US Economy Update October 2015 MACRO REPORT Key Insights Monica Defend Head of Global Asset Allocation Research Andrea Brasili Senior Economist Global Asset Allocation Research Also contributing Riccardo Soggiu Senior Economist, Central Banks Global Asset Allocation Research 2015-2016 Outlook: Final Q2 GDP tells a story of sustained consumption growth, fueled by gains in the labor market and further helped by purchasing power gains due to low oil prices. These factors have allowed US consumers to become more cautious (savings rate rose further) while simultaneously sustaining growth. These gains will not wane soon, and constitute strong insurance for US economic growth, despite challenges coming from external demand (strengthening USD, slowing EM growth). Inflation: To say it with Chairwoman Yellen, the 12-month change in total Personal Consumption Expenditures (PCE) prices is likely to rebound to 1-1/2 percent or higher in 2016, barring a further substantial drop in crude oil prices and provided that the dollar does not appreciate noticeably further. In addition, the contribution to low inflation from labour market slack has been steadily declining. The persistency of core inflation and the appearance of some wage pressures suggest that headline inflation will bounce back quite rapidly at the start of 2016, converging to core and nearing 2% for CPI inflation (likely a bit less for PCE deflator, as usual). On the monetary policy front: we expect the Central Bank to start hiking rates in one of the last two meetings of 2015, althought clearly the Fed has signalled that it prefers to err on the side of caution, and that it will take into account external conditions more than in the past. Graduality, in our view, is and will be the code word for the upcoming rate normalization. Macro Pulse Source: Pioneer Investments. Data available as of October 1, 2015. 1
Economic Conditions Growth & Economic Trend We learned that US GDP rose by a notable 3.9% QoQ annualized in Q2, giving a picture of a healthy economy, with personal consumption (up 3.6% QoQ annualized and contributing 2.42% to GDP growth) being the primary engine of growth. In general, domestic demand was particularly strong with investments up both in the residential (9.4% QoQ, slightly slowing but still a huge pace) and non residential (+4.1% QoQ annualized, accelerating) components. Net exports contributed positively, albeit marginally, but any assessment is made difficult by the volatility due to the erratic Q1 figures. The US economy rebound in Q2 was stronger than suggested by the first releases, thanks to consumption and investments. Figure 1. US GDP Contributions 6% 4% 2% 0% -2% -4% 2012:Q1 2012:Q4 2013:Q3 2014:Q2 2015:Q1 Economic Health in the Macro Pulse PCE Resid. Investment Non Res. Investment Gov.Cons Inventories Net Export Source: U.S. Bureau of Economic Analysis, Datastream, Pioneer Investments, as of September 28, 2015. It is in any event clear that the strength of the USD is putting some pressures on the manufacturing sector (and on inflation, see below). Government consumption gave a non trivial positive contribution (after two quarters of slight negative ones) while inventories was neutral after a huge contribution in Q1. Fueling consumption: the pace of PCE has been quite strong recently, with the average of the last 4 quarters at 3.3% QoQ ann. versus 1.8% in the period 2011-2014Q1, as the graph below shows. Figure 2. PCE QoQ annualized in the Period 2011-2015 Q2 5,0% 4,0% 3,0% 2,0% 1,0% 0,0% Q2 11 Q4 11 Q2 12 Q4 12 Q2 13 Q4 13 Q2 14 Q4 14 Q2 15 Source: U.S. Bureau of Economic Analysis, Datastream, Pioneer Investments, as of September 28, 2015. There are two main factors behind this performance, the further strengthening of the labour market (more on that below) and the improvements in real disposable income due to the decline in oil and commodity prices. It is obvious that there has 2
been a quite strong increase in real disposable income, that has allowed consumers to spend more while maintaining a relatively cautious (vis a vis historical experience) stance, as reflected in a stable savings rate in the proximity of 5%. Real disposable income rose notably due to declining energy prices. Savings rates are quite stable. Figure 3. Real Personal Income and Savings as a % of Disposable Income 8% 6% 4% 2% 0% -2% -4% 12% 10% 8% 6% 4% 2% -6% 0% Jan-04 Dec-05 Nov-07 Oct-09 Sep-11 Aug-13 Jul-15 Real personal income (PCE deflated) Source: Bloomberg, Pioneer Investments, as of September 28, 2015.. Savings rate RS Looking at PCE in real terms in late summer, it seems that in Q3 growth continued at approximately the same pace as in Q2 (real PCE rose by 0.3% MoM in July and by 0.4% in August, and even a slowing in September to 0.2% would mean hitting another 3.6% QoQ ann. for the quarter). Another confirmation of the current positive situation for US consumers comes from the housing market; as noted, residential investment rose 9.4% in Q2 after 10.1% in Q1. While the summer has seen growth continuing, it has been less uniform: New Home sales rose both in July and in August, but building permits and housing starts were much bumpier. Nonetheless, National Homebuilder optimism in September hit its highest level since November 2005, suggesting that the combination of an improving personal situation and continued extremely low interest rates is powerful. Residential investments were strong in H1 2015, and housing market indicators are continuing to trend up gently. Index Figure 4. Housing Market is Uptrending Without Excesses Thousand of Units Source: Bloomberg, Pioneer Investments, as of September 28, 2015. In our view: labour market improvements will still be the most carefully watched issue in the US economy. The unemployment rate dropped to 5.1% in August, a notch higher than the Fed members median estimation of the long term natural rate (4.9%). It must be kept in mind that the Fed clearly stated that in the period in which inflation is expected to approach the target, the economy should continue to 3
Two aspects of the labour market continue to lag a bit: the low participation rate, and the high level of employees working part time. But job quits and openings are telling a different story. grow (as it is doing now) slightly more than potential and hence the unemployment rate could fall below its natural level. Chairwoman Yellen also suggested that some slack remains in the labour market, hinting at the usual concepts to highlight it: participation rate, the number of people working part time who would prefer to work full time, and the churn rate. Let s review them quickly. The participation rate has declined quite steadily, plateauing around 62.6% in recent months (the lowest since 1978), as compared to around 66% before the crisis. While there is surely a demographic component here, there is also evidence of a pool of potentially available workers, restraining the market power of current employees. The number of people working part time for economic reasons (i.e. they would rather work full time) declined 500k units from the peaks in 2013, but it is still 1000k higher than the average in the period 2003-2007. Let s look at the churn rate, i.e., people changing employers, which is the easiest way to increase wages. It was on average 2% of the workforce monthly from 2003-2007, and after bottoming around 1.3% in 2009 it is now at 1.9%. Hence, while some slack may remain in the labour market (and more than is suggested by unemployment being close to its natural rate) it is clearly on the wane. Moreover, the upturn in job openings clearly suggests that the moment in which we will see more evidence of wage pressures may be near. Figure 5. US Labor Market Indicators 3.000 2,5 2.500 2,0 Thousand 2.000 1.500 1.000 500 1,5 1,0 0,5 Thousand of Units 0 0,0 Part time worker f.e.r. Jolts Quits rate RS Source: Bloomberg, Pioneer Investments, as of September 28, 2015. We have outlined a number of areas in which the US economy is displaying improvement. However, it is clear that uncertainties in the global environment have increased, particularly regarding the pace of growth in EMs. We have plugged in a less favourable scenario for two of the external variables involved in our forecasting model. The first is the dynamics of world trade growth that, after a fairly weak H1, we now expect to mildly accelerate, converging towards 3%-3.1% in the course of the forecasting horizon.the second is the nominal effective exchange rate, which we expect to appreciate a little further in the last part of the year. In this context, US growth will accelerate in coming quarters, but to a lesser degree than in our previous forecasts. According to our forecast, GDP growth will hit a peak in YoY terms in Q1 2016, maintain a reasonably high cruise speed in 2016-2017, and will be at 2.6% this year, 2.7% in 2016, slowing to 2.1% in 2017. Just for the sake of easy comparison with Fed projections, Q4 YoY growth will be 2.6%, 2.4% and 2.0% in the three years, vs. 2.1%, 2.3% and 2.2% (the median projections by FOMC members). 4
Headline inflation will likely catch up to core at the start of 2016, likely surpassing 2%, partly thanks to some mild wage pressures. Growth will likely be sustained by PCE, projected to be rise 3.1% this year and 2.8% the next. Consumption will moderate a bit in 2017. Residential investments will be strong for the whole year and at the beginning of 2016, but then will slow due to a rise in interest rates. Conversely, we expect non residential investments to accelerate in 2016. Net exports will be a drag on growth this year and to a lesser degree in 2016, before turning marginally positive in 2017. The opposite will happen to inventories, likely neutral this year and negative in 2016-2107. We have talked a bit about inflation; assuming a further (mild) appreciation of the USD and a slight rise in oil and commodity prices, prices will go up as the base effect of the Q4-2014 Q1-2015 drop in oil prices will vanish. Given the appearance of some mild wage pressures, it seems likely that headline CPI will rapidly converge to the core rate and possibly stay above 2% in 2016. Wages should continue a slight upward trend, helping to strengthen consumption. Economic Policies The US economy no longer seems to require interest rates at the emergency 0 to 0.25% level. Monetary policy The Fed has been preparing financial markets for a future rate increase for some time now. After the «taper tantrum» of the spring of 2013, the Fed has appeared to be very wary of making unexpected moves that might surprise financial markets and thus lead to undesired volatility in financial asset prices. It has therefore made every effort since then to clearly indicate its intentions well in advance. One of the ways in which «Quantitative Easing» has led to higher economic growth, apart from reducing the cost of finance for investments, is via the «asset price inflation» it has created; this has led the owners of assets such as housing and shares to «feel richer» and thus progressively reduce their precautionary savings (which were a significant drag on consumer demand during the more acute phases of the financial crisis). At the April FOMC meeting the prospect of an initial rate hike from June onwards was specified as being data dependent (unemployment and inflation data in particular). In recent meetings the Fed continued to signal «that it will be appropriate to raise the target rate for the Fed Funds rate when it has seen FURTHER improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term». At present, the US economy is expanding at a positive but not particularly brisk pace, while the Unemployment Rate has progressively declined in recent years. Despite the (energy and strong US$ induced) dip in headline inflation so far this year, the US economy no longer seems to require interest rates at the emergency 0 to 0.25% level. Consistent with the «dots» that accompany the official Fed statement, we expect interest rates to begin to increase at one of the remaining 2015 Fed meetings, initially moving to a 0.25% fed funds target, up from the current 0 to 0.25% range. Thereafter the Fed will evaluate the reaction of economic data and of financial markets before enacting further rate increases. While these are quite likely going forward, at the present time an aggressive rate hiking cycle of increases at every meeting is not forecast and does not appear to be in any way likely after having been virtually ruled out by Chairman Yellen in her testimonies so far in 2015. A more probable scenario is one where the Fed waits up to several meetings after each increase before raising interest rates again. A strong US$ on FX markets and weak worldwide economic growth are likely to act as limiting factors on the Fed s ability and desire to raise interest rates at a sustained pace. 5
2015 Triggers and Risks Triggers Stronger-than-expected global growth and trade, resulting in higher demand for U.S. exports, despite strong USD. Improvements in consumer balance sheets, coupled with stable income growth and anchored inflation expectations, could trigger higher confidence and support more sustained patterns of consumption than we currently envisage. Upside for consumption could come from lower oil price and lower inflation. Trans-Pacific Partnership implementation could support investments and confidence. Risks A significantly stronger USD might adversely influence the export sector by making U.S.-produced goods and services more expensive in foreign markets. Lower oil price could have sharper-than-expected effect on investments in oil and gas sector. Despite adjustments in fiscal policy so far, we remain concerned that over the medium term healthcare and social spending could be an important drag on fiscal balances. Renewed geopolitical tensions, involving directly or indirectly the U.S.; particularly renewed tensions with Russia, and the IS story in Middle East. 6
Macroeconomic Forecast US 2013 2014 2015E 2016E 2017E 2014 2015 E 2016 E 2017 E Macroeconomic Forecasts Q1 Q2 Q3 Q4 Q1 Q2 Q3E Q4E Q1E Q2E Q3E Q4E Q1E Q2E Q3E Q4E GDP & Components % YoY % QoQ Annualized % QoQ Annualized % QoQ Annualized % QoQ Annualized GDP 1.5 2.4 2.6 2.7 2.1-0.9 4.6 4.3 2.1 0.6 3.9 2.5 3.2 2.5 2.4 2.3 2.4 2.1 1.8 2.1 2.2 Personal Consumption Expenditures 1.7 2.7 3.1 2.8 2.3 1.3 3.8 3.5 4.3 1.7 3.6 2.9 3.2 2.7 2.4 2.5 2.4 2.4 1.9 2.2 2.2 Government Consumption Expenditures - 2.9-0.6 0.9 2.1 2.0-0.0 1.2 1.8-1.4-0.1 2.6 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 Fixed Investment 4.2 5.3 4.7 4.7 2.7 6.1 5.5 8.0 2.3 3.1 5.1 6.7 5.0 5.0 4.2 3.2 3.0 2.5 2.5 1.6 2.6 Nonresidential 3.0 6.2 3.6 4.8 4.1 8.3 4.4 9.0 0.7 1.6 4.1 5.4 4.2 5.2 5.0 4.7 4.3 3.8 4.0 3.4 3.7 Residential 9.5 1.8 9.3 4.4-3.0-2.7 10.4 3.4 9.9 10.1 9.4 12.7 8.5 4.1 1.2-2.6-2.3-2.9-3.8-5.9-2.4 Total Internal Demand Total Consumption + Fixed Investment+Inventories 2.2 3.2 3.4 3.2 2.4 0.7 5.4 4.4 3.8 3.0 3.9 1.3 3.7 4.1 2.2 1.0 2.3 3.2 1.4 0.6 1.9 Final Internal Demand Total Consumption + Fixed Investment 2.2 3.2 3.5 2.8 2.0 2.2 4.2 4.3 3.9 2.0 3.9 3.7 3.6 3.1 2.7 2.7 2.6 2.4 2.1 2.1 2.3 Exports 2.8 3.4 2.9 3.2 3.6-6.7 9.8 1.8 5.4-6.0 5.1 13.0 3.1-4.7 1.1 12.9 3.5-3.1 1.7 13.1 4.2 Imports 1.1 3.8 5.8 3.5 2.2 2.8 9.6-0.8 10.3 7.1 3.0 6.0 4.6 4.4 0.3 3.3 2.3 3.7-0.1 2.6 2.3 GDP Contributions Net trade 0.2-0.2-0.5-0.1 0.1 - - - - - - - - - - - - - - - - Inventories changes 0.0 0.0 0.0-0.3-0.4 - - - - - - - - - - - - - - - - Economic Trend % YoY % YoY % YoY % YoY Industrial Production 1.9 3.7 1.6 1.6 1.0 2.5 3.7 4.2 4.5 3.5 1.4 0.9 0.5 1.1 2.0 1.8 1.4 1.2 1.1 0.9 0.9 Average Hourly Earnings 2.0 2.3 1.9 2.4 2.8 2.4 2.4 2.4 2.2 1.9 1.9 2.0 1.8 2.1 2.3 2.4 2.7 2.8 2.8 2.9 2.9 Unit Labour Cost 0.8 2.0 1.8 1.4 1.3 3.3 0.9 1.1 2.8 1.1 1.7 3.0 1.5 1.5 1.8 1.1 1.4 1.4 1.4 1.3 1.2 Producer Prices Index 1.2 1.9-2.5 2.7 2.6 1.6 2.9 2.4 0.7-3.3-3.2-2.7-0.8 2.8 2.7 2.7 2.8 2.7 2.6 2.5 2.4 Consumer Prices Index 1.5 1.6 0.3 2.3 2.2 1.4 2.1 1.8 1.2-0.1 0.0 0.2 1.0 2.3 2.2 2.3 2.4 2.3 2.2 2.2 2.1 Unemployment Rate 7.4 6.2 5.3 4.7 4.5 6.6 6.2 6.1 5.7 5.6 5.4 5.1 4.9 4.8 4.7 4.7 4.6 4.5 4.5 4.5 4.4 Source: Pioneer Investments, Bloomberg, Datastream. Update as of 30th of September 2015; for time series with higher frequency (monthly or daily) than quarterly, we consider the quarterly average; in Italic exogenous variables; GDP components on quarterly frequency are %Q/Q annualized rates; all other figures, if not otherwise specified, are %Y/Y. Important Information Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of October, 1, 2015. The views expressed regarding market and economic trends are those of the author and not necessarily Pioneer Investments, and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Pioneer Investments product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: October 5, 2015. Follow us on: www.pioneerinvestments.com 0824_1015 7