Close to Fed Liftoff,
Despite Mixed Signals
Chris Low
Chief Economist
March 26, 2015
Fed Determined to “Normalize”




Deflation is a global threat
20 central banks have eased this year
Short rates negative in 5 of 20 countries on
Bloomberg World Bond page.
Fed prepping market for rate hikes
1
1
A Low Rate, Low Inflation World
Houston, TX, 2014
2
2
Growing Global Deflationary Pressure
7.0%
EU CPI, YOY%
UK CPI, YOY%
6.0%
US CPI, YOY%
Swiss CPI, YOY%
5.0%
China CPI, YOY%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
2010
2011
2012
2013
2014
2015
Source: Federal Statistics Office of Switzerland, National Bureau of Statistics of China, UK Office for National Statistics, Bureau of Labor Statistics,
and Eurostat
3
3
Hundreds
Global Yields Pulling US Yield Down
8.0%
US
7.0%
Germany
Japan
6.0%
Switzerland
5.0%
United Kingdom
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
2000
2002
2004
2006
2008
2010
2012
2014
Source: Bloomberg
4
4
Non-Energy Import Prices Falling
6.0%
Import Prices Ex-Petroleum
5.0%
USD Strong
4.0%
3.0%
2.0%
1.0%
USD Weak
0.0%
Import Price Index Ex-Petroleum,
YoY % Change
-1.0%
-2.0%
2010
2011
2012
2013
2014
2015
Source: Bureau of Labor Statistics
5
5
Economy Will Strengthen
Despite Trouble in the Oil Patch
6
6
GDP Dips, then Rebounds
6.0%
Oil price drop
primary GDP
influence until
liftoff.
Investment minus
plays out in
Q4-14 - Q2-15.
Consumer plus
bigger than
investment
minus, slow to
manifest.
Real GDP, qtr/qtr%
Final sales (4-qtr avg)
5.0%
Forecast
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
2012
2013
Source: Bureau of Economic Analysis
2014
2015
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7
Oil Price Drop Already Lifting Spending
Personal Consumption
6.0%
3m/3m % annualized
5.0%
4.0%
3.0%
2.0%
Nominal consumption
1.0%
Real consumption
0.0%
Jan-14
Apr-14
Jul-14
Oct-14
Jan-15
Source: Bureau of Economic Analysis
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8
Rig Count and Oil Output
1,600
Output rising
despite rig count
drop, keeping
price under
pressure.
1,200
1,000
800
US rig count, crude, left
Street consensus forecast
US Crude Output, right
Fracking means fewer
barrels per rig
12000
11000
10000
9000
600
8000
400
7000
200
6000
0
5000
-200
4000
1000 Barrels/Day
$20bn drop in
capex cuts 1.2%1.5% in Q1-15.
1,400
Rigs
Rig count
plunging. Likely
to drop more
than 50%
13000
'88 '91 '94 '97 '00 '03 '06 '09 '12 '15
Source: Baker Hughes Inc. & U.S. DOE
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9
Oil Inventories Breaking Records
460
440
Millions of barrels
420
400
380
360
340
320
300
2010
2011
2012
2013
2014
2015
Source: U.S Department of Energy
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10
Inflation Expectations Near 2011 Low
2.9%
US 10-yr breakeven rate
2.7%
2.5%
2.3%
2.1%
1.9%
1.7%
1.5%
2011
2012
2013
2014
2015
Source: Bloomberg
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11
Oil Price Drop = 3-Yrs of Low Core Inflation
$35
BOTH headline
and core effect
lasts years.
Inflation likely
to rebound in
late 2017.
6.0%
Core PCE, YoY% (right)
5.5%
$30
USD/Barrel
Substantial core
inflation impact
in every big,
sustained oil
price decline.
WTI Crude (left)
5.0%
4.5%
$25
4.0%
$20
3.5%
3.0%
$15
2.5%
$10
1985
2.0%
1986
1987
1988
1989
Source: Bloomberg & Bureau of Economic Analysis
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Fed focused on domestic recovery
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13
Dots Tumbled in March
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14
Fed’s Rate Call Moves
Closer to Market’s
4.00%
Tightening implied by FOMC forecasts - Dec. 2014
Tightening implied by FOMC forecasts - Mar. 2015
Market Expectations Mar. 17, 2015 (pre-FOMC)
Market expectations Mar. 23, 2015 (post-FOMC)
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
Sept. ‘15
0.50%
0.00%
Mar-15
Sep-15
Mar-16
Sep-16
Source: Federal Reserve, Bloomberg
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Mar-17
Sep-17
Communication, or Confusion?
A smooth
path upward
in the federal
funds rate will
almost
certainly not
be realized.
June is a viable option
for rate increases.
There is no single
thing … we must see
… in order to achieve
that level of
confidence. [That
inflation will reach
2%.]
The dots moved further
down the curve
because there was no
hike in March.
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Fed Was Bold Until
Tightening Drew Close
5
Target Federal Funds Rate at Year-End
Sep '13
Dec '13
Mar '14
Jun '14
Sep '14
Dec '14
Mar '15
4
3
Percent (%)
2
1
0
1900
2015
Source: Federal Reserve, March 2015
1900
2016
1900
2017
*Each dot represents the median fed fund target for the year from the corresponding meetings SEP.
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17
Fed Capitulates to New Normal
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Real GDP Growth
(Dangerous Seasonals)
6.0%
GDP Qtr/Qtr,
annualized
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
2010
2011
2012
2013
2014
Source: Bureau of Economic Analysis
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19
Real GDP Growth
(Dangerous Seasonals)
6.0%
5.0%
GDP Yr/Yr %
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
2010
2011
2012
2013
2014
Source: Bureau of Economic Analysis
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20
Real GDP Growth in Perspective
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
GDP Yr/Yr %
-2.0%
Recessions
-3.0%
-4.0%
-5.0%
1990
1995
2000
2005
2010
Source: Bureau of Economic Analysis
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21
Fed’s Inflation Forecast
Always Goes to 2%
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22
USD Spot Index with FOMC Meetings
105
Mar. ‘15
DXY Curncy
100
“Peak dots.” Suggest 5
hikes in 2015, liftoff
inside a year.
95
90
Jun. ‘12
Mar. ‘13
Sept. ‘13
Sept.‘14
Dec. ‘14
85
Apr. ‘12
Dec. ‘12
Dec. ‘13
80
Jan. ‘12
75
2012
Jun. ‘13
Sept. ‘12
Mar.‘14
2013
2014
Jun.‘14
2015
Source: Bloomberg
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US Rates Are Among
the Highest Already
3.0%
2-Year Yields
United
States
2.0%
1.0%
0.0%
-1.0%
Source: Bloomberg
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24
Job Growth Strong
5.0%
Nonfarm Payroll
4.0%
Year-over-Year % Change
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
-5.0%
1990
1994
1998
2002
2006
2010
2014
Source: Bureau of Labor Statistics
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25
Job Quality Lousy
55.0%
Full-time Employed as
% of Civilian Population
54.0%
53.0%
52.0%
51.0%
50.0%
49.0%
48.0%
47.0%
46.0%
1990
1994
1998
2002
2006
2010
2014
Source: Bureau of Labor Statistics
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26
Ratio of Private Debt to Private GDP
2.50
2.25
2.00
2Q '04, when Fed
last initiated rate
hikes.
Tightening
could happen
before credit
grows.
1.75
1.50
1.25
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Federal Reserve & FTN Financial
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Conclusions

Global growth is sluggish.

Global surprises abound.

US starting to import deflation.

Discipline and model dependence keeps Fed on course.

Q3 liftoff for fed funds rate likely.

Tightening will contribute to global strains.

Could pause/stop at 1%. Market thinks 2% peak ff rate.

If they push to 2% in ’16, rate cuts likely in 2017.
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