2018 Economic Outlook 2Q Update

Transcription

1 2018 Economic Outlook 2Q Update The Sky Is the Limit And the U.S. Economy Is Closer Dudley Carter Economist, Vining Sparks Craig Dismuke Chief Economist, Vining Sparks

2 Weak Q1 Growth Expected to Fade First quarter growth indicators, specifically those related to the consumer, have been weaker than expected. However, that s after a stellar 4Q for final sales and could also reflect residual seasonality % Weaker durable goods orders Weaker retail sales 0.0 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 Sources: Federal Reserve Bank of Atlanta, Vining Sparks Weaker durable goods orders Weaker retail sales 2 2.8%

3 Almost All Economic Engines Firing A strong consumer and more favorable business climate created a positive outlook for growth. Global growth also synchronized providing three engines of economic growth. 3 Low Unemployment Decent Wage Growth Low Household Debt Low Gas Prices Record-High Stocks Low Interest Rates Booming Confidence Booming Confidence Deregulation Expectations for Sales Record-High Stocks Low Interest Rates Weaker Dollar Housing Momentum Unprecedented Monetary Stimulus Low Interest Rates Record-High Stocks Synchronized Growth Strong U.S. Economy Federal: 2011 Budget Caps State and Local: Improved Tax Receipts, Property Values CONSUMPTION INVESTMENT GLOBAL GROWTH GOVERNMENT Tax Reform Tax Reform = Stable Outlook / Low Inflation / Patient Fed / Low Rates

4 Job Growth Continues to Beat Forecasts Total nonfarm payroll growth beat expectations again, initially rising 200k in January. The labor market has shown very few signs of slowing despite being almost nine years into the cycle JAN Sources: BLS, Vining Sparks

5 Earnings Growth Shows Traction 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. 3.0% 2.5% Average Hourly Earnings (YoY) Employee Cost Index 5 2.9% 2.6% 2.0% 1.5% 1.0% Sources: BLS, Vining Sparks

6 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% 10% 5% Government Expenditures by Category (QoQ, SAAR) Previous Federal Spending Caps Replaced by: 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 6 0% -5% Projected GDP Impact: % +0.4% Sources: BEA, Vining Sparks

7 Core CPI Inflation Rises 0.35% MoM Core CPI inflation showed the strongest monthly gain in prices since 2005, rising 0.35% MoM. While some of the increase should prove temporary, it exacerbated investors fears. 0.5% 0.4% 0.3% Core CPI (MoM) Core CPI (YoY) 3.5% 0.351% 0.349% 3.0% 7 2.5% 0.2% 0.1% 0.0% -0.1% 2.0% 1.8% 1.5% 1.0% 0.5% -0.2% % Sources: BLS, Vining Sparks

8 All Economic Engines Firing Add the boost from tax reform and more fiscal stimulus (deficit spending) to an already stable backdrop, and markets began to fear the economy over-heating. 8 Low Unemployment Decent Wage Growth Low Household Debt Low Gas Prices Record-High Stocks Low Interest Rates Booming Confidence Booming Confidence Deregulation Expectations for Sales Record-High Stocks Low Interest Rates Weaker Dollar Housing Momentum Unprecedented Monetary Stimulus Low Interest Rates Record-High Stocks Synchronized Growth Strong U.S. Economy Federal: Raised Budget Caps State and Local: Improved Tax Receipts, Property Values CONSUMPTION INVESTMENT GLOBAL GROWTH GOVERNMENT Tax Reform Tax Reform Fiscal Stimulus = Hot = Stable Outlook Outlook / Risks / Balanced to Inflation Risks / Reactive / Patient Fed // Higher Low Rates

9 Investors Fear Economy Over-Heating Driving longer interest rates have been 1) U.S. fiscal policy developments, 2) central bank actions, 3) geopolitical concerns, and 4) decent economic data French GOP lacks support for healthcare bill, election uncertainty about fiscal reform agenda fears Weak CPI, retail sales start Trump sworn in Fedspeak shifts markets to March Fed hikes Dots unchanged month of weaker economic data French Election Comey memos 2.99% J F M A M J J A S O N D J F M Sources: Bloomberg, Citi Eco Surprise Index, Vining Sparks 1.85% - Pre-Election Yield Fed hikes, hawkish slant, dots unchanged, roll-off cap sizes Senate healthcare failures begin Fed debate on inflation begins Fed announces October start date for roll-off Presidential advisory councils disbanded Fed Balance Sheet Roll-Off ECB Extends QE at 30B/Month BOE Hikes Tax framework ECB, BoE, BoC Irma and Harvey less surprisingly severe than feared hawkish North Korea tests hydrogen bomb Fed hikes Dots unchanged U.S. and Eurozone Eco Data Beating Expectations Tax Bill Passed Progress on Tax Reform 9 Fiscal Stimulus Firmer Inflation Stronger Earnings Economic Surprise Index

10 And Higher Rates Spooked Stocks Despite the sensational news headlines, stocks have recovered and remain well above preelection levels. As a result, the risk of frothy asset prices remains. 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Percentage Gains since U.S. Election Nasdaq Dow S&P 500 MSCI All-World Index, Ex-U.S. N D J F M A M J J A S O N D J F M Sources: Bloomberg, Vining Sparks Election Jan 26 (YTD) +45.2% (+7.7%) +43.8% (+8.7%) +34.3% (+7.5%) +33.5% (+7.1%) 10 Jan 26-Feb 8 (YTD) -10.4% (-3.5%) -9.7% (-1.8%) -10.2% (-3.5%) -7.8% (-2.8%)

11 Second Wildest Week of the Cycle Combining the intraday percentage trading ranges, those swings ultimately added up to the second wildest week for stocks since the Great Recession. 30% U.S. Debt S&P 500, Weekly Percentage Downgrade 24.92% 25% Trading Range 2010 Flash Inflation Chinese Market Crash Freak Out 20% Turmoil 18.34% 15% 10% 5% 17.72% 16.36% 0% Sources: Bloomberg, Vining Sparks 11

12 Second Wildest Week of the Cycle Combining the intraday percentage trading ranges, those swings ultimately added up to the second wildest week for stocks since the Great Recession. 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% Daily % Change S&P % Sources: Bloomberg, Vining Sparks 8 Days with >1% Move Days with >1% Move

13 Growing Risks to Stability in 2018 The risks to economic stability are growing. As the economy begins to heat up, imbalances are likely to become more pronounced with the largest risk coming from an asset price correction. Inflation runs hotter-than-expected Fed feels they re behind the curve, leading to more a aggressive policy Asset price recalibration stock prices, bond yields, credit spreads, cap rates Volatility excessively suppressed in financial markets, exacerbating future moves Global central banks simultaneously shift to less accommodative posture Geopolitical tensions and trade tensions Mid-term elections creating more political uncertainty Longer-term obstacles Aging population, Federal debt, Weak productivity 13

14 Expectations for Fed Rate Hikes The markets are now pricing in three hikes in 2018, but only one or two additional hikes through the end of The Fed continues to project a longer period of rate hikes % Fed Projections March SEP Fed Funds Futures December 29, % Fed Funds Futures March 29, % 2.44% % 2.07% Sources: Fed Funds Futures Contracts, March 2018 Fed SEP Projections, Vining Sparks

15 Unemployment Rate Below Target The Fed is likely to remain hawkish so long as unemployment rate 1) remains below their longerrun sustainable rate, 2) is not rising, and 3) financial conditions do not deteriorate dramatically. 10 Headline Unemployment Rate Fed s Longer-Run Projected Rate 4.1% Sources: BLS, Federal Reserve Summary of Economic Projections, Vining Sparks

16 Less Risk of Disinflation in 2018 There appear to be more risks to a modest acceleration in price gains in 2018 than deceleration. Rising commodity prices, possible wage growth, and a weaker Dollar should push prices higher. 16 $125 $100 $75 $ Oil Price per Barrel $ Trade-Weighted Dollar +46% Since June Small Business Compensation Plans Commodity Prices Highest Since % YoY % Since June Sources: Bloomberg, CRB Core Commodity Index, NFIB, Federal Reserve, Vining Sparks

17 FOMC Tilting More Hawkish 1) A strong assessment of future activity, 2) increased expectations for future growth and lower unemployment, and 3) more confidence in inflation stabilizing show a more confident Fed. FOMC Statement Labor Market: Job gains have been strong Economic Activity: rising at a solid moderate rate Economic Outlook: The economic outlook has strengthened in recent months Inflation: to move up this year in coming months Powell Press Conference no sense in the data we re on the cusp of inflation accelerating Because of the flatness of the Phillips curve 17 Sources: FOMC Statement, Vining Sparks

18 FOMC Tilting More Hawkish The FOMC s March SEP reflects expectations for faster growth in the short- to medium-term. However, the longer run outlook remains just 1.8%. 18 GDP Projections MARCH DECEMBER % % 2.4% % Longer Run 2.0% 1.8% 2.0% 1.8% U.R. Projections MARCH DECEMBER % 3.6% Longer Run 3.6% 4.5% % 3.9% 4.0% 4.6% Sources: FOMC Summary of Economic Projections, Vining Sparks

19 March FOMC Dot Plot Projections Thirty-four of forty-five dots through 2020 were raised in the March SEP Raised Dot *Based on estimation of which dot corresponds with each FOMC participant Longer Run

20 March FOMC Dot Plot Projections Additionally, the voting participants have tilted to the more hawkish side of the Committee in Non-Voters (by Year) Voters (by Year) Raised Dot *Based on estimation of which dot corresponds with each FOMC participant Longer Run

21 Financial Conditions Tightening Financial conditions have tightened in 2018 as fears of inflation and higher interest rates have roiled markets. This will be key to watch and is the most likely factor to limit Fed hikes. Normalized Versus Median* Tighter Financial Conditions Easier Financial Conditions A M J J A S O N D J F M A Sources: Chicago Fed, St. Louis Fed, Bloomberg, Vining Sparks Overall Financial Conditions - Bloomberg Index (Inverted) Interbank Liquidity - TED Spread Health of Financial System/Banks - Libor/OIS Spread Short-Term Corporate Borrowing - CP/3M TBill Spread Long-Term Corporate Borrowing - Corp 10Y Baa/Treasury Spread Municiapl Borrowing - Muni 10Y Aa/Treasury Spread Stock Values - S&P 500 YoY (Inverted) Stock Volatility - S&P 500 VIX Expected Bond Market Volatility - Swaption Volatility Chicago Fed Adj. National Financial Conditions Index St. Louis Fed Financial Stress Index Bloomberg Financial Conditions Index (Inv)

22 Longer Yields Remain Anchored Treasury yields continue to we weighed down by global yields, generally, and the impact of stilleasy monetary policy from the ECB and BoJ. 6.0 Fed, ECB, BOE, and BoJ Assets (Inverted, USD) $1 $3 $5 $ Year Treasury $ Y German Bund 10Y Japan JGB Trillions $11 $13 $15 Sources: Federal Reserve, BOE, ECB, BoJ, Bloomberg, Vining Sparks

23 Inflation Firming, but Remains Low Inflation in Japan and the Eurozone continue to run below-target despite the improving economic data and financial asset prices. This is likely to limit adjustments to monetary policy Core Inflation Measures by Country Sources: BoJ, CEIN, UK ONS, Eurostat, BLS, Vining Sparks U.K. U.S. Eurozone Japan % 1.6% 1.0% 0.5%

24 Housing Proven to Be Rate Sensitive Home sales have proven historically to be very rate-sensitive. The higher the 10-year yield rises above 3.00% (mortgage rates above 4.75%), residential investment is likely to weaken Homeowners Average Outstanding Mortgage Rate Homeowners Mortgage Current 30-Year Mortgage Rate Rates above Prevailing Market Rates Δ Economics Work to Buy More House Average Outstanding Mortgage Rate Minus Current 30-Year Mortgage Rate Sources: Census Bureau, NAR, Freddie Mac MMS 30-Year Mortgage Rate, Vining Sparks

25 YoY Change in Home Sales Home Sales Prove to Be Rate Sensitive Home sales have proven historically to be very rate-sensitive. The higher the 10-year yield rises above 3.00% (mortgage rates above 4.50%), residential investment is likely to weaken New Home Sales (YoY) Existing Home Sales (YoY) Sources: Census Bureau, NAR, Freddie Mac MMS 30-Year Mortgage Rate, Vining Sparks Outstanding Rate Less Available Rate

26 Federal Interest Expense Politicians have significant incentive to keep interest rates anchored now more than ever. Using modest projections, annual interest expense is expected to rise $580 billion by $900 $800 $700 $600 $500 $400 $300 $200 $100 $0 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Underlying Rate Assumptions 10Y Treasury and CBO Projection 3M Bill and CBO Projection 2.90% $240 B Sources: CBO March 2017 Projections, Treasury, Bloomberg, Vining Sparks 3.70% 2.80% 1.65% Annual Interest Expense 26 $818 B

27 Inflation Outlook Remains Anchored The biggest risk to longer yields rising more than expected appears to be an increase in inflation. While the New York Fed s UIG points to an imminent increase, market expectations remain tame Underlying Inflation Gauge New York Fed UIG (Adv. 18M) Sources: New York Fed, Bloomberg, Vining Sparks Core CPI (YoY) TIPS-Implied Inflation Expectations 5Y/5Y Forward Implied Inflation 10-Year Implied Inflation M A M J J A S O N D J F M Year Implied Inflation

28 Interest Rate Projections Short-end of yield curve likely to be pressured higher from Fed hikes while longer-end responds to inflation expectations, supply/demand, global yields, and other limiting factors March Vining Sparks Projections March 29 Forward Curve March 15 Bloomberg Survey (Avg) March 29 Current Yield Curve Risk to Financial Conditions Inflation Remains below Target Somewhat Fragile Economy 2.125% 2.35% Historically Low Unemployment Signs of Potential Inflation Continued Inflation of Asset Prices 2.75% FF 3M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y Sources: Bloomberg Survey (March), Vining Sparks Projections (March), Forward Curve (March 15) Easy Monetary Policy Globally Weak Inflation Outlook Slower Rate of Future Growth Risk to Financial Conditions Risk to Housing Sector Risk to Federal Interest Expense Geopolitical Fears / Trade Fears Stronger U.S. Growth Outlook Improved Global Outlook Signs of Potential Inflation Expectations for More Hawkish FOMC 3.00% Year-End 2018 Interest Rate Projections 28

29 2018 Economic Outlook Consumer Firmer wages, stronger labor market, and $140 billion boost from tax cuts Business Investment Improved capex as a result of tax reform, particularly structures Housing Tax reform diminishes some incentives to homeownership; however, housing should see another year of growth in presuming mortgage rates remain anchored Government Spending More deficit spending will yield better growth in the near-term but may tip the inflation scale; adds to the already excessive debt burden Risks to Growth Rising inflation biggest risk to outlook (higher interest rates, asset price correction, etc ) Too much of a good thing leads to correction-inducing imbalances Fed walking tightrope in removing support without roiling markets Interest Rates (Short Maturities) Fed likely to remain hawkish so long as financial conditions remain easy, particularly with unemployment below-target Interest Rates (Longer Maturities) - Longer yields likely to rise moderately on tug-of-war between stabilizing inflation, improving growth, and global supply/demand Longer Term Outlook Aging population Weak productivity Excessive debt 29

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31 INTENDED FOR INSTITUTIONAL INVESTORS ONLY. The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC. 31