Peter Donisanu Investment Strategy Analyst WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS The Wage Conundrum September, 17 Key Takeaways» Some market participants have taken the recent rebound in global economic growth as an indication that tighter monetary policy from the world s largest central banks will come sooner, rather than later.» While economic conditions have indeed improved in the U.S., Eurozone and Japan, we believe that lackluster wage inflation suggests that policymakers at the world s largest central banks likely will err on the side of caution. What It May Mean for Investors» We believe that such a cautious policy approach is likely to support an interest-rate environment that is favorable for international stocks and generally supportive of fixed-income investments. We also expect the U.S. dollar to gain modestly in the coming months but fade as the year comes to a close. With increasing evidence of a rebound in global economic growth, some market participants have argued that global monetary policy is set to tighten at a quickening pace in the coming months. While this view (strong economic growth equals tighter monetary policy) may have held some merit in past business cycles, we believe that labor-market distortions could be having a negative impact on inflation. This could prompt policymakers to take a cautious approach in coming months to raising interest rates, even as the pace of economic growth quickens. We believe that such a cautious policy approach is likely favorable for international stocks and generally supportive of fixed-income investments. We also expect the U.S. dollar to gain modestly in the coming months but likely fade as the year comes to a close. Chart 1. U.S., Eurozone and Japanese Core Inflation Remains Subdued Y/Y Change (%) 3..5. 1..5. -.5-1. - -. Annual Change in Core Headline Inflation U.S. Eurozone Japan Jul-7 Oct-7 Jan- Apr- Jul- Oct- Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-1 Apr-1 Jul-1 Oct-1 Jan-13 Apr-13 Jul-13 Oct-13 Jan-1 Apr-1 Jul-1 Oct-1 Jan-15 Apr-15 Jul-15 Oct-15 Jan-1 Apr-1 Jul-1 Oct-1 Jan-17 Apr-17 Jul-17 Sources: Wells Fargo Investment Institute, Bloomberg; 9//17 17 Wells Fargo Investment Institute. All rights reserved. Page 1 of
Labor Market Conditions Are Improving But Wages Are Stagnant Headline jobless measures in the U.S., Eurozone and Japan suggest that employment conditions are tightening. Indeed, as Chart shows, unemployment rates in these three regions have fallen to (or near) pre-crisis levels in recent months. At first glance, such figures would confirm part of the global economic recovery story and strengthen an argument for tighter monetary policies (higher interest rates) from the Federal Reserve (Fed), European Central Bank (ECB), and Bank of Japan (BoJ). Nevertheless, we believe that these figures likely are masking distortions in the region s labor markets. Chart. Levels of Part-Time and Temporary Workers Remain Elevated Rate (%) 1 1 1 1 1 1997 U.S. 1999 1 3 5 7 9 11 13 15 17 U.S. Headline Unemployment U.S. U Marginally Employed Unemployment Low - April U Low -- October Rate (%) 35 3 5 15 1 5 Eurozone Data represents, 13, 17 Percent. 1.75 1..75.5.5. 19.75 19.5 19.5 19. Japan Jan-13 Jun-13 Nov-13 Apr-1 Sep-1 Feb-15 Jul-15 Dec-15 May-1 Oct-1 Mar-17 Temporary and Part-Time Workers as % of Labor Force Sources: Wells Fargo Investment Institute, Bloomberg; 9//17. Note: Eurozone Panel : Blue Bar = total employed and underemployed rate; Gray Bar = headline unemployment rate. As the headline jobless rates suggest, more individuals are entering the workforce in the U.S., Eurozone and Japan, yet the type of employment they are finding does not naturally lend itself to higher wages. Various measures from the U.S. Bureau of Labor Statistics, the European Union s (EU) Eurostat, and Japan s Ministry of Health, Labor and Welfare reflect an elevated trend of individuals employed in part-time and temporary assignments (Chart ). It is these kinds of jobs in which a worker is marginally attached to the labor force and has a more limited ability to negotiate higher wages. Chart 3. Relationship between U.S. U Rate and Has Fallen Apart Y/Y (%) 9 7 5 3 1-1 - U Rate (Lagged 1 Year)? 1 1 1 1 1 U Underemployment Rate (%) Sources: Wells Fargo Investment Institute, Bloomberg; 9//17 17 Wells Fargo Investment Institute. All rights reserved. Page of
In the U.S., there historically has been an inverse relationship between wage growth and the U rate, which includes the unemployed as well as part-time and marginallyemployed workers (Chart 3). This suggests that wages rise as employer demand for labor increases amid a shallower pool of applicants, later prompting individuals employed in part-time and marginal positions to enter the formal job market. This is reflected in the lagged relationship between wage growth and U one year later. The continued weak trend in U.S., Eurozone and Japanese wage growth suggests that labormarket conditions could remain distorted for some time. Some investors may ask why these labor-market distortions even matter to central banks in the first place. For starters, the Fed s dual mandate of maximum employment and stable prices directly addresses the question. For the ECB and BoJ, the relationship between employment conditions and wage growth often is tied to potential inflationary pressures. Chart illustrates that headline inflation rates in the U.S., Eurozone and Japan have, at the very least, had a coincidental relationship with the pace of wage growth 1 months prior. Policy Rates Likely to Remain Lower for Longer Over the past few months, the historical relationship between wage growth and inflation (along with its recent weakness) has become a point of focus in monetarypolicy speeches delivered by Fed Chair Janet Yellen, ECB President Mario Draghi, and BoJ Governor Haruhiko Kuroda. Given this recent point of focus, looking forward, we believe that the Fed, ECB and BoJ are likely to keep rates lower for longer so long as data suggests that widespread labor-market distortions persist. A renewed commitment to lower interest rates is likely to impact activity in global equity, bond and currency markets. First, we believe that lower interest rates could help support the current global corporate earnings rebound as the cost of borrowing for businesses and consumers remains subdued. This earnings recovery has become more pronounced outside of the United States, and we expect this trend to continue into the coming year. While we maintain a neutral tactical recommendation on developed and emerging market equities, we believe that improving earnings fundamentals mean that now may be an opportune time for investors who are underinvested in foreign markets to bring their international-equity exposure up to their target strategic allocations. Second, for developed fixed-income markets, we expect government bonds to continue to benefit from a near-term price bounce as market participants reset rate expectations lower through year-end. An anticipation of tighter global monetary policy helped to push U.S., Japanese and Eurozone government bond yields higher in early July. This trend has reversed in recent months as central-bank heads have expressed caution over their respective labor markets and weaker inflation expectations. As bond prices strengthen, we caution investors to avoid being tempted by high-yield, low credit quality sectors of the bond market. We expect these sectors to be most sensitive to bouts of price volatility when policymakers at the Fed and ECB take action on tighter monetary policies. 17 Wells Fargo Investment Institute. All rights reserved. Page 3 of
Nevertheless, we believe that the recent cautiousness on monetary-policy tightening is tied to labor-market conditions, and we expect the Fed s policy-rate normalization in 1 to be influenced by it. Similarly, we expect ECB policymakers to announce a glide path off of negative interest rates, which is likely to begin after the central-bank s asset purchase program is concluded next year and labor-market conditions improve. In general, however, we anticipate that renewed market expectations for potential Fed and ECB policy tightening will put upward pressure on the interest-rate environment at the start of 1. Chart. Relationship between and Core Inflation Varies by Region Inflation Y/Y Change (%) 9 7 5 3 1-1 - U.S. Sep-9 Aug- Jul- Jun- May- Apr- Mar-1 Feb-1 Jan-1 Dec-15 Core CPI (Lagged 1 Year). 3.5 3..5. 1..5. Y/Y Change (%) Core Inflation Y/Y Change (%) - - - - Eurozone Mar-9 Feb- Jan- Dec-3 Nov-5 Oct-7 Sep-9 Aug-11 Jul-13 Jun-15 Core CPI (Lagged 1 Year) 3..5. 1..5. Y/Y Change (%) Core Inflation Y/Y Change (%) - - - - Japan Mar-9 Mar- Mar- Mar- Mar- Mar- Mar-1 Mar-1 Mar-1 Mar-1 Core CPI (Lagged 3 Months) 3..5. 1..5. -.5-1. - -. Y/Y Change (%) Sources: Wells Fargo Investment Institute, Bloomberg; 9//17 Finally, currency markets also are likely to be influenced by changes in monetarypolicy expectations. We believe that the U.S. dollar could strengthen modestly through year-end 17 as some market participants reset expectations on how quickly the Fed, ECB and BoJ will normalize policy. While the Fed and ECB could move on higher rates next year, we believe that market participants may have gotten ahead of themselves this year in terms of the timing, setting up currencies like the euro for a near-term pullback through year-end 17. This should favor the dollar in the near term. Nevertheless, we expect the U.S. dollar to face headwinds into 1 as the discussions involving higher rates from the ECB gain pace. 17 Wells Fargo Investment Institute. All rights reserved. Page of
Economic Calendar Date Report Estimate Previous 9//17 S&P CoreLogic CS -City MoM SA.3%.11% 9//17 S&P CoreLogic CS -City YoY NSA 5.7% 5.5% 9//17 S&P CoreLogic CS -City NSA Index --.5 9//17 S&P CoreLogic CS US HPI YoY NSA -- 5.77% 9//17 S&P CoreLogic CS US HPI NSA Index -- 19. 9//17 New Home Sales 59k 571k 9//17 New Home Sales MoM 3.3% -9.% 9//17 Conf. Board Consumer Confidence 1 1.9 9//17 Conf. Board Present Situation -- 151. 9//17 Conf. Board Expectations -- 1 9//17 Richmond Fed Manufact. Index 13 1 9/7/17 MBA Mortgage Applications -- -9.7% 9/7/17 Durable Goods Orders 1.% -.% 9/7/17 Durables Ex Transportation.%.% 9/7/17 Cap Goods Orders Nondef Ex Air.% 1.% 9/7/17 Cap Goods Ship Nondef Ex Air.5% 1.% 9/7/17 Pending Home Sales MoM -.5% -.% 9/7/17 Pending Home Sales NSA YoY -- -.5% 9//17 GDP Annualized QoQ 3.1% 3.% 9//17 Personal Consumption 3.% 3.3% 9//17 GDP Price Index 1.% 1.% 9//17 Core PCE QoQ.9%.9% 9//17 Initial Jobless Claims 5k 59k 9//17 Continuing Claims 1995k 19k 9//17 Advance Goods Trade Balance -$5.1b -$5.1b 9//17 Wholesale Inventories MoM.%.% 9//17 Retail Inventories MoM -- -.% 9//17 Bloomberg Consumer Comfort -- 5. 9//17 Kansas City Fed Manf. Activity -- 1 9/9/17 Personal Income.%.% 9/9/17 Personal Spending.1%.3% 9/9/17 Real Personal Spending -.%.% 9/9/17 PCE Deflator MoM.3%.1% 9/9/17 PCE Deflator YoY % 1.% 9/9/17 PCE Core MoM.%.1% 9/9/17 PCE Core YoY 1.% 1.% 9/9/17 Chicago Purchasing Manager 5.7 5.9 9/9/17 U. of Mich. Sentiment 95.3 95.3 9/9/17 U. of Mich. Current Conditions -- 113.9 9/9/17 U. of Mich. Expectations -- 3. 9/9/17 U. of Mich. 1 Yr Inflation --.7% 9/9/17 U. of Mich. 5-1 Yr Inflation --.% 1//17 Markit US Manufacturing PMI -- 53 1//17 ISM Manufacturing 5 5. 1//17 ISM Prices Paid -- 1//17 ISM New Orders --.3 1//17 ISM Employment -- 59.9 1//17 Construction Spending MoM -- -.% Source: Bloomberg as of 9//17 17 Wells Fargo Investment Institute. All rights reserved. Page 5 of
Risks Considerations Currency risk is the risk that foreign currencies will decline in value relative to that of the U.S. dollar. Exchange rate risk between the U.S. dollar and foreign currencies may cause the value of the portfolio's investments to decline. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities. There is no guarantee dividend-paying stocks will return more than the overall market. Dividends are not guaranteed and are subject to change or elimination. Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets. Investments in fixed-income securities are subject to interest rate, credit/default, liquidity, inflation and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond's price. Credit risk is the risk that an issuer will default on payments of interest and principal. This risk is higher when investing in high yield bonds, also known as junk bonds, which have lower ratings and are subject to greater volatility. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity. Definitions An index is unmanaged and not available for direct investment. General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 917-7 17 Wells Fargo Investment Institute. All rights reserved. Page of