Economic Insight

stifel

24Wvqpv

Economic

Commentary

Economic Insight

June 17, 2016

LINDSEY M. PIEGZA

CHIEF ECONOMIST

(312) 454-3873

PIEGZAL@STIFEL.COM

Broad-Based “Uncertainty” Lowers Odds of 2016 Rate Hike

Economist Estimates

Economic Data Calendar

Prior High Low Median Stifel

Monday 20-Jun

Tuesday 21-Jun

Wednesday 22-Jun Existing Home Sales - May 5.45m 5.68m 5.37m 5.53m 5.50m

Existing Home Sales MoM - May 1.7% 4.2% -1.4% 1.5% 1.0%

Thursday 23-Jun Chicago Fed National Activity Index - May 0.10 -- -- -- -0.20

Initial Jobless Claims - Jun 18 277k 275k 262k 270k 275k

New Home Sales - May 619k 610k 540k 570k 557k

New Home Sales MoM - May 16.6% -1.5% -12.8% -8.0% -10.0%

Leading Index - May 0.6% 0.3% -0.4% 0.2% 0.1%

Kansas City Fed Index - Jun -5.00 -- -- -- -8.00

Friday 24-Jun Durable Goods Orders - May P 3.4% 2.0% -2.8% -0.6% -1.0%

Durables Ex Transportation - May P 0.5% 0.5% -0.8% 0.1% -0.1%

U. of Mich. Sentiment Index - Jun F 94.3 95.4 93.0 94.1 93.0

Source: Bloomberg, Stifel

Following the release of the June FOMC statement announcing no change in policy, Chair Yellen

held a press conference reiterating lingering “uncertainties” surrounding the U.S economic outlook

and somewhat “unexpected” weakness in recent data. Furthermore, while the latest Summary of

Economic Projections (SEP) reported a decline in the expected level of rates longer-term, she

reminded her audience that each dot represents an individual Committee member’s forecast, which

are themselves subject to the “uncertainties” of how the data will evolve. Policy, Yellen said, is

not on a predetermined path, and every meeting should be considered a live meeting.

At this point, it is clear the Committee was poised and ready for a summer rate hike if the data had

continued to cooperate. The recent weakness in employment, however, coupled with ongoing

“uncertainties” surrounding global developments including a Brexit, temporarily derailed the

Committee’s commitment to hike rates Wednesday despite weeks of talking up the market to get

“on board.” Going forward, should we bypass a Brexit and the U.S. data rebound markedly, get

ready for another round of hawkish rhetoric. Talk, however, may be the extent of Fed action, at

least for the time being. More probable than an upside surprise in domestic data and utopic

tranquility on the global stage, the U.S. economy will likely continue along little changed from the

current lackluster pace.

Despite Fed optimism for near-term improvement, the U.S. economy is expected to continue to

alternate between “moderate” and “slow” activity levels, failing to meet even the Fed’s new, lower

forecast of 2% growth in 2016, with lackluster price pressures well below the Committee’s longerterm

objective of 2%. Furthermore, with the debate over U.K. membership in the EU heating up, a

near-term resolution on either side is unlikely, resulting in an overhang of “global risks.” While the

Fed has seemingly redirected their focus to September, swift improvement in the domestic

economy is unlikely, making it difficult for the Fed to justify a second-round rate increase in a little

more than two months. Lingering “uncertainties” both domestic and international could further

delay a second hike until the end of the year or beyond.

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

June 17, 2016

Surface Optimism

The June FOMC statement, released earlier this week, read modestly positive as policy makers highlighted the notion that

economic activity has “picked up” in the second quarter following a weaker-than-expected start to the year. Acknowledging

the recent weakness in hiring and ongoing lackluster business investment, the Committee nevertheless went on to affirm their

expectations for the U.S. economy to continue to improve and labor market conditions to “strengthen” over the near to

medium-term. Additionally, the Committee reiterated the likelihood of further improvement in inflation as the impact of

earlier declines in energy prices and prices of non-energy imports “dissipate.”

During the press conference, however, Chair Yellen’s comments revealed a much more conservative view of the economy

than proposed in the policy statement itself. Highlighting a number of “uncertainties” surrounding the longer-term outlook

for the U.S. as a result of both international and domestic “risks,” Yellen urged a “cautious” approach to monetary policy.

Signaling an increased number of concerns and “unknowns,” her remarks appeared at odds with the surface optimism

proposed in the FOMC statement. In other words, while presenting a calm and optimistic front on the surface, underneath

policymakers continue to grapple with a plethora of lingering worries that could easily stall or impede further improvement in

growth and inflation, as well as further policy adjustments. 1

Labor Market Weakness

In the aftermath of the April policy meeting, Fed officials were quite boisterous in their growing impatience for a summer

rate hike. However, following a weaker-than-expected May employment report, the Committee appeared to lose their

appetite for a further removal of accommodation near-term. While Fed officials are hesitant to put too much emphasis on a

single data point, the labor market was nevertheless at the forefront of the argument for a second-round rate hike sooner than

later. Thus, coupled with a number of additional “uncertainties” at home and abroad, a slowdown in the labor market

seemingly stalled the campaign for a June policy adjustment.

1 “Be like a duck. Stay calm on the surface but paddle like hell underneath.”

Page | 2

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

June 17, 2016

According to Yellen at Wednesday’s press conference, while the recent weakness in hiring was both “unexpected” and

“disappointing,” there are a number of employment indicators that continue to suggest improvement in labor market

conditions, including the JOLT survey. “I don’t think labor market progress has come to an end,” Yellen noted, although the

recent decline in headline hiring does bear close monitoring. The latest bout of weakness is difficult to understand, she said,

but most likely reflects lingering “uncertainties” surrounding the Committee’s outlook for how the labor market and other

areas of the economy will continue to develop.

“Uncertainties”

“Uncertainty” was a reoccurring theme in Chair Yellen’s comments at Wednesday’s press conference. In her prepared

remarks, Yellen highlighted a number of “uncertainties” surrounding the longer-term outlook for the U.S. economy including

domestic headwinds from sluggish productivity growth and restrained corporate investment, as well as global “risks”

including a potential Brexit and slow Chinese growth. Other “uncertainties,” Yellen said, include the longer-term prospects

for topline growth and continued progress in the labor market. We do expect moderate, healthy growth for the rest of the

year, she said; however there are a number of “uncertainties” that could impact that expectation.

While these “uncertainties” are hardly new developments and were certainly well known to policy makers whilst calling for

a summer rate hike earlier in the second-quarter, the severity of these peripheral variables has clearly increased against the

back drop of unexpected domestic weakness culminating in a six-year low in the pace of hiring. Failing to develop and

improve as expected in the six months following liftoff, domestic fundamentals were unsuccessful in supporting the Fed’s

more optimistic outlook for above trend activity and multiple rate hikes in 2016. We are quite “uncertain” where rates are

headed in the longer-run, Yellen said.

The SEP, released in tandem with the June policy statement, furthermore echoed Chair Yellen’s more tepid and “uncertain”

assessment of the longer-term pathway for growth and rates in the U.S. The Committee’s 2016 GDP forecast was reduced

from 2.2% to 2.0%, now on par with stagnant expectations for 2017, 2018, and the Fed’s longer-run growth forecast.

Additionally, amid an expected tepid growth environment, the Committee also reduced their outlook for rates. According to

the June SEP, now six Committee members anticipate only a single hike in rates in the remaining six months of 2016. The

Page | 3

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

June 17, 2016

median forecast for the Federal funds rate in 2017 was lowered from 1.9% to 1.6% and from 3.0% to 2.4% in 2018. Finally,

the longer-run forecast was reduced by 25bps to 3.0%.

According to Yellen, the reduction in the outlook for rates reflects a great deal of “uncertainty” around individual Committee

member’s assessment of rates, particularly as “we go out longer on the horizon.” These longer-term “uncertainties” to the

outlook for growth and inflation including sluggish productivity growth and an aging population could serve to depress the

longer-run neutral rate. These factors, she noted, may become part of the Committee’s assessment of a “new normal.” In

other words, lingering “uncertainties” could further depress the Fed’s expected longer-term pathway for rates already

reduced 50bps since liftoff in December 2015.

Federal Reserve Board Economic Projections, June 15 th , 2016

Source: Federal Reserve http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20160615.pdf

Federal Reserve Dot Plot, June 15 th , 2016

Source: Federal Reserve http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20160615.pdf

Page | 4

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

June 17, 2016

Brexit

One of the biggest factors impacting the Committee’s rate decisions this year and going forward is international

“uncertainty” including a potential Brexit, or British exit from the European Union. According to Yellen, a possible Brexit

was discussed at this week’s two-day policy meeting and was “one of the factors that impacted [Wednesday’s] decision.” A

Brexit could have large “consequences” for global economic and financial market conditions and, thus, such an event could

impact the outlook for the U.S. The outcome of the U.K. referendum vote on membership in the EU, the Chairman noted,

will factor into additional policy decisions “going forward.”

Oddschecker Average Probability of BREXIT Implied from Betting Odds

Source: Bloomberg

With less than a week to go before the vote, markets are already showing signs of apprehension, fears exacerbated by

Yellen’s comments and other central bankers’ remarks of concern surrounding the health of the global economy. Amid

growing unease, equity markets stumbled this week, continuing their longest losing streak since August. According to

Bloomberg, more than $2 trillion has been wiped from global equities in the past week, with more losses anticipated to follow

as speculation the U.K. will favor a “leave” vote grows. Meanwhile, demand for safe havens such as treasuries, gold and the

yen have increased. Following the Fed’s announcement on Wednesday, U.S. treasury 10-year note yields dropped to the

lowest level since 2012 and the yen surged to the highest since 2014. For the Fed, continued market volatility is a nonstarter

for a near-term adjustment in rates.

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

June 17, 2016

Treasury 10-yr Note Yield

Source: Blomberg

Bottom Line

Looking at the June FOMC statement alone, the Committee’s assessment of the U.S. economy appears to be much improved

from earlier this year despite unexpected weakness in the labor market. However, the statement in and of itself was unable to

convey the numerous underlying concerns that policymakers identify as potential barriers to a further removal of

accommodation. The outline of “uncertainties” in Chair Yellen’s comments during the press conference suggest it was not

solely the May employment report that kept the Fed sidelined this week. Rather it was a number of “risks” both international

and domestic that forced policy makers to maintain the status quo.

Moving past a potential Brexit, should the U.S. data improve, the Chairman was clear that every meeting is a live meeting

and policy is not on a “predetermined path.” Thus, under the best case scenario that calm is restored to global markets and

the U.S. economy reverts to a more robust growth path, the Committee remains anxious to continue with rate increases

sooner than later. However, given the widespread worries still dominating the policy conversation, it will likely take more

than one good data point or even two strong reports to offset lingering concerns surrounding the underling health of the U.S.

economy – supposing we see improvement at all in the second-half of the year, which itself is a bold assumption.

At this point, the market remains skeptical that swift Fed action as a result of better-than-expected data is a real possibility.

Fed officials remain committed to a “gradual” removal of accommodation; however, should the data remain lackluster

fueling “uncertainty,” the next interest rate hike could be further delayed until the end of the year or potentially 2017.

Today’s modest pace of activity, tepid hiring and sluggish inflation levels do not warrant a further increase in rates, nor did

they justify December’s liftoff. The Fed’s expectations of rapid improvement have failed to come to fruition leaving the

Committee in an awkward position of potentially doubling down on last year’s policy mistake amid today’s still-fragile

economic conditions.

-Lindsey Piegza, Chief Economist

Page | 6

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

June 17, 2016

Glossary

EU – European Union

FOMC – Federal Open Market Committee

GDP –Gross Domestic Product

JOLTS – Job Openings and Labor Turnover Survey

SEP – Summary of Economic Projections

U.K. – United Kingdom

Page | 7

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

June 17, 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 | 8

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

More magazines by this user
Similar magazines