Economic Update: Inside the Yield Curve

Transcription

1 SA, Thousands 9/16/2015 Economic Update: Inside the Yield Curve September 2015 Dan Collins, CPA, CFA Senior Vice President FTN Financial Prime Determinants of Tightening Pace: How Much Slack is in the Labor Market? How Job Growth Reacts to Hike Labor Force Trends are Deflationary Have We Hit Peak Employment? International Developments in Fed s Wake Central Bank Divergence in Developed World Emerging Market Resilience? Credit Worthy Jobs Struggle to Recover Population and Employment SA, Thousands Civilian Noninstitutional Population Yrs (left) Civilians Employed Full-time (right) Source: Bureau of Labor Statistics 1

2 Billions of Hours 9/16/2015 Rise of the Machines Output Growth Without Labor Total Hours Worked, SAAR, Bil Hrs (left) Final Sales, Chained $ Bil. SAAR (right) Source: Bureau of Labor Statistics & Bureau of Economic Analysis $, Bil. Gov t Don t Forecast too Good 6.5% Natural Rate of Unemployment (NAIRU) 6.3% 6.1% 5.9% 5.7% 5.5% 5.3% Natural Rate of Unemployment are figures taken 5.1% directly from the CBO's 'Key Assumptions in CBO's 5.1% Projection of Potential Output' table. These numbers 4.9% reflect the quarterly historical and projected estimates the NAIRU. 4.7% 4.5% Source: Congressional Budget Office Speaking of % 67.0% Labor Force Participation 65.0% 63.0% 61.0% 59.0% Civilian Participation Rate: 16 yr + (SA, %) Long Term Projection: % Long Term Projection: 2006 Long Term Projection: % Source: Bureau of Labor Statistics 2

3 Peak Employment in 2000? 68% 67% 66% 65% 67.3% 11% 10% 9% 8% 7% 64% 6% 5% 63% Labor Force Participation Rate (lhs) 4% Unemployment Rate (rhs) 3.8% 62% 3% Source: Bureau of Labor Statistics Removes Looking Distortion 66.0% 64.0% Employment to Population Ratio 64.7% 62.0% 60.0% 58.0% 56.0% 54.0% Source: Bureau of Labor Statistics Developed World Problem: Demographics 3

4 Index Oct 2014 =100 9/16/2015 In the Bankers We Trust Central Bank Divergence 1.3 Central Bank Total Assets Federal Reserve European Central Bank Bank of Japan 0.8 Oct '14 Jan '15 Apr '15 Jul '15 Source: Federal Reserve, Bank of Japan & European Central Bank European Recession: 7 Years and Counting Real GDP Index Q1 2008= Germany 85 France Spain 80 Portugal Ireland 75 Italy Greece Source: German Federal Statistical Office, INE, INSEE National Statistics Office of France, Eurostat, Central Statistics Office Ireland, ISTAT, National Statistical Service of Greece 11 4

5 Party Like it s 1997 YTD performance against USD (9/9/15) Taiwan Dollar Singapore Dollar Peruvian Sol South Korean Won Thai Baht Chilean Peso Indonesian Rupiah Russian Ruble South African Rand Malaysian Ringgit Colombian Peso Brazilian Real -30.0% -25.0% -20.0% -15.0% -10.0% -5.0% 0.0% Source: Bloomberg The Devaluation has Begun 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% Source: The People's Bank of China & Bloomberg China 1-Yr Benchmark Lending Rate (left) CNY/USD Curve volatility in a low yield market 1) Current sensitivity to Fed vs ) Inevitability of flatter curve. Question of degree 3) Influences beyond the Fed: Inflation/Overseas 4) Strategy for

6 2004 was almost a classic flattening Curve shift from February, 2004 to September, 2006 Many investors eager to anticipate the same trade. Long rates held down by overseas buying and abrupt halt to household leverage. Curve shape pivoted at the 10- yr maturity 2015 starts at same relative position UST curve September, 2015 vs February, 2004 Despite lessons of 2007, Fed trying to manage the nominal yield curve. Could the curve pivot at the 7-yr in this move by Fed? 4 segments to the current yield curve UST curve September, 2015 vs February, 2004 Curve looks same shape but has different underlying dynamics. 5-yr is only segment that is 90+% sensitive to Fed policy. Stock market risk Low inflation prospects Economy in 2019 THE FED The Fed Oil Global economics Risk insurance Pension investment Curve trading Low inflation hedge Old QE holdings 6

7 2s/5s curve easiest to forecast Consider the 2-yr as Fed tightens on one example. In 2016, the following 2 yrs of rates in the red box Next 2 yrs of rates in the blue box 2-yr in 2016 under two scenarios 2% by August % by March Yr at 1.75% in Sept Yr at 1.60% in Sept 2016 Any Fed path looks something like this Short-end curve shift in 1 year, 100bp of flattening 7

8 5s/10s not so simple: Life past liftoff 1) Inflation s timetable impacts real rate policy 2) Monetary policy trends outside the US 3) Supply/demand and shape of the real interest rate curve 4) Estimating longer intermediate rates in a tightening What real cost of money impacts economy? Inflation adjusted fed funds: Fed best fights inflation by managing the cost of borrowing after inflation. Avg in 04 cycle was 1.9% Does tightening work on amount of change or absolute cost? If inflation normalizes as Fed expects Inflation adjusted fed funds: 2017 & 2019 Fed sees normal 2% in Policy will still try to move ahead of inflation for at least 2 years. 8

9 If inflation is slower as FTN expects Inflation adjusted fed funds: 2017 & 2019 FTN sees normal 1.7% in Higher real rates raise dollar more, stifle economy. A larger share of costs are real. Cycle s back end critical to 5s and 7s Global economy and inflation will guide policy rates in Without inflation to actually fight, Fed can throttle back Leveling off at 3.0% puts 7-yr close to 2.30% fair value. 5s/10s curve set by expected 2019 policy. US real rates low but way ahead of others 10 Years of Real 10-Yr Interest Rates Normal conditions are near parity. Europe faces several bigger challenges than US economy in next 5 years. 9

10 Moving forward thru foggy FOMC policy 1) Few things are predictable about this Fed or this environment. Curve flattening, however, is predictable. 2) Markets have identified what could and should be different this time around and will move quickly to seize any advantage. 6-mo forward planning a must. 3) Most important tool: Bracket Fed moves to define risk and portfolio opportunities. Conclusions 1) Fed decision making still focused on economic cycles and not broader secular changes obscured by financial crisis fallout 2) Fed monetary policy and trading complicated by i) outside forces; and ii) lingering aftershocks of previous unconventional policy tools. 3) The timing of inflation s return is the most important unknown for portfolio managers who want to err on side of caution but lose too much value if that instinct proves incorrect. 4) The most stable long-term value on the curve is likely to be centered near the 7-year maturity as long as Fed doesn t exceed 2.5%. 10