Economic Update: Fed Takes on Growth Chris Low June 6, 2018 Chief - PowerPoint PPT Presentation

0 Economic Update: Fed Takes on Growth Chris Low June 6, 2018 Chief Economist

On the one hand… Rising yields reflect changing Fed goals Fear of deflation & zero lower bound dominated Bernanke/Yellen Fed  Powell says will respect PhDs on the committee  Old-school Phillips curve thinking reemerging 

10-yr US Treasury yield 2 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: Bloomberg

The long decline in the natural rate 3 5.0% Williams-Laubach r* estimate 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 Source: San Francisco Fed. Williams-Laubach two-sided estimates

Real 10-yr yield Reflects supply of/demand for credit 4 3.5% 10-yr TIPS yield 3.0% Old Normal 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% 2003 2005 2007 2009 2011 2013 2015 2017 Source: Bloomberg

10-yr breakeven inflation expectations Average inflation expected over next 10 years 5 3.00% 2.75% Old Normal 2.50% 2.25% 2.00% 1.75% 1.50% 1.25% 1.00% 0.75% 0.50% 0.25% 0.00% 2003 2005 2007 2009 2011 2013 2015 2017 Source: Bloomberg

Treasury yield curve year-end 2017 & now 6 3.00% 2.50% 2.00% Dec '17 1.50% Now 1.00% 100bp 67 65 75bp 58 52 56 58 57 52 49 50bp 30 25bp 0bp 1M 1Y 2Y 3Y 5Y 7Y 10Y 30Y Source: Bloomberg

Economy humming, labor is tight Stronger economy can handle higher rates  Confidence points to increased spending  Higher rates could limit the consumption bounce 

GDP to accelerate past 3.0% in 2018 Problematic for Fed as unemployment falls below 4.0% 8 5.0% GDP with Sector Contributions 4.0% yr/yr% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% Q1-14 Q1-15 Q1-16 Q1-17 Q1-18 Q1-19 Consumption Res Investment Bus. Fixed Invest Inventories Net exports Government Real GDP, Yr/Yr% Final Sales, Yr/Yr% Source: Bureau of Economic Analysis and FTN Financial

Cap spending plans rose before tax cut 9 BRT CEO Survey: Capex Sub-Index & Private Fixed Invest IP Equipment 150.0 30% CEO Survey: Capex Sub-Index (left) 125.0 20% Business equipment investment, y/y%, right 100.0 10% 75.0 0% 50.0 -10% 25.0 -20% 0.0 -25.0 -30% 2004 2006 2008 2010 2012 2014 2016 2018 Source: CEO Roundtable

NFIB small business good time to expand 10 40 Small-business optimism: Good time to expand 35 34% is highest ever. 30 25 20 15 10 5 0 1980 1985 1990 1995 2000 2005 2010 2015 Source: NFIB

ISMs point to strong growth 11 62.0 ISM manufacturing index 60.0 ISM nonmanufacturing index 58.0 56.0 54.0 52.0 50.0 48.0 46.0 2012 2013 2014 2015 2016 2017 2018 Source: Institute for Supply Management

Solid employment growth 12 Nonfarm Payrolls Government Pvt svce producing Change, 000s 400k Goods producing Payrolls 350k 12-mo average 300k 250k 200k 150k 100k 50k 0k -50k -100k Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Source: Bureau of Labor Statistics and FTN Financial

Unemployment rate under 4% 13 10.5% 4.9% 4.7% 9.5% 4.5% 4.3% 4.1% 8.5% 3.9% 3.7% 7.5% Jan-17 Jul-17 Jan-18 6.5% 5.5% 4.5% 3.5% 1990 1995 2000 2005 2010 2015 Source: Bureau of Labor Statistics and FTN Financial

Average hourly earnings weak, but rising 14 4.50% Production & nonsupervisory Year-on-Year % 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 1988 1993 1998 2003 2008 2013 2018 Source: Bureau of Labor Statistics

Faster productivity = higher living standard “To get wages to go up sustainably in the long term we need higher productivity.” - Jay Powell, March 1, 2018

Late-cycle productivity key to happiness 16 7.0% Recessions 6.0% Productivity, yr/yr% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% 1990 1995 2000 2005 2010 2015 Source: Bureau of Labor Statistics

Why productivity is important 17 7.0% Sources of GDP Growth 6.0% Nominal GDP Inflation 5.7% 5.0% 1.6% (GDP Deflator) Real GDP 4.0% 4.1% Nominal GDP Productivity 3.7% growth 3.0% 1.5% 2.5% Real GDP 2.0% 0.8% 2.2% Employment 1.0% 1.6% 1.5% growth 0.0% 1995-99 2013-17 Source: Bureau of Labor Statistics and Bureau of Economic Analysis

Wages should rise faster 18 5.6% Original Phillips Curve From 1998, U6 lagged 3 quarters 5.1% 4.6% Dec. 2019: 4.7% 4.1% Dec. 2018: 4.2% 3.6% Median wage growth 3.1% Latest data 2.6% 2.1% 1.6% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% U6 underemployment rate Source: Atlanta Fed, Bureau of Labor Statistics and National Bank of Canada

But wage inflation… 19 5.6% Original Phillips Curve From 1998, U6 lagged 3 quarters 5.1% 4.6% Dec. 2019: 4.7% 4.1% Dec. 2018: 4.2% 3.6% Median wage growth 3.1% Latest data 2.6% 2.1% 1.6% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% U6 underemployment rate Source: Atlanta Fed, Bureau of Labor Statistics and National Bank of Canada

…does not always trigger price inflation 20 2.0% New-Keynesian Phillips Curve From 1998, U6 lagged 3 quarters 1.8% 1.6% 1.4% 1.2% 1.0% Core PCE Inflation 0.8% Latest data 0.6% 0.4% 0.2% 0.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% U6 underemployment rate Source: Atlanta Fed and Bureau of Labor Statistics

The dot plot and central tendency 21 5% Target federal funds rate at year-end (Mar '18) 4% Central tendency 3% 2% 1% 2018 2019 2020 Longer-Term Note: Each blue dot represent the expectations of one FOMC member. The median target range for 2018 is 2.125, for 2019, it is 2.875%, for 2020 3.375%, and for the Longer-Term is is 2.875%. Source: Federal Reserve and FTN Financial

Median dots and FF futures 22 FOMC dot-plot year- 4.0% Longer-run end medians. FOMC median 3.5% 3.0% 2.5% 2.0% 1.5% Fed funds futures 6/14/18 1.0% Tightening implied by FOMC forecasts - June 2018 0.5% Dec-17 Jun-18 Dec-18 Jun-19 Dec-19 Jun-20 Dec-20 Source: Federal Reserve, Bloomberg, and FTN Financial

What could stop the Fed Emerging market unrest  Higher oil prices  Stock market 

IMF Risks to Global Outlook tilted down 24 Source: IMF

Oil price rising 25 $85 Brent Crude $80 Price per barrel, active contract $75 $70 $65 $60 $55 $50 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Source: Bloomberg

Brent crude in Turkish Lira 26 400 125.88% (143.62% ann.) 350 300 250 200 150 May-17 Sep-17 Jan-18 May-18 Source: Bloomberg and FTN Financial

Emerging market capital flight 27 Argentina tightens as peso stumbles 45% 0.065 40% 0.060 35% 0.055 30% 0.050 25% 0.045 US dollars per peso 20% 0.040 central bank 7D repo rate (left) 15% 0.035 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Source: Bloomberg

Stocks volatile 28 2900 S&P 500 2850 2800 2750 2700 2650 2600 2550 2500 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Source: Bloomberg

Bottom line: Late-cycle dynamics 29  3.5% growth; cools next year  Wage growth rising, inflation low  Fed controls expansion’s length  Productivity necessary to sustain expansion  1-2 more rate hikes this year  Bonds rally as long as Fed is disciplined  Watch for tighter credit in subprime, leveraged loans and foreign bank USD funding