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Economic Outlook 1Q 2015 Economic Outlook OIL, Interest Rates, Jobs .. Oh My! Gregory Miller Chief Economist The ONE THING You Need to Remember The Economy is Stronger Than You Think. First: the Fed … The Fed will begin raising interest rates. It is less important when they do it than it is how much and how fast. Fed aims at “Fed Neutral” – in the neighborhood of 3.5%. Interest Rate Forecast U.S. Treasury Yield Curve Rises and Flattens 3.5 3.0 % 2.5 2.0 1.5 1.0 0.5 0.0 Fed Funds 3 Mo 6Mo 1 Yr 3Q15 2 Yr 4Q16 5 Yr 10 Yr 4Q17 30 Yr Monetary Policy: Transmission Shift is Material The Fed is still providing liquidity. Shift from bond purchase to Fed funds rate shifts liquidity transmission from long-end to short-end of yield curve. o Bond purchases were transmitted to large investors. o Small business and households borrow through banks. o So even as rates rise, more (smaller) investors have access. Rising Rates are not the same as High Rates. Bank lending accelerates during initial phase. Oil: In Economics, All Roads Lead Back to Price The drop in oil prices positive for US economy Prices fell 2/3’s in 200 days. $50 oil implies US gas price at $2.25. $40 oil implies gasoline price at $2.00 US Consumer and US Business – an “after-tax, tax cut” o Implied per driver saving: $1,200 per year. 4.00 3.80 3.60 3.40 3.20 3.00 2.80 2.60 2.40 2.20 2.00 120 100 90 80 Motor gasoline prices: Unleaded gasoline 70 60 West Texas Intermediate 50 Feb 2015 Oct 2014 Jun 2014 Feb 2014 Oct 2013 Jun 2013 Feb 2013 Oct 2012 Jun 2012 Feb 2012 Oct 2011 Jun 2011 Feb 2011 Oct 2010 Jun 2010 40 USD per Barrel, NSA 110 Feb 2010 USD per gal, NSA Crude Oil The Fed’s Inflation vs. Deflation Conundrum Inflation/Deflation is a lagging event. Excess liquidity on the Fed’s balance sheet is a hyper-inflation risk, so is wage inflation. But farther out on the horizon. A few prices have been skirting deflation for the past year, but.. Oil is not deflationary, immediately. o Oil lag to Core-PCE is 1.5 to 2 years. o The Globe is deflationary. The dollar is the linkage. Contemporary US inflation is driven by capacity. o Services sector prices are rising about 2.0%. o Goods sector is deflating -1.1%. o Wages have only begun to rise. US$: Pits Exporters against Consumers Strong dollar reduces US exports; o export producers unable to shift to domestic sales, production slows, jobs suffer. Weak bilateral currencies drop $-prices to sustain trade; o US consumers benefit. Unstable global currencies risk collapse. Currencies: US Trade Weighted Dollar Index, Euro, Yen (Indexed to 100 = March 2009) 130 120 110 100 90 80 70 60 2010 United States Dollar Index 2011 2012 Euro 2013 Yen 2014 2015 Non-residential Construction and Hotels Non-Res construction peaked late, about mid-recession; then it flatlined until recovery began in 2013. Dodge Construction Index (US$ Mill): "Post-weather Momentum" (US$ Mill) 350000 300000 250000 200000 150000 100000 Jan 2000 Jan 2002 Jan 2004 Jan 2006 Jan 2008 Dodge Construction Index: Non-Res (2000 = 100) Jan 2010 Jan 2012 Jan 2014 Non-Res (12mma) Finance: Mortgage Money Available at a Price. Banks are eager to make loans, but the rules are different … Average Mortgage Commitment: Hotel/Motel LTV Turning Higher, From a Very Low Place 105000 90 80 65000 70 45000 60 25000 50 5000 Commercial Mortgage Commitment: Hotel/Motel 1965Q3 1967Q3 1969Q3 1971Q3 1973Q3 1975Q3 1977Q3 1979Q3 1981Q3 1983Q3 1985Q3 1987Q3 1989Q3 1991Q3 1993Q3 1995Q3 1997Q3 1999Q3 2001Q3 2003Q3 2005Q3 2007Q3 2009Q3 2011Q3 2013Q3 2013Q3 2010Q3 2007Q3 2004Q3 2001Q3 1998Q3 1995Q3 1992Q3 1989Q3 1986Q3 1983Q3 1980Q3 1977Q3 1974Q3 1971Q3 1968Q3 -15000 40 1965Q3 US$ 000 85000 Loan to Value: Hotel/Motel LTV (5cma) -2.0 6.0 % Y/Y ENR: Building cost index, (1913=100) 4.0 2.0 0.0 -4.0 ENR: Building cost index, (1913=100) 6.0 Jan 1984 Jun 1985 Nov 1986 Apr 1988 Sep 1989 Feb 1991 Jul 1992 Dec 1993 May 1995 Oct 1996 Mar 1998 Aug 1999 Jan 2001 Jun 2002 Nov 2003 Apr 2005 Sep 2006 Feb 2008 Jul 2009 Dec 2010 May 2012 Oct 2013 Mar 2015 Jan 1984 Jan 1985 Jan 1986 Jan 1987 Jan 1988 Jan 1989 Jan 1990 Jan 1991 Jan 1992 Jan 1993 Jan 1994 Jan 1995 Jan 1996 Jan 1997 Jan 1998 Jan 1999 Jan 2000 Jan 2001 Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 % Y/Y Construction Cost: Low but for how long? Costs, like mortgage rates, are low, but the direction is clearly shifting. ENR: Labor Cost 12.0 5.0 10.0 4.0 8.0 3.0 2.0 1.0 0.0 ENR: Common Labor Index, (1913=100) ENR: Skilled Labor Index, (1913=100) Back to the fundamentals: US Returns to Normal The US economy is in acceleration mode o 2015 GDP should grow 3.5%+. o Slowdown by mid-2016 as production and labor market hit capacity constraints. o However, significant risks persist. Acceleration Drivers. o The Fed buries QE3 and begins grooming successor: Bank Lending. o Business spending re-accelerates. o Housing adds sales to production. o Government contributes. o Energy supports low business and household cost. o Global malaise boosts US. Four Significant Risks Cycle risk is high. There is a recession out there somewhere. o The expansion has been running for five years. o Normal cycle dynamics have been running for six years. Credit transmission. o Bank Lending to replace QE. o Mortgage finance hinders home sales; housing needs easier access to mortgages. The most likely risk of failure: Government continues in recession. The most dangerous risk: Consumer Spending. o Resources stretched thin. o Wages no longer include pay for productivity. o Business assigns 102% of productivity gains to profit. o Management’s wage bargain: “If you’ll work at 102% of capacity we won’t fire you first.” Topic Appendix: The Failure of Political Policy Jobs rebound is skewed toward Skills and Experience. o Unemployment is below NAIRU (NonAccelerating Inflation Rate of Unemployment) . o Policy does a poor job of employing the NAIRU remainder. The 2% Consumer is an economic health warning. o The Skewing of Incomes and Dissipation of Wealth. o Declining public safety net, with more entering the Population at Risk. The Death of the American Dream. o o o o The labor force as vagabond. Permanently Weak Home Sales. First the home, then the vacation, then the car. Then things get tough. Waiting longer to buy fewer years to accumulate. The Greatest Country on the Globe. Job gains late but now formidable Jobs returned. But labor market remains nettlesome. o Skill dearth and Inexperience. o Wages no longer stagnant, but gains are weak, and… o Gains are dominant in only a few skills or industries. o Labor force faces demographic and economic inflection. Jobs: Broad-based Acceleration w/ one conspicuous exception -- Government Federal Government Leisure & Hospitality Heath Care Education "Office Using" Past Twelve Months Retail Trade Long-term trend Manufacturing Construction Mining Payroll Jobs -50 0 50 100 150 200 250 300 Most Dangerous Risk: Consumer Spending Media tells us: “Consumers are OK,” i.e., “growing at a modest pace.” We suggest: 2% consumer is not healthy. Consumer should grow 4%. o Non-durables and services are particularly weak. o Were it not for autos, durable goods spending would also be weak. • And a 17 million run rate for unit auto sales is unsustainable. Consumer Spending: Growing "Half" as Well as We Should Expect % y/y Personal Consumption Durable Goods Typical 1974 to 2007 Current Expansion 3Q09 to 3Q14 3.8 1.8 7.1 5.8 Source: BEA; STIEcon Non-durable Goods Services Autos 2.9 1.4 3.6 1.4 6.6 12.1 Home Sales: Positive but multifaceted underperformance Home sales increasing 0.7% five years into expansion. o 1990 - 2005, home sale grew an average 4.6%. Affordability is high. Production is slowing with inventories up. Home Ownership hasn’t been so low since the mid-1990s… o … When mortgage rate averaged 9.5%! Young Fall Hard Millennials Alienated Young Homeownership Falls Hardest 125 115 105 95 85 75 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 Index: 1982 = 100 135 <25 years 1st time 35 years 1st move up 45 to 54 years Prime move up > 65 years move down Brief digression on US Global Status US global economic status unrivaled. It’s not even close -- Really o Population % of globe: 5% o Largest global producer: 25% o Largest global consumer: 35% o Largest global wealth holder: 40% o Deepest global capital markets. o Strongest global productivity. Economic Outlook The US economy is on the verge of returning to NORMAL economic cycle. o o o o Consumer spending is holding on, but resources are stretched thin. Labor market is generating jobs; unemployment is lower, but … … College grads, millennials, retirees, and women leave the labor force. Government has resources to contribute to growth, but chooses to fail. The overriding issue is non-quantifiable: UNCERTAINTY. o Government still has extensive unfinished and barely-started business. o Global recession is a real issue but impact X/M effects are offsetting. Monetary Policy: o The Fed isn’t trying to slow the economy. Just return to Neutral. o Transition to traditional monetary transmission through bank lending. o Target is “Fed Neutral”; rates will be higher but low by historic standards. Economic Outlook 1Q2015 Economic Outlook OIL Bust ! Prepared by Chief Economist Gregory Miller. Material we present here is based upon information available on the date of publication. We believe our data is reliable. However, we do not represent that it is accurate or complete. We solicit no action based upon this material. Opinions we express are our judgment as of this date and may change.