Economic Insight

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Economic

Commentary

Economic Insight

April 1, 2016

LINDSEY M. PIEGZA

CHIEF ECONOMIST

(312) 454-3873

PIEGZAL@STIFEL.COM

“Cautious” Fed Outlook and Updated Forecast Grid

Economist Estimates

Economic Data Calendar

Prior High Low Median Stifel

Monday 4-Apr ISM New York - Mar 53.60 -- -- -- 54.00

Durable Goods Orders - Feb F -2.8% -- -- -- -2.7%

Dureable Goods Ex Transportation - Feb F -1.0% -- -- -- -1.2%

Tuesday 5-Apr Trade Balance - Feb -$45.68b -$41.60b -$48.30b -$46.30b -$47.00b

ISM Non-Manufacturing - Mar 53.40 55.10 53.00 54.00 54.50

Wednesday 6-Apr March 16 FOMC Meeting Minutes

Thursday 7-Apr Initial Jobless Claims - Apr 2 276k -- -- -- 270k

Consumer Credit - Feb $10.538b $18.500b $12.000b $15.000b $14.500b

Friday 8-Apr Wholesale Inventories MoM - Feb 0.3% -0.1% -0.6% -0.3% -0.4%

Source: Bloomberg, Stifel

At the Economic Club of New York earlier this week, Chair Yellen emphasized the need to

“proceed cautiously” given lingering uncertainty and downside risks to the domestic economy as a

result of global and financial market developments. Calling into question the Fed’s ability to meet

even their new lowered bar of expectations for just two rate hikes in the remaining nine months of

the year, Yellen reiterated a continued expectation of a slow, tepid, "gradual" removal of

accommodation. In response to Yellen’s dovish comments, yields fell, the dollar weakened, and

the implied probability of a June rate hike dropped from 38% to 28% as the market interpreted the

remarks to mean potentially fewer rate hikes this year than was projected at the latest March FOMC

meeting. The implied probability of an April rate hike fell from 6% to 0.0% following Tuesday’s

comments.

“Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in

adjusting policy.”

– Chair Yellen, March 29, 2016

Implied FOMC Rate Hike Probability

Please see the last page of this

report for important

disclosures and disclaimers.

2016 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

April 1, 2016

Of course the FOMC is rarely of one mind. In the aftermath of the March FOMC meeting and just days prior to the

Chairman’s overtly dovish remarks, other policy makers strengthened their argument for a second rate hike sooner rather than

later. Speaking in New York City on March 24, Federal Reserve Bank of St. Louis President James Bullard said the Federal

Reserve may be getting close to raising interest rates again after opting to remain sidelined at the March 16 meeting. “The

relatively minor downgrades contained in the March SEP,” Bullard said, “suggest that the next rate increase may not be far

off provided that the economy evolves as expected.” Earlier that day, in an interview with Bloomberg News, Bullard

explicitly noted that policy makers should indeed consider another rate hike as early as the April FOMC meeting.

Echoing Bullard’s hawkish comments, Atlanta Fed President Dennis Lockhart, San Francisco Fed leader John Williams and

Philadelphia’s Patrick Harker have all called for continued tightening in comments following the March FOMC meeting,

keeping June – and even April – as a possible date for a second hike. Furthermore, Chicago Federal Reserve President

Charles Evans, one of the most dovish members of the Committee, says he too is open to a nearer-term rate hike.





According to Atlanta Fed President Dennis Lockhart, "There is sufficient momentum evidenced by the economic data

to justify a further step...as early as the meeting scheduled for the end of April.”

Speaking in an interview published by Market News International, according to San Francisco Fed President John

Williams, “April or June would definitely be potential times to have an increase in interest rates," assuming that,

“everything else is basically the same and the data flow continues the way I hope and expect.”

In a speech on March 22 nd to the Money Marketeers in New York, Philadelphia Fed President Patrick Harker noted

he is not in favor of just two rate hikes this year. “I am not,” Harker said, “a two (rate) rise person. I'd rather see

more (hikes) this year.” While Harker noted he did support the Committee’s decision to leave policy unchanged in

March, he added, “I think we need to get on with it.”

In an interview with CNBC on Wednesday, Chicago Fed President Charles Evans suggested he would support

another interest rate increase in June, if the labor market continues to show improvement. “My assessment is the

economy is going to be strong enough, we’ll be raising rates two times this year, could well be more if we do better,”

Evans said.

Ongoing Divide between Hawks and Doves

The clear juxtaposition in Committee members’ comments suggests an ongoing divide among central bankers regarding the

appropriate pathway for monetary policy. Having failed to meet the expected level of improvement following liftoff thus far,

the Fed – or at least some at the Fed – now appears to acknowledge the lingering weakness in the U.S. economy and stillpresent

downside risks to future growth and inflation. Arguably the very same conditions that should have delayed liftoff in

the first place, a continued trend of disappointing data, particularly on the consumer side, still-sluggish inflation data,

ongoing risks posed by global volatility and weakness, and tighter financial conditions will likely remain at the forefront of

the argument to extend the timeline for adjusting policy.

On the other hand, some central bankers argue that policy would remain historically accommodative even 50 to 100bps

above current levels and therefore a near term rate increase or two is warranted. Coupled with credibility concerns arising

from a perception of neglecting the Committee’s commitment to “gradual” and adopting a more ‘one and done’ approach,

not to mention the need to restock their toolbox with potential stimulus measures should the U.S. economy loose further

Page | 2

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Economic

Commentary

Economic Insight

April 1, 2016

momentum from here, the argument for many policy makers is clearly titling towards a continued removal of accommodation

in the near-term, if not by April then certainly June.

As Yellen highlighted in her comments this week, the nature of the Fed’s forecast, however, is fluid; the "guidance"

Committee members provide via the dot-plot and independent commentary, Yellen said, should be understood as a "forecast"

for the trajectory of rates, "not a plan set in stone that will be carried out regardless of economic developments.” In other

words, the Fed will adjust the expected and realized pathway of rates, accelerating or extending the timeline for additional

hikes based on the evolution of the data.

Summary of Economic Projections, Fed Funds Rate Forecast

Source: Federal Reserve March 16, 2016

Rate Forecast

How will Fed members interpret the latest data? “Moderate” improvement was good enough for liftoff but after resuming a

“moderate” pace of activity in March, Committee members opted to remain on the sideline with domestic improvement

overshadowed by increased “risks” from international developments. Going forward, with weaker-than-expected headline

activity, as well as sluggish consumer spending at the start of the year, will the Fed focus on the rear view mirror or what lies

ahead? Would “solid” domestic data be enough to offset fears of further weakness on the global stage? It remains unclear;

the precise combination of domestic and international activity levels needed to trigger additional Fed action remains in

question – not just to the market but perhaps to the monetary policy makers themselves.

A “moderate” economy is hardly the desired backdrop for a rising rate environment; however, for the Fed, “moderate” was

good enough to warrant liftoff in the final month of 2015. While our still-fragile assessment of current conditions is little

changed from last year, our expectations for the Fed’s rate pathway has shifted in light of the Committee’s reduced thresholds

for action, coupled with their acknowledgement – or realization – of weaker-than-expected conditions and progress in early

2016. No longer looking for “solid” or “robust” growth as they have in the past, this time around, central bankers are

satisfied with “moderate” as long as additional growth is expected in the future and “risks” from abroad are contained.

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2016 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

April 1, 2016

As a result, with relatively firm, albeit cautious expectations, the Fed is likely to squeeze out an additional rate hike this year

as early as the second quarter. Additionally, the possibility of a second rate hike by the end of the year (third overall)

remains on the table as well, should the data improve markedly with reduced fears of contagion from global weakness. Of

course, should the data continue to deteriorate and weigh down the Fed’s forecast for growth and inflation, the Fed will have

trouble raising rates once this year, if at all.

-Lindsey Piegza, Chief Economist

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2016 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

April 1, 2016

Glossary

FOMC – Federal Open Market Committee

SEP – Summary of Economic Projections

Page | 5

2016 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Economic

Commentary

Economic Insight

April 1, 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. © 2016

ADDITIONAL INFORMATION AVAILABLE UPON REQUEST

Page | 6

2016 Stifel, Nicolaus & Company, Incorporated One South Street, 15 th Floor Baltimore, MD 21202 Member NYSE Member SIPC 888.290.1762


Lindsey M. Piegza

Chief Economist

(312) 454-3873

April 2016

piegzal@stifel.com

End of Quarter Figures

Average Annual Figures

Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 2015 2016 2017

Growth indicators

GDP, QoQ % 2.0% 1.0% 0.7% 2.2% 2.5% 1.9% 1.1% 2.5% 1.7% 1.5% 1.9% 1.8% 1.7%

Fixed Investment, % 3.7% 0.1% 1.2% 5.0% 3.5% 1.9% 0.8% 3.0% 1.5% 1.7% 3.1% 2.9% 1.8%

Housing Starts, k 1,207 1,149 1,150 1,050 1,100 1,020 985 1,080 995 990 1,130 1,080 1,013

Car Sales, M 18.07 17.22 17.50 17.20 17.15 16.85 16.95 17.20 17.35 16.90 17.36 17.18 17.10

Unemployment Rate, % 5.1% 5.0% 5.0% 4.9% 4.8% 4.8% 4.7% 4.6% 4.6% 4.5% 5.2% 4.9% 4.6%

Participation Rate, % 62.4% 62.6% 63.0% 62.7% 62.5% 62.3% 62.3% 62.4% 62.3% 62.2% 62.6% 62.6% 62.3%

Savings Rate, % 4.8% 5.5% 5.3% 5.4% 5.1% 4.8% 4.9% 5.2% 5.4% 5.5% 5.4% 5.2% 5.3%

Inflation indicators, YoY%

CPI 0.0% 0.7% 1.0% 1.1% 1.3% 1.3% 1.1% 0.9% 0.9% 1.0% 0.2% 1.2% 1.0%

PCE 0.2% 0.6% 1.0% 1.2% 1.2% 1.4% 1.3% 1.0% 1.2% 1.2% 0.4% 1.2% 1.2%

Core PCE 1.3% 1.4% 1.5% 1.4% 1.3% 1.2% 1.3% 1.1% 1.2% 1.3% 1.3% 1.4% 1.2%

Interest rate, %

FF 0.25 0.50 0.50 0.75 1.00 1.00 1.00 1.25 1.50 1.50 0.31 0.81 1.31

3month UST bills -0.02 0.16 0.21 0.45 0.70 0.65 0.75 0.90 1.15 1.20 0.04 0.50 1.00

2yr UST notes 0.63 1.05 0.73 1.05 1.30 1.22 1.25 1.55 1.85 1.75 0.72 1.08 1.60

5yr UST notes 1.36 1.76 1.21 1.55 1.75 1.68 1.75 1.90 2.15 2.05 1.54 1.55 1.96

10yr UST notes 2.04 2.27 1.78 2.00 2.15 1.92 1.95 2.20 2.25 2.20 2.15 1.96 2.15

30yr UST bonds 2.85 3.02 2.61 2.90 3.05 2.90 2.95 3.00 2.80 2.75 2.88 2.87 2.88

2s to 10s Spread bps 141 122 105 95 85 70 70 65 40 45 143 89 55

Lindsey Piegza - Chief Economist

Red identifies actual figures

Source: Bloomberg, Stifel

Forecasts were last updated March 23, 2016 and are updated on a quarterly basis

IMPORTANT DISCLOSURES:

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. © 2016

ADDITIONAL INFORMATION AVAILABLE UPON REQUEST

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