Rebalancing Economic Themes and Emerging Risks for the Balance of 2016 Page 1
Themes Oil s Not Well A world of cheap petroleum Eastern Anxiety China attempts a difficult transition Growing Prospects Central banks tackle a complicated mandate Age Isn t Just a Number Demographics and economic performance Page 2
Sapping Energy Page 3
Per Barrel Per Gallon Millions of Barrels, 12-Month MA Depths of Decline Crude prices have fallen by two-thirds in 18 months Production continues to expand $120 $100 Oil and Gasoline Price Trends WTI Crude Oil (Left Scale) Gasoline (Right Scale) $4.00 $3.50 2000 1600 Rig Count (Left Scale) U.S. Crude Production (Right Scale) 300 280 $80 $3.00 1200 260 $60 $2.50 800 240 $40 $2.00 400 220 $20 Jun-14 Dec-14 Jun-15 Dec-15 $1.50 Sources: Bloomberg, EIA 0 Jun-14 Dec-14 Jun-15 200 Page 4
Millions of Barrels No Relief in Sight Running out of storage capacity This is a supply story 500 U.S. Crude Oil Inventories 3.0% Oil Supply and Demand Growth Global Supply Global Demand 450 2.5% 400 350 300 250 2.0% 1.5% 1.0% 0.5% 200 0.0% 1982 1992 2002 2012 2011 2012 2013 2014 2015 Sources: Department of Energy, BP, Northern Trust Page 5
Per barrel Billions Pain Points Social benefits and interest payments must be sustained How long can the game go on? $140 Oil Producers: Fiscal Breakevens $800 Saudi Arabia: Foreign Reserves $120 $100 $700 $80 $60 $600 $40 $500 $20 $0 Current Price Sources: IMF, Haver Analytics $400 $300 2002 2003 2004 2005 Page 6
Jan 2013 = 100 The Benefits of Cheap Fuel The proceeds have not been used to enhance savings Spending outside of retail on rent and health care 115 110 105 100 95 U.S. Household Trends Saving Rate (right) Personal Income 8% 7% 6% 5% 4% 100% 80% 60% 40% 20% 2013 2014 2015 2016 Total Savings Spending Detail Sources: Haver Analytics, JP Morgan Institute 0% How Have Consumers Spent Gasoline Savings? Other Durable Goods Non-Durable Goods Services Gasoline Savings Page 7
Exposure to Energy Energy lending is only 3% of total lending at U.S. banks Most credit has been sourced from the markets Energy Loans as a Percent of Total Bank Loans Wells Fargo Morgan Stanley JPMorgan Goldman Sachs Citigroup Bank of America 0% 2% 4% 6% 18% 15% 12% 9% 6% 3% High Yield Bond Spreads Ex-Energy Energy 0% 2012 2013 2014 2015 2016 Sources: Reuters, Bloomberg, Haver Analytics Page 8
China s Challenges Page 9
Year-over-year change China: Seeking Sustainability Slowing pace of growth Heavy industry hindered by slow global demand 14% 12% 10% China: Real GDP Growth QOQ Annualized YOY 25% 20% China: Industrial Production 8% 15% 6% 10% 4% 2% 5% 0% 2010 2013 Source: Haver Analytics 0% 2010 2011 2012 2013 2014 2015 Page 10
Year-over-year change Debt as a percent of GDP China: The Challenge of Managing Leverage Credit at all levels has been growing very rapidly 35% 30% China: Credit vs. GDP Growth Nominal Growth Private Sector Credit Growth 40 China: Local Government Debt 25% 30 20% 15% 20 10% 10 5% 0% 0 2009 2010 2011 2012 2013 2014 2007 2009 2011 2013 Sources: Wall Street Journal, Haver Analytics Page 11
Billions Trillions Controlling Capital Money has been leaving China Pressure on asset and currency values $100 China: Capital Outflows $5.0 China: Foreign Exchange Reserves $50 $0 -$50 -$100 -$150 -$200 -$250 $4.0 $3.0 $2.0 $1.0 $0.0 2011 2012 2013 2014 2015 2007 2009 2011 2013 2015 Sources: Goldman Sachs, Haver Analytics Page 12
Potential Contagion Dependence on China and commodities drives weakness Direct U.S. exposure is modest, indirect exposure is large EMs: Exports to China Currency Depreciation Since May Oman South Korea Chile Peru Brazil Saudi Arabia Malaysia Thailand Colombia Vietnam Indonesia South Africa Russia 0 10 20 30 40 50 Percent Share of Total Goods Exports Russia Colombia Kazakhstan Zambia Malaysia Chile Brazil Mexico Turkey South Africa Indonesia South Korea Source: IMF, Haver Analytics 0 10 20 30 Change versus U.S. dollar Page 13
Central Strategies Page 14
Challenges for Central Bankers Global forces challenge local policy Can central banks control inflation as effectively as they used to? Risking addiction to extraordinary measures At some point, economies need to demonstrate self-sufficiency Balancing mandates Currency control, financial stability, inflation, etc. Maintaining independence The extremes of policy have attracted more attention from politicians Communicating effectively The most honest outlook is also the least helpful to markets Page 15
Current Interest Rates Monetary policy is very easy in developed markets Safe assets are popular at any price 0.60% 0.40% 0.20% 0.00% -0.20% -0.40% -0.60% -0.80% -1.00% Central Bank Deposit Rates Fed BoE ECB BoJ SNB 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% Sources: Haver Analytics, Bloomberg Sovereign Yield Curves U.S. Germany Switzerland 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 30Y Maturity Page 16
Percent change, year-over-year The Fed s Dual Mandate Joblessness has fallen sharply in the last two years Inflation has been creeping up Unemployment Rate Broad Unemployment Rate 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 2007 2009 2011 2013 2015 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Sources: Bureau of Labor Statistics, Bloomberg Target U.S. Inflation Overall Core CPI PCE Deflator Page 17
U.S. Credit Creation and Capital The banking channel is open The basis for taking risk has been reinforced 15% U.S. Lending Growth 13% Tier 1 Capital Ratio Top 10 U.S. Banks 10% 12% 11% 5% 10% 9% 0% 8% 7% -5% C&I CRE 6% RRE Credit Card -10% 5% 2011 2012 2013 2014 2015 2009 2010 2011 2012 2013 2014 2015 Sources: Federal Reserve, SNL, Haver Analytics Page 18
Year over Year Change Draghi s Dilemma Clean balance sheets facilitate credit creation Monetary policy cannot compensate for poor capital Eurozone Lending 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% 2009 2010 2011 2012 2013 2014 2015 2016 36% 30% 24% 18% 12% 6% 0% Non-Performing Bank Loans 2012 2013 2014 Source: Haver Analytics. IMF Financial Sector Indicators Page 19
A Few Words on Negative Interest Rates Less Stigma than 2008 Little, if any hoarding of currency Institutional markets have adjusted comfortably Quantitative Easing may have lost its luster Successive rounds have been less effective Central banks are unnatural asset managers Some complications to respect Retail depositors may not react well Money market mutual fund dislocations System constraints For the U.S., a remote possibility for now Page 20
Systemic Issues? 300 250 200 150 Commercial Property Price Index CRE Lending (left) Standards recently tightened Cyber Security Trends in payments and information flow Asset Managers The new shadow banking system? A Prolonged Search for Yield 100 2007 2009 2011 2013 2015 Source: Federal Reserve Investors gravitate towards asset classes they are not naturally comfortable with Page 21
Aging Gracefully Page 22
Slow Population Growth Modest growth and shifting composition across markets Potential for a shrinking labor force 2.5% World Population Growth 68% U.S. Labor Force Participation Rate 2.0% 65% 1.5% 62% 1.0% 59% Projected 0.5% 56% 0.0% 53% 1950 1970 1990 2010 2030 1950 1970 1990 2010 Sources: Bureau of the Census, CBO Page 23
Sustaining Population Promoting fertility rarely works Accepting new entrants successfully is key Fertility Rates Per Woman, 2013 Immigrant Population, 2013 1.9 1.9 China Japan U.K. 1.5 Germany 1.4 U.S. Ireland Canada Eurozone U.K. Japan U.S. 0% 5% 10% 15% 20% 25% Sources: CIA, United Nations Page 24
$Billions The Long-Term is Here Aging populations can stress retirement systems Most Americans are woefully unprepared 400% 350% 300% Social Security Trust Fund Ratio (Assets as a % of Annual Benefits) History Intermediate Low-cost High-cost 3500 3000 State Pension Funds Assets Liabilities 250% 2500 200% 150% 2000 100% 50% Minimum level for full benefit payments 1500 0% 1000 2000 2005 2010 2015 2020 2030 2055 2080 Sources: Social Security Administration, Pew Center 1997 1999 2001 2003 2005 2007 2009 2011 Page 25
Our Expectations Global Economic Forecast January 2016 2013 2014 2015F 2016F United States Real GDP (% change) 1.5 2.4 2.4 2.4 Unemployment Rate (%) 7.4 6.2 5.3 4.9 Inflation (%) 1.5 1.6 0.1 1.2 Policy Rate (Top), EOP (%) 0.25 0.25 0.50 1.00 Eurozone Real GDP (% change) -0.3 0.9 1.5 1.7 Unemployment Rate (%) 12.0 11.6 11.0 10.5 Inflation (%) 1.4 0.4 0.1 1.0 Policy Rate, EOP (%) 0.75 0.25 0.05 0.05 Deposit Rate, EOP (%) 0.0-0.20-0.30-0.30 United Kingdom Real GDP (% change) 2.2 2.9 2.4 2.6 Unemployment Rate (%) 7.6 6.2 5.4 5.5 Inflation (%) 2.6 1.5 0.1 1.0 Policy Rate, EOP (%) 0.50 0.50 0.50 1.00 Japan Real GDP (% change) 1.4-0.1 0.5 0.9 Unemployment Rate (%) 4.0 3.6 3.4 3.3 Inflation (%) 0.4 2.8 0.1 0.4 Policy Rate, EOP (%) 0.10 0.10 0.10 0.10 China Real GDP (% change) 7.7 7.3 6.9 6.5 Unemployment Rate (%) 4.1 4.1 4.1 4.1 Inflation (%) 2.6 2.1 1.5 2.0 Policy Rate, EOP (%) 3.00 3.00 1.5 1.25 Exchange rates (EOP) Dec-2015 Mar-2016F Jun-2016F Sep-2016F EUR/USD 1.09 1.08 1.07 1.05 GBP/USD 1.49 1.50 1.48 1.47 USD/JPY 120.3 123 125 122 Page 26
Parting Thoughts The global outlook is cloudy We expect China to avoid a hard landing Performance will continue to be somewhat uneven Some regions and sectors are further along Risks to the outlook are varied Potential for further instability Page 27
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