US Economic Outlook:

Transcription

1 For institutional and registered representative use only. Not for public viewing or distribution. US Economic Outlook: F d on track Fed t k to t raise i rates t in i September S t b April 215 Torsten Slok, Ph.D. Chief International Economist Managing Director 6 Wall Street New York, New York 15 Tel: Torsten.Slok@db.com DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/4/214.

2 We are getting close to full capacity in the US economy Capacity utilization Inflation and wages rising Full capacity No inflation pressure Time Source: DB Global Markets Research Deutsche Bank Research Torsten Slok, April 215 1

3 % The US economy is close to full capacity. That s when you normally begin to see inflation Capacity utilization (ls) Unemployment rate (rs) Capacity utilization at levels Unemployment rate close to Fed NAIRU=5.1% Source: Fed, BLS, Haver Analytics, DB Global Markets Research % Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 2

4 % Wall Street economists have been consistently wrong in their forecasts for the ten-year rate over the past decade Actual 1y rate and forecasts for the 1y rate from the Fed's quarterly Survey of Professional Forecasters Latest forecast for 215Q4: 2.5%; adjusted for average forecast error: 1.9% % Average 12-month forecast error over the past decade: d 6bps too high h Source: FRB, FRBPHIL, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 3

5 FOMC forecasts beginning to look like secular stagnation. Getting easier for the economy to outperform expectations Q4/Q4 % chg Q4/Q4 % chg Actual GDP growth June 1 projections Nov 11 projections Dec 12 projections Dec 13 projections Dec 14 projections 5 Mar 15 projections Note: FOMC forecasts are q4/q4 and actual GDP is annual data. Source: FRB, BEA, DB Global Markets Research 1 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 4

6 FOMC projections: Inflation three years out always ends up at 1.9% % q4/q4 % q4/q4 Actual core PCE inflation Dec 12 FOMC projections Dec 13 FOMC projections Dec 14 FOMC projections 2. Mar 15 FOMC projections How the market views inflation How the Fed views inflation Source: BEA, FRB, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

7 Market expectations still well below FOMC dots % 5 4 Fed Funds Futures Dec-14 Median Mar-15 Median Minutes Mar-15 Sep-14 Median % Longer Term Source: Fed, Bloomberg, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 6

8 % The March FOMC dots fit very well with optimal control in FRB/US assuming NAIRU of 5.% Fed funds rate under optimal control NAIRU March 215 SEP median dot Optimal Control: FRB/US baseline with NAIRU=5.5% Optimal Control: NAIRU=5.% % Source: FRB, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 7

9 The ongoing housing recovery is healing household h and banking sector balance sheets Household Banking Government Corporate sector balance sector balance sector balance sector balance sheet sheet sheet sheet Rising home prices Fiscal drag shrinking in 214 Moving away from bank loans toward credit market loans Source: DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 8

10 Headwinds are fading in the housing market Deutsche Bank Research Torsten Slok, April 215 9

11 % Distressed home sales 9% of all sales Share in existing home sales Distressed home sales Non distressed home sales Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Source: National Association of Realtors, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April %

12 % The % of loans going into foreclosure per quarter is at levels % of loans going into foreclosure per quarter Prime Prime: FRM Prime: ARM Sub prime Sub prime: FRM Sub prime: ARM % Note: ARM=Adjustable Adj Rate Mortgage, FRM=Fixed Fi Rate Mortgage Source: MBA, Datastream, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

13 Thous 36 The number of homes for sale is low Single family homes available for sale Thous Source: NAR, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

14 y/y chg 25 Household formation has increased dramatically in recent months Total Number of Households, Break-adjusted, Thous Are Millennials moving out of their parents basement? y/y chg Source: Census, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

15 % All households created during this recovery are renters Cumulative percentage change in number of households Total Owner occupied Renter Source: Census, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April %

16 Shortage of homes to rent Mln Surplus/Shortage of Vacant Homes For-sale inventory For-rent inventory Mln Note: Average for-rent vacancy rate (8.18%) and for-sale vacancy rate (1.64%) is calculated from 1994Q1 through 23Q4. Then the actual vacancy rate observed each quarter was compared to construct the excess # of vacant units. Source: Len Kiefer Freddie Mac, Census, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

17 The number of people per household coming down Ratio Number of people 16 and older per household 2-3 average Ratio Source: Census, BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

18 Home price appreciation moderating % y/y S&P case shiller home price index:composite 2 CoreLogic national house price index %y/y CoreLogic national HPI distressed excluded 2 FHFA HPI purchase Mortgage rates increased 1bps Source: S&P, CoreLogic, FHFA, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

19 Index 19 US home prices currently at 25 levels S&P/Case-Shiller home price index: US national Index Source: S&P, Haver Analytics, DB Global Markets Research 13 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

20 A continued drag on consumer spending: Owners of less expensive homes are three times more likely to be underwater than owners of expensive homes. In NY the ratio is five. Percent of underwater homeowners % Bottom tier Middle tier Top tier % US Atlanta Chicago Detroit Los Angeles New York San Washington Francisco Source: Zillow data as of 214Q3, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

21 Headwinds d are fading in the banking sector Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 2

22 Banking sector quarterly net income currently at the same level as in 25 and 26 $ bln All FDIC institutions 5 Net operating income Securities gains/losses $ bln Source: FDIC, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

23 Delinquency rates coming down Loan delinquency rate: all insured commmercial banks % % Consumer loans Real estate loans C&I loans Source: FRB, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

24 % Balance sheet repair almost complete in small banks Total non-performing loans as % of total loans BHCs>$5bn All institutions BHCs $5bn-5bn Banks and BHCs<$5bn % Note: Non-performing loans include loans that are (1) 9 days or more past due and still accruing or (2) non-accrual. Source: FRBNY, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

25 %y/y 2 Credit growth continues to accelerate, driven by both small and large banks Loans & Leases in Bank Credit All commercial banks Large commercial banks Smallcommercialbanks %y/y Source: FRB, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

26 Are we at the cusp of a capex and productivity boom? %y/y 12 Real private non residential fixed investment: Research & Development %y/y Source: BEA, Haver Analytics, DB Global Markets Research -8 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

27 Higher R&D points to higher productivity growth ahead %y/y, 4q MA Non farm business sector: real output per hour(ls) Real pvt. Non residential fixed investments: R&D (12 q lead,rs) %y/y Source: BLA, BEA, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

28 Lower energy prices Deutsche Bank Research Torsten Slok, April

29 66Q1=1 12 The effects of lower oil prices starting to show up: Consumer sentiment high across income groups Bottom third household income tercile Middle third household income tercile Top third household income tercile 66Q1= Source: UMichigan, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

30 Index Lower oil prices helping restaurants, which is a labor intensive industry, so that bodes well for employment Restaurant Performance Index Restaurants doing better than in Index Note: The National Restaurant Association's Restaurant Performance Index is a monthly composite index that t tracks the health of and the outlook for the U.S. restaurant t industry. Source: NRA, Haver Analytics, DB Global Markets Research 96 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

31 Only a small share of capex goes to the energy sector % 15 Share of energy investments in total non residential fixed investments % Source: BEA, Haver Analytics,DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 3

32 Mln bbl/day The rig count is not important Crude oil field production (ls) Oil rig count(rs) Count Source: Baker Hughes, Blomberg Finance LP, EIA, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

33 Labor markets tightening i Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

34 One year ago there was no wage pressure. Now the ECI and ECEC are trending higher %, AR Employer Costs for Employee Compensation: wages & salaries (rs) Employment cost index: wages & salaries (rs) Avg hourly earnings, All workers (rs) %y/y Employment cost index: wages & salaries, 3-qtr change, ann (ls) All four wage measures flat Two wage measures trending up Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

35 Employer costs have risen significantly in recent quarters % y/y Employer costs for employee compensation % y/y Total Compensation, $ per hour Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

36 Significant increase in bonuses in recent quarters % y/y Employer costs for employee compensation: supplemental % y/y nonproduction bonuses Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

37 Wages rising faster for union workers % y/y Employer costs for employee compensation: private % y/y industry workers' compensation Union Non-union Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

38 The 2, 3, and 4 quarter change in ECI shows solid momentum in wages in recent quarters ECI: Wages and salaries, civilian workers % change 2 qtr ann change % change 6 3 qtr ann change 4 qtr ann change Source: BLS, Haver Analytics, DB Global Markets Research 1 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

39 Companies are planning to raise wages % of firms %y/y 25 2 NFIB: Companies planning to raise worker compensation (9 month lead, ls) ECI: wages & salaries: private industry workers (rs) Correlation= Source: NFIB, BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

40 Unit labor costs points to higher inflation ahead %y/y Unit labor cost (ls, 9 month lead) Core CPI (rs) %y/y Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

41 Wage and income expectations near highest levels in five years % Expectations of personal finances in 1 year: Relative score (ls) Percentage of consumers expecting household income to rise over next year (rs) 14 7 % Source: University of Michigan, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

42 People are voluntarily quitting jobs at a pre-crisis rate % JOLTS: Quits Rate (ls) Fed funds target rate (rs) % Pre-crisis quits rate Source: BLS, FRB, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

43 People per job opening Less slack in the labor market: Number of available people per job opening is back to its pre-crisis average (People not in the labor force who want a job now + total number of unemployed) divided by (total number of job openings) Pre-crisis average People per job opening Source: BLS, JOLTS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

44 Labor shortage in construction worse than in 25 % % of builders reporting shortages for 9 types of labor % Serious or some shortage in labor availabilitya ab In 24 and 25 when builders were surveyed more than once a year, results from july survey are shown. For 214, GDP growth is reported for Q1 and unemployment rate are averaged for first 5 months, real non-residential construction for first 4 months (includes all construction except residential building, inflation adjusted using CPI). This information has been sourced from: Source: NAHB, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

45 Number of workers on strike up recently Thous 5 Number of workers on strike Thous Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

46 Recent Fed work suggests that those who left the labor force are not coming back % Labor force participation rate 68 Latest Fed projection (September 214) % Source: Aaronson et al. Labor Force Participation: Recent Developments and Future Prospects ( BLS,Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

47 Most of the jobs created during this recovery are high-wage jobs Thous Cumulative increase in employment since Jan 21 High wage occupations Low wage occupations Medium wage occupations Total Thous High wage occupational categories are management, professional and related occupations. Medium wage categories are sales and office occupations; construction and extraction occupations; installation, maintenance and repair occupations; and production/transportation and material moving occupations. Low wage occupations are service occupations and farming, fishing, and forestry. Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

48 The red line is important for the timing of Fed liftoff and the speed of rate hikes. The blue line determines the level of the terminal fed funds rate %y/y 4 Civilian labor force Total nonfarm payrolls %y/y Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

49 Strong employment growth for teenagers in recent months Employment growth % y/y % y/y 15 Total nonfarm (ls) Teenagers ( years, rs) Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

50 Millennials have recovered completely from the financial crisis: Employment rate for people age back at pre-crisis average % 22. Percent employed between 25 to 34 years as share of total labor force % Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

51 % 2 Solid rise in employment to population ratio for people 65 years and over Employment to population ratio: 65 years and over % Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 5

52 Is the Fed behind the curve? Deutsche Bank Research Torsten Slok, April

53 Basis points The bid-ask spread doesn t measure the depth and breadth of the market Treasury bid-ask spreads 1 year 2 year Basis points Source: FRB, Bloomberg Financial LP, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

54 Fed uncertainty is creating volatility. Front-end vol is now above taper tantrum levels 3MoX2Yr and 3MoX1Yr swaption vol year swaption vol (ls) year swaption vol (rs) Jan- 13 Mar- 13 May- 13 Jul- 13 Sep- 13 Nov- 13 Jan- 14 Mar- 14 May- 14 Jul- 14 Sep- 14 Nov- 14 Jan- 15 Mar- 15 Source: Bloomberg (USSNC2 Curncy and USSNC1 Curncy), DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

55 As we get closer to the first Fed hike volatility trends higher 1/1/213=1, 1 day MA Jan-1 13 Feb-1 13 Mar-1 13 May-1 13 FX vol (ls) VIX (ls) Fixed income vol (ls) Months to first Fed hike based on fed fund futures(rs) Jun-1 13 Aug-1 13 Sep-1 13 Nov-1 13 Dec-1 13 Feb-1 14 Mar-1 14 Vol measures currently close to taper tantrum levels May-1 14 Jun-1 14 Aug-1 14 Sep-1 14 Oct /1/213=1, 1 day MA Dec-1 14 Feb-1 15 Mar Note: FX vol: Deutsche Bank 3 month implied FX Volatility Index, FI vol: MOVE Index. Source: Bloomberg Finance LP, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

56 Yield, % Vol will move up as we get closer to the first Fed hike Yield curve with dovish forward guidance Yield curve with no forward guidance Once the Fed removes forward guidance the standard deviation of outcomes will increase, ie vol will go up Dovish Fed forward guidance pushes the yield curve closer to zero, which lowers the standard deviation of potential outcomes 1y 5y 1y Source: DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

57 % The FOMC doesn t want to repeat the policy mistakes made by these five central banks Central bank policy rates Euro Area Sweden Norway Australia New Zealand % Source: ECB, SRB, NB, RBA, RBNZ, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

58 The Fed can easily begin to hike rates: The taper tantrum had no impact on the speed of the recovery % 1. Unemployment rate (ls) Total nonfarm employment (rs) thous Euro crisis Debt ceiling Fiscal cliff Taper tantrum High yield blowout/ October turbulence Jan- 1 Jul- 1 Jan- 11 Jul- 11 Jan- 12 Jul- 12 Jan- 13 Jul- 13 Jan- 14 Jul- 14 Jan Source: BLS, BEA Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

59 Europe, Japan, and China Deutsche Bank Research Torsten Slok, April

60 Europe starting to benefit from lower oil and lower euro %y/y 6 Euro area Retail trade ex auto & motorcycles (ls) PMI: composite employment (rs) Index Source: EuroStat, Markit, Haver Analytics, DB Global Markets Research 4 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

61 Spain: New orders at highest level since 27 Index Spain : PMI Manufacturing new orders Index Source: MARKIT, Haver Analytics, DB Global Markets Research 2 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 6

62 % 3m ann chg 15 European bank lending coming back Euro area Bank lending to private sector % 3m ann chg Source: ECB, Haver Analytics, DB Global Markets Research -5 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

63 A falling euro is good for European inflation. And it holds back inflation in the US Effects of a ten percent euro depreciation Deviations from baseline, in percent Year United States GDP Level Inflation (Consumer prices) Japan GDP Level Inflation (Consumer prices) European Union GDP Level Inflation (Consumer prices) Source: OECD, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

64 Investors don t expect Italy to benefit from lower euro and lower oil and the solid recovery in the US and Germany % consensus GDP growth expectations Italy Spain % Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15. Source: Bloomberg Finance LP, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

65 Markets underestimating the progress made in Europe Difference in ranking between Germany and the periphery p in the World Bank s survey of how easy or difficult it is to do business in different countries Greece Portugal Spain Italy Ireland For example: In 21 Greece was 84 places behind Germany in the ranking, in 215 the difference was 47 Source: World Bank Doing Business Survey, DB Global Markets Research -1 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

66 Reform responsiveness measures how many OECD-recommended structural reforms have been implemented in each country since 27 Overall reform responsiveness over the period Greece, Portugal, Ireland, and Spain have implemented many OECD-recommended d structural t reforms in recent years and US, Germany, and Netherlands have not Gree ece Portu ugal and Irel Sp pain Denm mark taly I UK nce Fra EU Note: Responsiveness measures how many OECD-recommended reforms that have been implemented. Source: OECD Going for Growth 215, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April Finl land ada Can pan Ja den Swe Netherla ands any Germ USA

67 Rate India has done more structural reforms than other BRIICS countries in recent years Responsiveness to OECD Going for Growth recommendations across BRIICS countries, Indonesia Russia South Africa China Brazil India Rate Note: Responsiveness measures how many OECD-recommended d reforms that have been implemented. Source: OECD Going for Growth 215, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

68 Australian unemployment rate trending higher % 7.5 Australia: unemployment rate % Source: Australian Bureau of Statistics, Haver Analytics, DB Global Markets Research 3.75 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

69 Australian housing market in trouble % 5 Australia Proportion of interest-only loans in total new residential term loans to households % Source: APRA, DB Global Markets Research 25 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

70 How over/undervalued are home prices today relative to historical averages of home price/rent and home price/income? Country 1) Home price/income (% above historical average) 2) Home price/rent (% above historical average) Current average over/undervaluation of home prices (=average of column 1) and 2) (%) Canada New Zealand Belgium Australia Norway United Kingdom Sweden France Finland Denmark Spain Ireland Netherlands Italy 3-4 Switzerland US Germany Greece Korea Japan Source: OECD, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

71 % Abenomics is working Japan: Female employment rate: age December 212 Abenomics begins % Source: OECD, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 7

72 Japan wage growth highest since 1998 % y/y, 9m MA Japan Total cash earnings % y/y, 9m MA Source: Haver Analytics, DB Global Markets Research -4 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

73 Recent data from China is worrying %y/y China Industrial production (ls) Real GDP(rs) Source: CNBS, Haver Analytics, DB Global Markets Research %y/y Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

74 Home prices are falling in China Number of cities with rising home prices Unchanged Number of cities with falling home prices Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Note: Month over month changes. Source: CNBS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

75 Mn The number of 15-to-3-year-olds in China falling by 25% over the next decade China: Population aged 15-3 years Source: UN, Haver Analytics, DB Global Markets Research Mn Deutsche Bank Research Torsten Slok, April

76 Commodity prices trending lower Index KR-CRB spot commodity price index Index 6 All commodities Metals Source: CRB, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

77 How will a slowdown in China impact the rest of the world? Percent of total exports consumed by China % Australia Japan South Korea US Germany Brazil % Source: IMF, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

78 Housing supply for sale rising in China Million square China: Floor space waiting for sale (Vacant) meters 7 Million square meters Source: CEIC, CNBS, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

79 Growth in Chinese retail sales slowing %y/y, 12 m MA 22 China: retail sales %y/y, 12 m MA Source: Thomson Reuters, CNBS, DB Global Markets Research 1 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

80 Investment Implications Deutsche Bank Research Torsten Slok, April

81 What will happen to equities, credit, rates, the dollar, and vol when the Fed starts hiking rates this summer? - Expect front end rates to move up, closer to the Fed's median dots. Why? Because the market will realize that the FOMC is serious when they say that they will hike rates. The fact that the FOMC minutes yesterday talked about median and trimmed mean inflation is also a hawkish signal because these measures of inflation have not fallen in recent months like core PCE and core CPI. - Expect long rates to grind higher. Why? Because the Fed hiking rates and a more and more tight labor market will put upward pressure on the long end. - Expect the yield curve to flatten (3y and 5y rates will move up more than 1s). Why? Because we will continue to see solid demand from foreign central banks and Europe, particularly with a strengthening dollar. In addition, many tourists will be leaving HY and IG to come back to rates. - Expect credit spreads to widen, in particular for IG. Why? Because with the Fed signaling g that the carry trade is over it will be much more difficult for investors to make money in a rising rates environment. IG could get hit more because it is a closer substitute to rates. Also, rising rates and widening spreads will be magnified by low dealer inventory. - Expect equities to continue to grind higher. Why? Because the backdrop for Fed hikes is solid economic fundamentals, including higher employment and higher wages. That all bodes well for topline growth for corporate America. - Expect the dollar to appreciate. Why? Because the US recovery is more advanced than the recovery in the rest of the world, including Europe, this will widen the spread between short rates in the US and abroad. - Expect vol across all asset classes to continue to trend higher. Why? Because with the Fed hiking rates there will be more disagreement in markets (i.e. more vol) as investors debate whether the Fed will continue hiking rates or whether they will have to reverse soon. Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 8

82 Interest rates and potential growth rates trending lower globally % Population aged as a share of total population US UK Canada Germany France Japan Smaller demographic problems Big demographic problems Source: OECD, Going for Growth 215, DB Global Markets Research % Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

83 If you think US rates are artificially low because of safe haven status then take a look at foreign ownership of German government bonds % Foreign ownership of US treasuries and German government bonds German government bonds US Treasuries % Source: Bbk, FRB, Haver Analytics,, DB Global Markets Research 15 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

84 Lower yields in Europe driving US long rates down: US term premium compressed by the Treasury/bunds spread US 1y yield - German 1y yield (ls, 4m lead) % % 1 year term premium (rs, inverted, Fed calculated) Note: Term premium is from the NY Fed (Adrian, Crump, and Moench (213)). Source: Bbk, FRB, Haver Analytics,, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

85 Have ex-energy spreads widened because of fear of coming Fed hikes? 6 Option Adjusted Spread (weighted by market value) of the US Dollar HY and IG: All Cash Bonds sector 2 HY Spread (ls) IG Spread (rs) Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Source: Blomberg Finance LP, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

86 Primary dealer inventory of IG and high yield bonds currently 2% of what it was in 27 and the outstanding stock of corporate bonds has almost doubled since 27 USD trn 4.5 Total stock of US corporate bonds outstanding (ls) Primary dealer inventory of corporate bonds (rs) USD bln The credit liquidity gap Source: FRB, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

87 Fed funds at zero sent households on a hunt for yield. Households now own 29% of IG and HY outstanding, up from 15% in 26. Will they sell when the Fed turns hawkish later this year? % 1 year treasury note yield (ls, inverted) % Household holdings of corporate bonds as share of all outstanding corporate 1.5 bonds (rs) Note: Flow of funds data; household holdings is the sum of household direct holdings + ETF + Mutual funds 12 Source: FRB, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

88 6% of outstanding are now cov-lite % Percentage of CovLite bonds % 8 New issue Outstanding Source: Bjarni Torfason, S&P LCD, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

89 US long term interest rates disconnected from Fed expectations Months to first Fed hike based on fed funds futures (ls) Months 1 year Treasury yield (inverted, rs) % May- 9 Nov- 9 May- 1 Nov- 1 May- 11 Nov- 11 May- 12 Nov- 12 May- 13 Nov- 13 May- 14 Nov- 14 Source: Bloomberg Finance LP, Deutsche Bank Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

90 Contracts Market is now long VIX: Fear of rate hikes? CFTC VIX futures net speculative position For the first time in many years the market betting on higher vol Contracts Source: CFTC, Bloomberg Finance LP, DB Global Markets Research -12 Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

91 Investment implications summarized Fed outlook Fed will hike in either June or September Bond markets - Rates modestly higher in 215 Stock markets - Better private sector balance sheets June hike still in play: Will depend on ECI and employment numbers. Fundamentals suggest 1y rates are below fair value. As growth accelerates rates will move higher. But demand from Europe and tourists leaving HY+IG coming back to rates will keep a lid on the uptrend. Corporate, household, and banking sector balance sheets continue to heal. This bodes well for equities. FX - USD up Stronger US recovery will mean Fed hiking sooner, which will mean higher USD Commodities - Downside risks Slowing Chinese construction growth likely to continue to put downward pressure on commodity yprices. If commodity yp prices fall, Australia, Latam, and Canada likely to be hit. Emerging markets - Will benefit from US recovery Structural problems starting to appear in a number of emerging markets, including China. Source: DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 9

92 Rules of thumb for the US economy Experiment Cumulative impact on GDP growth and unemployment rate after 1, 2, and 3 years Year 1 Year 2 Year 3 1% decline in the dollar GDP Unemployment rate $1 increase in oil prices GDP Unemployment rate % increase in stock market GDP Unemployment rate Note: Percent change from baseline. All experiments assuming constant real funds rate Source: Federal Reserve FRB/US Model, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

93 Index 25 This time is different? The Misery index is at the lowest level since 1959 Average fed funds rate at previous troughs: 5.4% Misery index (=the sum of unemplyment and headline inflation) Index % 4.6% 81% 8.1% 3.5% 5.5% 5.25% % Fed funds rate at trough Source: BLS, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

94 Relative price of K and L drives productivity % y/y % y/y, Wage growth minus capex price growth (ls) 4qtr MA 8 Productivity (rs) Correlation = Note: Wage growth is measured as the year-over-year change in average hourly earnings for production and non-supervisory employees and productivity is output per hour Source: BLS, BEA, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

95 G2 core inflation: Number of countries with deflation: Zero Number 4 Number of G-2 countries with year-over-year core inflation below % Number 4 Japan+ Korea+ Saudi Arabia+ 3 3 Canada+ Saudi Arabia Japan+ South hafrica Japan+ China 2 2 Saudi Arabia 1 1 Japan Japan Note: G2 is Argentina, Australia, Brazil, Canada, China, EU, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, Korea, Turkey, UK, and US. Source: National Sources, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

96 % % of US households are zero-savers Percentage of families who don t save anything out of their current income Source: FRB Survey of Consumer Finances, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April %

97 Trading volumes rising as we get closer to the Fed exit Million shares, 6m avg NYSE Volume Traded, Daily Million shares, 6m avg Trading volumes up 2% over the past six months Source: NYSE, Haver Analytics, DB Global Markets Research Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

98 Torsten Slok, Ph.D. Chief International Economist, Managing Director Deutsche Bank Securities, Inc. Torsten Slok joined Deutsche Bank Securities in the fall of 25. Mr. Slok s Economics team has been top-ranked by Institutional Investor in fixed income and equities for the past five years. Slok currently serves as a member of the Economic Club of New York Prior to joining the firm, Mr. Slok worked at the OECD in Paris in the Money and Finance Division and the Structural Policy Analysis Division. Before joining the OECD he worked for four years at the IMF in the Division responsible for writing the World Economic Outlook and the Division responsible for China, Hong Kong, and Mongolia. Mr. Slok studied at University of Copenhagen and Princeton University. He has published numerous journal articles and reviews on economics and policy analysis, including in Journal of International Economics, Journal of International Money and Finance, and The Econometric Journal. Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

99 Deutsche Bank Appendix 1 Important Disclosures Additional Information Available upon Request For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at / /di /Di l t Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Torsten Slok Deutsche Bank Research Torsten Slok, torsten.slok@db.com April

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101 Risks ssto Fixed Income Positions ostos Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates these are common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to the risks related to rates movements. Deutsche Bank Research Torsten Slok, torsten.slok@db.com April 215 1