals Tariffs Exemptions Expired Fed Hike 10 U.S. to Move Forward with Tariffs on $50B Chinese Imports

11 Downside Surprise in Global Data A soft patch for the economic data wasn t just a U.S. story. Almost every major developed economy started off 2018 at a slower-than-expected pace Economic Surprise Indexes U.S. Eurozone China Emerging Markets United Kingdom Japan Sources: Citigroup, Vining Sparks 11

12 Tariffs Spark Trade War Fears For months, amped up rhetoric around potential tariffs between the U.S. and several key trading partners have caused investors some concern and created pockets of market volatility around each event. In 2017, the U.S. imported $2.3T worth of goods from more than 200 countries. Sources: Census Bureau, Vining Sparks

13 600, , , , , ,000 - The Real Risk is in Possible Escalation Import tariffs enacted, to date, are relatively benign for the broader economy, representing roughly 0.5% of the U.S. economy. But the amounted threatened ($800B) would be more meaningful. 600, , , ,000 Tariffs Enacted Unaffected Import Balance Total Exports $1.4 trillion 62% of total Imports $807 billion 34% of total Imports , ,000 $85B, 4% - China EU Mexico Canada Japan India Vietnam Taiwan Russia Turkey UAE Others Sources: Census Bureau, Peterson Institute for International Economics, Vining Sparks

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15 Implications of a Flattening Curve The yield curve has historically been the most reliable leading indicator of economic cycles. While a recession appears a remote concern at this point, investors should make note of past trends. Why is the flattening yield curve creating concern Is a recession is imminent? Trends from previous yield curve inversions Will the yield curve invert? 15

16 5 4 3 Shape of the Yield Curve The yield curve is currently flat relative to the historical norm. This generally occurs mid- to lateeconomic cycle. 2yr10yr Spread Arguably the best 6 indicator for economic cycles Mid Cycle / Average -0.19% 0.31% 1.16% Late Cycle Early Cycle Late-Mid Cycle % Mid-Cycle Yield Curve (Average 1987-Current) Early-Cycle Steep Yield Curve (Feb. 4, 2011) Late-Cycle Inverted Yield Curve (Nov. 16, 2006) Mid- to Late-Cycle Flat Yield Curve (Current) FF3M Years Sources: Bloomberg, Vining Sparks

17 2-Year / 10-Year Spread Has Tightened The average 2s10s spread since 1988 has been 1.16%. The spread is between 0.28% and 2.05% 68% of the time. While the curve has flattened, history shows that it can remain flat for years before inverting σ: 2.05% 20 Avg: 1.16% % -0.5 The curve can 2y10y Spread 5 remain flat for a Recession prolonged period Sources: Bloomberg, Vining Sparks -1σ: 10

18 Inverted Curve Foreshadows Recessions The shape of the yield curve has historically been an advance indicator for economic cycles. Recessions have occurred shortly after three of the four curve inversions during the Modern Fed era GDP (QoQ, SAAR) 2s10s Spread An inverted yield curve has historically been the most accurate, market-based indicator preceding a recession Sources: BEA, Bloomberg, Vining Sparks

19 Implications of a Flattening Curve The yield curve has historically been the most reliable leading indicator of economic cycles. While a recession appears a remote concern at this point, investors should make note of past trends. Why is the flattening yield curve creating concern Is a recession is imminent? Trends from previous yield curve inversions Will the yield curve invert? 19

20 Change in GDP from Peak of Previous Economic Cycle Slow Growth for Current Cycle The current economic cycle has shown solid durability, but a much slower rate of expansion than previous cycles. 50% 1990 Recession and Subsequent Expansion: 128 Months, GDP +41% 20 40% 1981 Recession and Subsequent Expansion: 108 Months, GDP +35% 30% 20% 2001 Recession and Subsequent Expansion: 81 Months, GDP +18% Current Cycle: 126 Months, GDP +16% 10% 0% -10% Economic Cycles during Modern Fed Era Previous Cycle Peak Quarters from Previous Cycle Peak Sources: BEA, NBER, Bloomberg, Vining Sparks

21 Leading Indicators Appear Strong The Composite LEI index is one of the better predictors of economic cycles. If the LEI (YoY) is negative for consecutive months, there is a strong probability of a recession The LEI index is made up of 10 different economic variables which have historically been indicators (of varying accuracy) of changes in economic cycles. *Appendix includes breakdown of LEI subcomponents 10% 8% 6% 4% % 0% -2% Sources: Conference Board, Bloomberg, Vining Sparks 2s10s Inverted Recession Leading Eco Index (YoY) Leading Eco Index -4% -6% -8% -10%

22 Yield Curve More Accurate, More Timely While they are likely to be a lagging indicator for a yield curve inversion, the NBER s leading economic indicators and the LEI composite index show no signs of a curve inversion, nor recession, at this time. 22 Sources: NBER, Bloomberg, Vining Sparks

23 Curve Inverts before Data Turns Lower The curve tends to invert well before the economic data points to a slowing cycle. In two of the three most recent recessions, the LEI index actually showed no signs of weakness when the curve inverted Leading Eco Index (YoY) 2s10s Spread Recession 23 15% 14% 10% 12% % 5% % 0% s10s inverts 12 months before LEI (YoY) turns negative 2s10s inverts 11 months before LEI (YoY) turns negative 2s10s inverts 9 months before LEI (YoY) turns negative 6% -5% 4% -10% 2% % -15% Sources: Conference Board, Bloomberg, Vining Sparks

24 Economic Indicators Not Pointing to Recession While they have historically been a lagging indicator for an inverted yield curve, the NBER s leading economic indicators show no signs of a curve inversion, nor recession, at this time. 24 Sources: NBER, Bloomberg, Vining Sparks

25 Implications of a Flattening Curve The yield curve has historically been the most reliable leading indicator of economic cycles. While a recession appears a remote concern at this point, investors should make note of past trends. Why is the flattening yield curve creating concern Is a recession is imminent? Trends from previous yield curve inversions Will the yield curve invert? 25

26 Market Trends During Curve Inversions 26 Apart from the fundamental economic reasons, the 2s10s spread tends to invert when short yields are being driven higher by Fed policy but longer yields remain anchored. 30 Recession Year Treasury Yield 10-Year Treasury Yield Fed Funds Rate 0 Sources: Bloomberg, Vining Sparks

27 False Flag Inversion The economic environment surrounding the 1998 false flag inversion was unique. The Fed was not actively hiking interest rates and global financial problems created an acute flight-to-quality Treasury yields already falling as a result of Asian Financial Crisis Inversion First Occurs Russian Debt Default Long-Term Capital Fails 10-Year Treasury 2-Year Treasury Fed Funds Rate Fed Had Not Hiked in 13 Months 4.5 Fed changes policy bias 1 month later, cuts 2 months later 4.0 Sources: Bloomberg, Vining Sparks

28 Market Trends Inversion 2s10s inversion occurred as the 10-year yield held near 9.00% but shorter yields were pushed above 9.00% by Fed rate hikes. As they continued, the 10-year yield plunged shortly thereafter Year Treasury 2-Year Treasury Inversion First Occurs Recession months until 10-year yield declines sharply below 9.00% Recession officially begins 19 months later Fed Funds Rate Fed hikes continue another 2 months post-inversion, 100 bps Fed cuts rates 6 months post-inversion Sources: Bloomberg, Vining Sparks

29 Market Trends 2000 Inversion 2s10s inversion occurred as the Fed continued pushing shorter yields, with longer yields following higher for almost 2 years. Eventually, longer yields dropped below 6.00% signaling the end of the cycle Year Treasury 2-Year Treasury Inversion First Occurs Recession Longer yields immediately decline, but wait 6 months before moving below 6.00% pre-inversion trend. 2.0 Recession officially begins 13 months later Fed Funds Rate Fed hikes continue another 4 months post-inversion, 100 bps Fed cuts rates 10 months post-inversion Sources: Bloomberg, Vining Sparks

30 Market Trends 2006 Inversion Markets were surprised when the Fed hiked above 4.50%, initially inverting the curve. However, longer yields eventually moved higher with Fed Funds before declining at a faster pace than shorter yields Year Treasury 2-Year Treasury Inversion First Occurs Longer yields actually rise 70 bps after 2s10s initially inverts; 10- year eventually falls below pre-inversion trend rate of 4.50% 21 months later Recession officially begins 26 months later Fed Funds Rate Fed hikes continue another 5 months post-inversion, 75 bps Fed cuts rates 19 months post-inversion Sources: Bloomberg, Vining Sparks

31 Why Fed Continues to Hike Labor and Inflation 31 The predominant catalyst for the Fed hiking, when doing so contributes to an inverted curve, has been the fear of inflation caused by a tight labor market, rising wages, and rising input costs. Sources: BLS, BEA, CRB, Federal Reserve, Bloomberg, Vining Sparks

32 Market Trends from Previous Inversions 32

33 Implications of a Flattening Curve The yield curve has historically been the most reliable leading indicator of economic cycles. While a recession appears a remote concern at this point, investors should make note of past trends. Why is the flattening yield curve creating concern Is a recession is imminent? Trends from previous yield curve inversions Will the yield curve invert? 33

34 Economic Conditions for Curve Inversion 34 The labor market strength has convinced the Fed to tighten monetary policy. However, the inflation data would need to become more convincing for the Fed to hike into an inverted curve. Sources: CRB, BLS, BEA, Federal Reserve, Bloomberg, Vining Sparks

35 Market Conditions for Curve Inversion Based on historical precedent, the Fed would need to continue hiking despite a flat yield curve in order to create an inverted curve. They have already hiked 1.75% and expect to hike another 1.50% Effective Fed Funds FOMC Median Projection (YE) Longer Run

36 Implications of a Flattening Curve 36 Why is the flattening yield curve creating so much concern? An inverted yield curve is the most accurate, timely indicator of peak economic conditions Does the flattening yield curve mean a recession is imminent? Economic data still looks very strong amidst a confluence of tailwinds Economic data typically does look strong when the yield curve inverts Will the yield curve invert? Historically occurs when Fed believes inflation risk is greater than the implicit risk of inverting curve Fed may prioritize financial conditions over rate hikes absent an increase in inflation (or expectations) Longer yields could also move higher as short yields rise (1989, 2000, 2006) If the curve inverts, what can investors learn from previous cycles? Look through inversions caused by exogenous events Much of the rate cycle for longer yields has likely already occurred, though can move higher for a period of time Shorter maturity yields can continue to rise after the curve inverts, although tightening cycle likely near end The economic cycle is likely in its later stage

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