US ECONOMIC OUTLOOK Joseph Brusuelas Chief Economist RMS US LLP October 2016
US Economic Outlook Base Case: Trend US growth near 2 percent in 2016 Long-term growth trend 1.5 percent Sustained growth above 2% implies risk of rising inflation, labor market tightening, and rising wages Q3 16 GDP tracking at 2.4% 2016 Recession probability near 20% Middle market business index indicated slowing growth mid-year Household consumption to remain solid near 2.5 percent Service spending remains solid. Q2 16 consumption tracking increased at 4.3% pace Likely to slow in Q3 16 to more sustainable pace near 3% Residential recovery accelerates Starts to 1.1 million at annualized pace Traditional building season underway Major supply issues in new home markets
Millions Residential Investment 2.3 2.1 Housing Starts Building Permits (2 Month Lead) 1.9 1.7 1.5 1.3 1.1 0.9 0.7 0.5 0.3 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: RSM US, US Census
US Growth Forecast 2015-2017 Q1'15 Q2'15 Q3'15 Q4'15 Q1'16 Q2'16 Q3'16 Q4'16 2017 Real GDP Unemployment CPI PCE Core 0.6 3.9 1.8 1.0 0.8 1.4 2.4 1.9 1.7 5.6 5.4 5.2 5.0 4.8 4.7 4.9 4.9 4.9-0.1 0 0.21 0.6 1.1 1.1 1.4 1.8 2.3 1.3 1.3 1.3 1.4 1.7 1.6 1.7 1.8 1.8 Central Bank Rate 3-Month Rate 2-Year Note 10-Year Note EUR/USD 0.25 0.25 0.25.25 0.25.25.25.50 1.0 0.27 0.28 0.32.61 0.66 0.66.71.72 1.11 0.56 0.64 0.63 1.05.72.58.71.92 1.2 1.92 2.35 2.04 2.27 1.77 1.47 1.48 1.73 2.0 1.07 1.11 1.12 1.09 1.12 1.11 1.10 1.09 N/A
1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Percentage Probability Recession Probability Low 100 90 80 70 60 50 40 30 20 10 0 Source: RSM US Recessions Recession Probability Index
US Economic Outlook Fixed Business Investment Still Contracting Dependent on floor in oil, energy and commodities holding Corporate earnings contracted in five of the past six quarters Monitor capital expenditures as US nears election RSM MMBI indicates firms pulling back on capital expenditures and inventories going forward Government spending supportive of growth Lifting of fiscal ceiling agreement to add 0.2 ppts to growth in 2016 Highway spending bill supportive of growth Temporary government spending bill keeps federal government operating until December 9 Major risks are external and around 2016 US election Policy uncertainty rising as election intensifies Risk to capital expenditures and hiring.
US Economic Outlook Domestic Economic Challenges Regional variation in economic growth accelerating Dodd-Frank asymmetrically impacting U.S. northeast Strong dollar negatively impacting manufacturing in upper Midwest. Bank and insurance business model is at risk due to zero interest rate policy State of national infrastructure holding back growth Political polarization a risk should recession arrive in 2017 due to diminishing returns from monetary policy and need for fiscal stimulus once business cycle comes to an end.
Index Modest Manufacturing Rebound 80 ISM Manufacturing ISM New Orders Contraction=Less Than 50 Recession= Less Than 43.1 70 60 50 40 30 20 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: RSM US, Bloomberg
Year-Over-Year Percentage Change Modest Manufacturing Rebound 0.3-0.7-1.7-2.7-3.7-4.7-5.7-6.7-7.7-8.7-9.7-10.7 Industrial Production Manufacturing Durable Goods Non-Durables Mining
Manufacturing Outlook: Autos Auto Outlook Auto spending still at robust levels Inventories remain well managed How long can automakers sustain incentive based invoice pricing Subprime and leasing as a percentage of total transactions Drivers Demographics Technology and Connectivity Fuel Efficiency Age of the U.S. fleet Challenges Tesla Apple and Google Self driving cars and ride sharing
Days Supply Auto Inventories Well Managed 90 85 Days Supply=61 (RHS) Manageable Inventory Days Supply=65 80 75 70 65 60 55 50 45 40 2012 2013 2014 2015 2016 Source: RSM US, Bloomberg
Manufacturing Outlook: Aerospace Orders Boeing Backlogs: 5 Years for narrow body and wide body aircraft Orders for Boeing 737 s and A320 s drive earnings Airbus backlogs solid Embraer and Bombardiers much shorter Challenges Introduction of new and repowered aircraft Excess aircraft orders and cancellations from abroad Cash outlays to expand production Improved profitability for older aircraft due to low fuel prices
Pecentage of GDP Insufficient Private Fixed Investment 21% 20% 19% 18% 17% 16% 15% 14% 13% 12% 1973 1978 1983 1988 1993 1998 2003 2008 2013 Source: RSM US, BEA
US Economic Outlook Risks to the Outlook: Global growth decelerates to 2.9 percent with downside risk Emerging markets and MENA states face challenging year European sovereign debt and financial tensions simmer Brexit triggered increase in E.U. banks credit default swaps European banking system needs to be recapitalized to the tune of 150-200 billion Deutsche Bank and Italian banks at risk Italian referendum in late 2016 a potential game changer Pullback in Chinese growth and fixed business investment Shifting Chinese growth dynamics to damp recovery in commodity prices US Policy Risk Following Election U.S. federal government and the commercial community CRE and auto lending a risk.
Index E.U. Banking & Credit Default Swaps 400 350 S&P/ISDA CDS Select OTR Weighted Average Index Spread DB 5-Year Credit Default Swaps 300 250 200 150 100 50 0 2012 2013 2014 2015 2016 Source: RSM US, Bloomberg
Percentage (Annual) Percentage (Annual) China s Debt Problem 260 170 250 240 230 160 150 220 140 210 200 130 190 180 170 160 China Total Debt as a Percentage of GDP (LHS) China Corporate Debt as a Percentage of GDP (RHS) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 120 110 100 Source: RSM US, Bloomberg
Index US & EU Policy Uncertainty Elevated 300 275 250 225 200 European Economic Policy Uncertainty Composite Index (LHS) US Economic Policy Uncertainty Composite Index (RHS) 250 225 200 175 175 150 125 100 75 150 125 100 75 Index 50 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 50 Source: RSM US, Bloomberg
US Policy and Rate Outlook Rate Drivers Negative interest rates have caused more than $10 trillion in global fixed income securities to post negative yields. This is driving capital into the U.S., German and Japanese bond market driving down yields. Long term rates range between 1.4 percent and 1.7 percent. Risk of much lower rates due to negative rate policy in Europe and Japan Risk of test of 1 percent should the financial situation in Europe deteriorate Differentials in growth, inflation and employment between U.S. & the rest. Capital flows from EU, Asia and EM space to keep rates low at the long end of the curve even as Fed tightens Fed likely to hike by 25 bps in December 2016 and another 50bps in 2017
US Policy and Rate Outlook Rate Outlook Policy Direction at Fed: Gradual rate normalization should growth continue Low real neutral interest rate and slow growth What will the Fed do if the economy slows or falls into recession? Integration of monetary and fiscal policy Fed financed tax cuts Yield curve targeting Purchasing wider array of assets Return of QE and forward guidance Targeting nominal GDP and lifting inflation target. Fiscal Policy: Policies to support greater spending Infrastructure spending Expanding of social safety net Begin issuing 50 year debt 20
Z-Score Global Financial Conditions 3 Z-Score of Zero Indicates Neutral 2 1 0-1 -2-3 -4-5 Bloomberg Financial Conditions Plus=0.56 Bloomberg EU Financial Conditions Index=--0.291 Bloomberg Asia Financial Conditions Index Excluding Japan=0.066-6 2011 2012 2013 2014 2015 2016 Source: RSM US, Bloomberg
Yield (Percentage, Monthly Average) Global Interest Rate Benchmarks 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5 Germany 10Y Yield US 10 Year Yield -1.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: RSM US, Bloomberg
US Spending Outlook Non-Durables Structural shift in retail spending to accelerate towards online purchases and away from traditional big box and mall anchors Electronics and home improvement outlays to remain solid Service Sector Wage and job gains to support strong demand for services Experiential, accommodation and recreation behind recent spending surge Gasoline prices to cool further this year Risk to spending Rising rents, service and medical service inflation
3-Month Annualized Percentage Change Retail Sales Easing Mid-Year 9.0 8.0 Retail Sales Ex-Autos Ex-Gasoline Ex-Autos & Building Materials Ex-Autos & Gasoline Ex-Food Service Ex-Building Materials & Auto Dealers Control Group 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0-1.0 January'16 February'16 March'16 April'16 May'16 June'16 July'16 August'16 Source: RSM US, Bloomberg
Percentage Vacancy Rate Implies Rising Shelter Costs 6 7 Rental Vacancy Rates (LHS, Inverted) US CPI Rent of Shelter (RHS) 6 5 8 9 10 11 4 3 2 1 0-1 Year-Over-Year Percentage Change 12 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016-2 Source: RSM US, Bloomberg
US Employment Outlook Sustained employment gains and falling unemployment to support solid spending outlook. Slowing trend in monthly job growth likely to define 2016 as economy enters full employment 2016 Average is 160,000 per month Hiring of roughly 75,000 to 100,000 per month sufficient to bring down unemployment rate Unemployment falls to 4.5 percent by end of 2016 Jobless claims near historic 1973 lows. Pace of firings remarkably stable implying full employment has arrived. Wage pressures slowly building imply upside risk to spending outlook. Wages set to increase above 3 percent next year Workers that change jobs earn a 4.3% increase in wages according to the Atlanta Fed. Scarcity of technically skilled, semi-skilled and public facing employees to define labor market and driving up premiums at upper end of the employment ladder Minimum wage and Department of Labor overtime regulations debate to intensify
Job Openings Per Person Labor Market Tightening 7.0 6.5 Number of Unemployed Persons Per Job Opening=1.44(LHS) 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: RSM US, BLS
Year-Over-Year Percentage Change Rising Wages: Controlling for Retirees 7 Overall Job Switcher 6 5 4 3 2 1 0 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Atlanta Fed
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