Economic Insight

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Economic

Commentary

Economic Insight

January 8, 2016

LINDSEY M. PIEGZA

CHIEF ECONOMIST

(312) 454-3873

PIEGZAL@STIFEL.COM

Global Volatility Draws Attention to Domestic Fundamentals in 2016

Economist Estimates

Economic Data Calendar

Prior High Low Median Stifel

Monday 11-Jan

Tuesday 12-Jan NFIB Small Business Optimism Index - Dec 94.8 96.0 93.6 95.0 95.5

Wednesday 13-Jan

Thursday 14-Jan Import Price Index MoM - Dec -0.4% -0.2% -2.1% -1.5% -1.0%

Import Price Index YoY - Dec -9.4% -8.0% -14.1% -8.6% -7.1%

Initial Jobless Claims - Jan 9 277k 310k 270k 275k 270k

Friday 15-Jan Retail Sales MoM - Dec 0.2% 0.3% -0.5% 0.1% 0.0%

Retail Sales ex Auto MoM - Dec 0.4% 0.7% 0.0% 0.2% 0.1%

PPI MoM - Dec 0.3% 0.2% -0.1% 0.1% 0.1%

PPI YoY - Dec -1.1% 1.0% -1.2% -1.0% -1.0%

Core PPI MoM - Dec 0.3% 0.2% -0.1% 0.1% 0.1%

Core PPI YoY - Dec 0.5% 0.5% 0.0% 0.3% 0.3%

Empire Manufacturing Index - Jan -4.59 6.40 -8.00 -4.00 -2.00

Industrial Production MoM - Dec -0.6% 0.2% -0.7% -0.2% -0.4%

Capacity Utilization - Dec 77.0% 77.0% 76.5% 76.8% 76.9%

Business Inventories MoM - Nov 0.0% 0.2% -0.2% 0.0% 0.0%

UMich Consumer Sentiment - Jan P 92.6 95.0 91.0 93.0 91.5

Source: Bloomberg, Stifel

It was a volatile week for the markets as a steep decline in Chinese equities, sparked by further

evidence of a weakening economy, triggered a global selloff. The PBOC was quick to step in,

halting trading at the start of the week and flooding the banking system with 130B yuan ($19.94B),

the largest cash injection since last September. The action, however, provided only temporary

calm. The PBOC halted trading in Chinese equities for a second time Thursday when the market

declined more than 7% within the first half hour of the open.

In the U.S., it’s been a dismal start to the year as well with both the Dow and the S&P 500 posting

their worst starts to the year ever. Following China’s volatile lead, U.S. equities finished down in

three of the first four trading sessions of the year, with the Dow dropping nearly 400 pts on

Thursday alone. Equities remain in the red year-to-date and are poised to close down 5.2% as of

1:45pm ET in the first week of trading.

With U.S. equities wrapped up in international volatility, the broader concern remains the resiliency

of the U.S. economy in a new year, as well as a new, higher rate environment. If the global

economy slows in 2016, can the U.S. economy weather a global storm? Early indications suggest

the U.S. economy is in fact losing momentum as we turn the calendar. Just three weeks since the

Fed unveiled its monumental policy decision to raise the Fed funds rate for the first time in nine

years, few domestic economic barometers appear to be gaining momentum with most treading

water and many turning to the downside. Amid a growing threat of global unease due to weakness

in China, a modest pace of activity in the U.S. has some market participants nervous about the

longer-term prospects for growth. While the latest employment figures offered some relief, at least

some Fed officials are still left questioning whether liftoff in December was the appropriate policy

decision after all.

Please see the last page of this

report for important

disclosures and disclaimers.

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

A new year post-Fed

With just 15 days before year-end, the Federal Reserve opted to raise the Federal funds rate 25bps to 50bps, a long awaited

policy adjustment to say the least. A preemptive policy move based on expectations of future momentum rather than realized

improvement, the latest data, however, suggest the U.S. economy may be lucky to maintain the current moderate pace, let

alone gain traction. In other words, the U.S. economic calendar did not start 2016 off on a markedly positive note. Since the

December 16 FOMC meeting, business spending remains negative, manufacturing continues to contract, housing activity has

perpetuated its retreat, consumers, while still spending at a positive pace, remain restrained, and with commodity prices

deepening their decline, inflation remains under significant pressure. Of course, the recent strength in the December

employment report tells a different, much more positive story, offering at least a temporary and welcome sigh of relief this

week against the backdrop of mounting concern.

Going forward, however, there will need to be other signs of improvement in the U.S. economy, aside from the occasional

better-than-expected payroll report, for the market to be as confident as the Fed that the U.S. economy can remain

resilient. After all, employment gains will quickly fizzle without improvement elsewhere. In other words, the jobs follow

growth and development, not the other way around. With Q4 GDP tracking just 0.8%, according to the Atlanta Fed’s

GDPNow model, first quarter activity will need a sizable surge to maintain these types of robust payroll gains in the new

year.

The latest data since the December 16 FOMC Meeting

While many Americans were celebrating the Holidays, the latest U.S. economic data offered mixed signals regarding the

economy’s underlying momentum. As we head into a new year and a new rate environment, how strong is the U.S.

economy’s footing?

Page | 2

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Employment gains mount at year-end with modest improvement in wages

Nonfarm payrolls rose 292k in December, noticeably stronger than expected. The three-month average rose from 235k to

284k at year-end, a step in the right direction, although still not as strong as the 324k pace at the end of 2014. The

unemployment rate meanwhile held steady at 5.0%, a seven-year low. While still modest, the pace of hiring appears to be

gaining momentum at year-end, marginally above the 200-250k range needed to cover first-time entrants and population

growth. Of course, warmer-than-usual weather at year-end may prove to have been only a temporary boost to hiring come

January.

Average hourly earnings were flat in December. On an annual basis, average hourly earnings rose from 2.3% to 2.5%, a

welcome increase, albeit shy of the 2.7% rise expected. In other words, slightly improved but slightly lower-than-expected

wage growth leaves confidence in the consumer’s ability to spend in the future still in question.

Inflation (still) remains sluggishly low, defying 2% target

The PCE was unchanged in November, falling short of the expected 0.1% rise. The annual rate of headline inflation,

however, while still sluggishly low, rose two-tenths to 0.4%. Excluding food and energy prices, the Core PCE rose 0.1% in

November, as expected, leaving the annual pace of core prices unchanged at 1.3%. As the Fed has acknowledged in every

communication since 2012, inflation remains well below their 2% target, with mounting downside risks as commodity prices

continue to retreat.

According to the University of Michigan Consumer Sentiment Index, inflation expectations remain unchanged at 2.6% for

both 1-year and 5-10 years into the future, a near six-year low. While stable, as the Fed pointed out in the latest December

FOMC statement, inflation expectations remain at a disappointing, multi-year low.

Page | 3

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Manufacturing activity continues to contract; Services activity expands at a slower pace

The Philly Fed Manufacturing Index fell 8pts to 5.9 in December, a three-month low. The Kansas City Fed Manufacturing

Index dropped from 1 to -9 in December, the lowest reading since August despite expectations of no change, and the Dallas

Fed Manufacturing Index plummeted a whopping 15pts to -20.1 at year-end, the weakest reading since May 2015.

Additionally, the Chicago PMI unexpectedly dropped from 48.7 to 42.9 at the end of the year to a six-year low, the second

consecutive drop after reaching a near-term peak of 56.2 in October.

Following widespread regional weakness, the ISM Manufacturing Index declined from 48.6 to 48.2 in December, the second

month of contraction (a reading below 50) and the first back-to-back sub-50 readings since 2009. Facing extreme pressure

from a rising U.S. dollar, inventory overhang and tepid international demand, U.S. producers are pulling back. In fact, the

last time manufacturing activity was this restrained, the Fed was adding stimulus via QE1.

The ISM Non-Manufacturing Index unexpectedly fell, albeit just a small bit from 55.9 to 55.3 in December, the weakest

reading since April 2014. While still in expansionary territory, service activity has slowed noticeably from the +60 pace in

July. With mounting weakness in other areas of the economy, the service sector appears to be the primary support to the

economy. At this point, a further decline in service sector activity could greatly threaten the pace of the economic expansion.

Page | 4

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Business spending remains negative

Durable goods orders were reportedly flat in November. While zero seems a disappointing headline, relative to the sizable

decline expected, no growth is a welcome alternative. Year-over-year, headline orders are up 1.2%, a ten-month high. More

importantly, however, non-defense capital goods orders excluding aircraft – a proxy for business spending – fell 0.4% in

November, the third month of contraction in the past four with the growth rate in October revised down from -0.5% to -1.0%.

Year-over-year, business spending is down 1.8% compared to a +3.6% gain this time last year. Without business growth and

development, there is little hope of maintaining the current pace of activity, let alone gaining topline momentum in 2016.

Page | 5

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Consumer spending remains restrained

Personal spending rose 0.3% in November as expected, a three-month high after no growth the month prior. Year-over-year,

consumer spending is up a modest 2.9%, albeit down from a 4.4% pace this time last year. Despite record low gasoline

prices, consumer spending, while still positive, continues to lose momentum amid minimal income growth and still modest

hiring gains.

Vehicle sales slowed from 18.05M to a 17.22M unit pace at the end of the year, the second month of decline after reaching a

10-year peak of 18.12M in October. Still at the top of consumer’s shopping lists, vehicle sales have slowed 4.6% from

October’s peak.

Housing activity retreats to 1 ½ year low

Existing home sales fell more than 50 times 1 the expected decline, dropping 10.5% in November to a 4.76M unit pace, the

weakest since April 2014. Furthermore, pending home sales – which typically become existing home sales a month or two

later – unexpectedly fell 0.9%, suggesting additional weakness in demand in the pipeline.

New home sales rose 4.3% in November to a 490k, albeit the third consecutive month below a 500k unit pace.

1 The expected decline in November was 10k, according to Bloomberg. The actual decline in pace of sales was 560k.

Page | 6

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Topline momentum expected to slow at year-end

Q3 GDP was revised down a minimal one-tenth to 2%. After a sluggish start to the year and a sizable rebound in Q2, thirdquarter

growth appeared to split the difference, returning to the trend pace. End of the year activity, however, appears to be

losing further momentum. According to the Atlanta Fed’s GDPNow model, Q4 GDP is poised to rise just 0.8%. Assuming a

0.8% gain at year-end, the annual pace of activity would total 2.3%, a minimal slowdown from a 2.4% pace in 2014.

Page | 7

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Bottom Line

With ongoing volatility on the global stage and downside momentum in equities, could mounting weakness spill over into

U.S. fundamentals? Can a modest U.S. economy withstand a global slowdown? The Fed remains optimistic that a new

calendar year will bring new momentum to the U.S. economy; however, the lack of improvement in the broader data suggests

the Committee’s thesis may prove, once again, unattainable and overly optimistic. Recent reports of the weakest production

activity in more than six years, negative business spending, modest retail consumption, waning housing market activity, and

still non-existent inflation – these are not the story lines monetary policymakers were hoping for as we now embark on a

rising rate environment. While the recent strength in jobs offers a glimmer of hope against the backdrop of the latest slew of

disappointing data, the recent market volatility, compliments of China, leaves some question as to the resilience of the U.S.

economy.

Looking forward, it appears the U.S. economy may be lucky to remain on par with trend growth, meaning modest but

positive top line activity. As the Fed embarks on a rising rate environment, driven by expectations rather than realized

improvement, will the U.S. economy be able to catch up to a new stage of more aggressive monetary policy? Or,

alternatively, will a preemptive adjustment in rates without clearly established momentum in the fundamentals undermine the

economy’s ability to improve?

-Lindsey Piegza, Chief Economist

Page | 8

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

Glossary

FOMC – Federal Open Market Committee

GDP – Gross Domestic Product

ISM – Institute for Supply Management

PCE – Personal Consumption Expenditures

PBOC – People’s Bank of China

QE – Quantitative Easing

Page | 9

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

January 8, 2016

This material is prepared by the Fixed Income Strategy Department of Stifel Nicolaus & Co (“Stifel”). This material is for

informational purposes only and is not an offer or solicitation to purchase or sell any security or instrument or to participate

in any trading strategy discussed herein. The information contained is taken from sources believed to be reliable, but is not

guaranteed by Stifel as to accuracy or completeness. The opinions expressed are those of the Fixed Income Strategy

Department and may differ from those of the Fixed Income Research Department or other departments that produce similar

material and are current as of the date of this publication and are subject to change without notice. Past performance is not

necessarily a guide to future performance. Stifel does not provide accounting; tax or legal advice and clients are advised to

consult with their accounting, tax or legal advisors prior to making any investment decision. Additional Information

Available Upon Request.

Stifel Nicolaus & Co is a broker-dealer registered with the United States Securities and Exchange Commission and is a

member FINRA, NYSE & SIPC. © 2015

ADDITIONAL INFORMATION AVAILABLE UPON REQUEST

Page | 10

2015 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762

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