Economic Outlook: Higher Rates Amid Continued Moderation, Slower Inflation & Fiscal Uncertainty July 2017

Transcription

1 Economic Outlook: Higher Rates Amid Continued Moderation, Slower Inflation & Fiscal Uncertainty July 2017 Lindsey M. Piegza, Ph.D. Chief Economist Refer to the last page of this report for Stifel Fixed Income Capital Markets disclosures and analyst certifications. Stifel, Nicolaus & Company, Incorporated Member NYSE / SIPC. 0

2 The Fed: Raising Rates with a Cautious Tone 1

3 Historically Low Rates Fed raises rates 25bps to 1.25% at latest June meeting, the second rate increase in 2017 (March), and the third rate increase in six months Fed kept rates steady at May meeting at a range of % Fed raised rates 25bps to 0.75% in December 2016 after seven consecutive meetings of unchanged policy 2

4 Fed Agrees to Gradual Rate Pathway Lingering uncertainties could limit rate hikes over the next two to three years The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate. -June 14 th FOMC Meeting Minutes 3

5 Fed Dot Plot Shows Another Hike in 2017 The Fed continues to forecast one additional rate hike in the remaining five months of the year Several participants expressed concern that a substantial and sustained unemployment undershooting might make the economy more likely to experience financial instability or could lead to a sharp rise in inflation that would require a rapid policy tightening that, in turn, could raise the risk of an economic downturn. However, other participants noted that if a sharp rise in inflation or inflation expectations did occur, the Committee could readily respond using conventional monetary policy tools. - June 14 th FOMC Meeting Minutes Source: Federal Reserve June 14 th FOMC Dot Plot 4

6 Focus Shifts to Normalize Balance Sheet Participants expressed a range of views on the timing for adjusting reinvestment policy. Several preferred within a couple of months. Others emphasized that waiting until later in the year would allow access to more data.. -June 14 th FOMC Meeting Minutes For payments of principal from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month. For payments of principal from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month. -June 14 th FOMC Statement 5

7 Waning Justification: Soft Inflation 6

8 Inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent. inflation is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term., revising previous language describing inflation as relatively close to policymakers' goal. near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely. -June 14 th FOMC Statement 7

9 SEP Forecast : Inflation June 14 th Summary of Economic Projections The FOMC lowered the medium-term forecast for inflation in 2017 from 1.9% to 1.6%, while maintaining their 2.0% forecast for 2018 and beyond The Fed has been forecasting 2% inflation next year for the greater part of the past seven years Source: Federal Reserve 8

10 Inflation Momentum Wanes: PCE The PCE fell 0.1% in May and rose 1.4% year-over-year, a sixmonth low, and down from a recent peak of 2.1% in February, the first +2% reading since April 2012 The core PCE rose 0.1% in May and rose 1.4% year-over-year, down from a 1.5% pace in April, and down from a peak of 1.8% in January 9

11 Energy Component of Inflation The energy component of inflation rose from a -7.45% annul pace in 2016 to an 11.8% pace in 2017 In the latest May report, energy growth has slowed to 5.3%, down from a peak of 18.5% in February 10

12 Inflation Momentum Stalls: PPI & CPI The PPI was unchanged in May following a 0.5% increase in April Year-over-year, headline producer prices rose 2.4% in May, down from a recent peak of 2.5% reported at the start of Q2 The CPI fell 0.1% in May following a 0.2% increase in April Year-over-year, headline consumer prices rose 1.9% in May, a six-month low, and down from a peak of 2.7% in February 11

13 Inflation Expectations Slow Inflation expectations climbed to a more than one-year high at 2.2% in March amid expectations of increased fiscal investment being simulative and becoming reflationary, but have since lost momentum, currently at 1.8% as of June, and further below a peak of 2.9% in February

14 Waning Justification: Labor Market Stable but Far from Robust 13

15 Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined. -June 14 th FOMC Statement 14

16 Payrolls Positive but Growth Declining 81 consecutive months of positive payroll growth June payrolls increased 222k, a fourmonth high, and following a 152k rise in May and a 207k rise in April Payroll growth averaged 180k in 2016 compared to 229k in 2015 and 251k in

17 U.S. State Employment Recovery The recovery has been notably uneven across state lines Michigan Maine States in the Central Plains were among the earliest states to reach and surpass their previous peaks in employment However, several states in the Deep South and West are among the slowest labor markets to recover Wyoming New Mexico Alabama Mississippi Rhode Island 16

18 Unemployment at 4.4% Unemployment rose one-tenth of a percentage point to 4.4% in June, a twomonth high The unemployment rate has been in the Fed s full employment range since October

19 Participation Rate Still Declining Participation rate at a multi-decade low, 62.8% in June year olds account for the majority of the decline in the labor force, 8.0m Americans (only 59% of working age population) 18

20 Still-Moderate Labor Market Conditions, Consumers Losing Momentum 19

21 Retail Sales Still Weakening May sales fell 0.3% Y/Y sales are up 3.8% vs. 4.5% in April Ex-autos & gas May sales were flat Y/Y up 3.6% vs. 3.7% in April Ex-autos & gas 12- month avg: 0.3% 20

22 Gas Prices Give Muted Boost Consumption averaged 3.0% over the previous 12 months, down from a 3.1% pace 12 months prior June price of $2.35 near 2009 low $2.36 six-month average vs. $3.55 longterm average Down $1.34 and 36% from a peak monthly average of $3.69 in June 2014 (star) Gas prices are down 0.9% from $2.37 a year ago 21

23 Household Balance Sheet 22

24 Avg. Hourly Earnings Edging Lower Wages rose 0.2% in June, following a 0.1% rise the month prior Up 2.5% Y/Y as of June following a 2.4% rise the month prior 2.5% 3-month average in June 2.6% 12-month average in June 2.1% average since Recession 23

25 Business Investment Sluggish 24

26 Still-Modest Business Investment Nonresidential fixed investment fell 3.3% at end of 2015, the first quarterly decline since Q Investment rose 5.1% in 2014, 0.9% in 2015 and 0.1% in 2016 Investment rose 10.4% in Q1 2017, the highest since Q1 2012, thanks to a 22.6% increase in structures, a 7.8% increase in equipment and a 6.4% increase in intellectual property investment 25

27 Business Investment Still Weak Orders ex-air, ex-def fell 0.2% in May, up 6.4% Y/Y, the sixth month of reported gain after 23 months of near-zero or negative growth Durable goods fell 1.1% in May and rose 5.1% year-over-year Transportation orders fell 3.4% in May and rose 0.8% year-overyear 26

28 Fiscal Policy Agenda 27

29 Trump s Key Agenda Points Simplified tax plan with reduced brackets (10%, 25% and 35% vs. current 10%, 15%, 25%, 28%, 33%, 35% and 39.6%) and a reduced corporate tax rate to 15%. Reduce regulation, repeal Dodd-Frank and sweeping bank reforms, and eliminate ones that needlessly kill jobs. Undoing the Obama administration s policies on energy and climate control. Repeal & reform the Affordable Care Act while keeping coverage for people with pre-existing conditions, and allowing Americans under the age of 26 to stay on their parents plans. 28

30 Trump and the Consumer Additional discretionary income resulting from a direct tax cut or indirect cost reduction will help alleviate mounting pressure from moderate employment opportunities and waning income growth, and reflate the household balance sheet. A simplified tax and reduced regulatory burden will boost corporate participation in the market, helping to reverse the restrained activity of the past several years. 29

31 Limited Fiscal Impact: Crude Oil Prices Improving Modestly Monthly prices for June averaged $46.37, the first monthly average below $50 since November 2016, and following a $50.33 monthly average in May The price of oil is down 60+% from 2008 high Prices pushed above $55 for the first time since July 2015 Oil prices up 64% ($19.63 a barrel) from a low in January

32 Limited Fiscal Impact: Low Productivity in U.S. I ve continued to highlight the importance of spurring productivity growth, that I think that would be something that s beneficial for the economy. -Chair Janet Yellen, December 2016 Press Conference Productivity has hit historic lows since 2014 Productivity in Q1 was 0.7%, averaging 0.6% in 2016 and 0.6% over the past 5 years 31

33 Trump s Key Agenda Points Infrastructure spending to build roads, bridges, schools and airports second to none, potentially totaling $1 trillion. 32

34 Debt Appetite Diminished 77% of GDP, the highest level relative to the size of the economy since s decade-long expansion posting over 4.5% GDP vs. stagnant 2% According to the CBO, financing the debt coupled with rising interest rates would result in a four-fold increase Federal interest outlays totaled more than $330b 33

35 Market Optimism 34

36 Positive Market Reaction: Equities Rally on Optimism Dow Jones Industrial Average After an initial fallout on election day, equities have since rebounded, pushing the Dow to a record high as of June 19 th Since the start of May, the Dow is up 2.1% and up 7.4% since the start of the year 35

37 Positive Market Reaction: Pressure on the U.S. Dollar The dollar fell from $ to $ in June, the sixth decline following six consecutive months of gains Average: $ Average: $

38 Trump s Key Agenda Points International fairness and protectionist policies; immigration reform by building a wall (or fence in some areas) and deporting 2-3 million illegal immigrants with criminal records. Withdraw from TPP and renegotiate trade deals that have left the U.S. disadvantaged with technologies and patents exploited or goods counterfeited. Proposed a 5-35% tariff or tax on imported goods into the U.S. to disincentivize moving overseas. 37

39 Continued Moderation 38

40 Still-Moderate, Positive Growth Q1 GDP rose 1.4%, the slowest pace of growth since Q Average growth since Recession: 2.1% 2014: 2.4% 2015: 2.6% 2016 : 1.6% 2017: 1.4% 39

41 Market Reaction: Treasury Yields U.S. treasury yields surged after election day with the 10-year pushing over 2% for the first time since January year UST reached a high of 2.63% on March 13 th, the highest level since September year UST is up 12bps since the start of 2016, and down 24bps since March peak; up 54bps since the November election to 2.39% Increased expectations of pro-growth policies from Trump administration U.S. 10-Year Treasury Waning optimism after little action taken after first 100 days in office 40

42 Market Optimism During the Taper Tantrum of 2013 yields rose more than 100bps January to December before recapturing 79bps 35 months later 10-yr yield rose 80bps from November 1 st to 2.63% on March 13 th, the highest since July yr yield is down 24bps from March 13 th peak, at 2.39% 41

43 Interest Rate Forecast Grid End of Quarter Figures Average Annual Figures Q Q Q Q Q Q Q Q Q Q Growth indicators GDP, QoQ % 0.8% 1.4% 3.5% 2.1% 1.4% 2.1% 1.8% 1.6% 0.9% 1.1% 1.9% 2.0% 1.7% 1.0% Fixed Investment, % -0.9% -1.1% 0.1% 2.9% 11.0% 1.3% 2.2% 2.8% 2.6% 1.8% 3.4% 0.3% 4.3% 2.1% Housing Starts, k 1,128 1,190 1,062 1,268 1,189 1,225 1,190 1,185 1,120 1,115 1,131 1,162 1,197 1,118 Car Sales, M Unemployment Rate, % 5.0% 4.9% 4.9% 4.7% 4.7% 4.4% 5.0% 5.0% 5.0% 5.1% 5.3% 4.9% 4.8% 5.1% Participation Rate, % 63.0% 62.7% 62.9% 62.7% 63.0% 62.8% 62.9% 62.9% 62.7% 62.6% 62.6% 62.8% 62.9% 62.7% Savings Rate, % 6.1% 5.9% 5.9% 4.9% 5.1% 6.2% 6.1% 5.9% 6.3% 6.5% 5.8% 5.7% 5.8% 6.4% Inflation indicators, YoY% CPI 0.9% 1.0.% 1.5% 2.1% 2.4% 1.8% 1.5% 1.3% 1.2% 1.2% 0.2% 1.5% 1.8% 1.2% PCE 0.8% 0.9% 1.2% 1.6% 1.9% 1.5% 1.3% 1.1% 1.0% 1.0% 0.4% 1.1% 1.5% 1.0% Core PCE 1.6% 1.6% 1.7% 1.7% 1.6% 1.6% 1.5% 1.2% 1.2% 1.2% 1.4% 1.7% 1.5% 1.2% Interest rate, % FF month UST bills yr UST notes yr UST notes yr UST notes yr UST bonds s to 10s Spread bps Lindsey Piegza, Ph.D. - Chief Economist Source: Bloomberg, Stifel Please see Economic Insight, "Politics and Policy: An Improved Forecast of Continued Moderation," for further forecast analysis 42

44 Questions? 43

45 Trump and the Consumer Individual Reform Tax relief for American families, especially middle-income families: Reducing the 7 tax brackets to 3 tax brackets of 10%, 25% and 35% Doubling the standard deduction Providing tax relief for families with child and dependent care expenses Simplification: Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers Protect the home ownership and charitable gift tax deductions Repeal the Alternative Minimum Tax Repeal the death tax Repeal the 3.8% Obamacare tax that hits small businesses and investment income Business Reform 15% business tax rate Territorial tax system to level the playing field for American companies One-time tax on trillions of dollars held overseas Eliminate tax breaks for special interests 44

46 Trump and Health Care Still No Vote on Revised Health Care Reform Bill: House GOP Bill: Removes financial penalties for those without insurance. Instead, insurers would be allowed to charge a 30% penalty above original premiums if an insured person's coverage is interrupted for 63 days. Eliminates individual and employer mandates. Phases out Medicaid expansion under Obamacare, freezing funding for the expansion in Requires insurance companies to cover such essential health benefits, but allows states to apply for waivers to eliminate the requirement to cover those services. Eliminates most Obamacare taxes, such as the 3.8% tax on investment income. Allows people to stay on their parents' health insurance plan until age 26. CBO Score: lower premiums, reduce coverage (23m by 2026) Senate GOP Bill: Removes financial penalties for those who don't have insurance, eliminates individual and employer mandates. Tax credits based on age, income and geography. Phases out additional Medicaid funding under Obamacare by 2024 in states that expanded Medicaid; allows states to choose between a block grant funding format and per-capita funding; allows states to impose a work requirement for people who aren't pregnant, disabled or elderly. Allows states to request a waiver to opt out of essential health benefits. Eliminates most Obamacare taxes, such as the 3.8% tax on investment income. Allows people to stay on their parents' health insurance plan until age 26. CBO Score: decrease federal deficits by a total of $321, reduce coverage (22m by 2026) 45

47 Disclosures Disclosures and Disclaimers The Fixed Income Capital Markets trading area of Stifel, Nicolaus & Company, Incorporated may own debt securities of the borrower or borrowers mentioned in this report and may make a market in the aforementioned securities as of the date of issuance of this research report. Please visit the Research Page at for the current research disclosures applicable to the companies mentioned in this publication that are within Stifel s coverage universe. The information contained herein has been prepared from sources believed reliable but is not guaranteed by Stifel and is not a complete summary or statement of all available data, nor is it to be construed as an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of investors. Employees of Stifel or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinions expressed within. No investments or services mentioned are available to private customers in the European Economic Area or to anyone in Canada other than a Designated Institution. The employees involved in the preparation or the issuance of this communication may have positions in the securities or options of the issuer/s discussed or recommended herein. Stifel is a multi-disciplined financial services firm that regularly seeks investment banking assignments and compensation from issuers for services including, but not limited to, acting as an underwriter in an offering or financial advisor in a merger or acquisition, or serving as a placement agent in private transactions. Moreover, Stifel and its affiliates and their respective shareholders, directors, officers and/or employees, may from time to time have long or short positions in such securities or in options or other derivative instruments based thereon. Stifel Fixed Income Capital Markets research and strategy analysts ( FICM Analysts ) are not compensated directly or indirectly based on specific investment banking services transactions with the borrower or borrowers mentioned in this report or on FICM Analyst specific recommendations or views (whether or not contained in this or any other Stifel report), nor are FICM Analysts supervised by Stifel investment banking personnel; FICM Analysts receive compensation, however, based on the profitability of both Stifel (which includes investment banking) and Stifel FICM. The views, if any, expressed by FICM Analysts herein accurately reflect their personal professional views about subject securities and borrowers. For additional information on investment risks (including, but not limited to, market risks, credit ratings and specific securities provisions), contact your Stifel financial advisor or salesperson. Our investment rating system is three tiered, defined as follows: Outperform For credit specific recommendations we expect the identified credit to outperform its sector specific peers over the next six months. Market perform For credit specific recommendations we expect the identified credit to perform approximately in line with its sector specific peers over the next six months. Underperform For credit specific recommendations we expect the identified credit to underperform its sector specific peers over the next six months. Additional Information Is Available Upon Request I, Lindsey Piegza, certify that the views expressed in this research report accurately reflect my personal views about the subject securities or issuers; and I certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report Stifel, Nicolaus & Company, Incorporated, One South Street, Baltimore, MD All rights reserved.. 46