the macroeconomic outlook · page 3 the macroeconomic roadway tailwinds neutral headwinds political...

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July 2017

The Macroeconomic Outlook

Table of Contents:

1. The Quarterly Macroeconomic Outlook

Appendix. Thoughts on Ultra-Long Treasury Bonds

The Macroeconomic Roadway

Tailwinds Neutral Headwinds

Political Risk Anti-trade rhetoric may cause an anti-American retaliation in countries such as Mexico and China

The political mood is sour. A populist rebellion, nurtured by years of sluggish growth and disruptions of old business models, is still spreading globally.

Even though more than 80% of job losses in the US are due to technology and only about 15% due to international trade, globalization is out of favor

Economic Growth

(US)

(International)

US GDP growth expectations move up slightly to around 2% plus versus a historical average of ~3%. Aging demographics, slowing population growth,

slowing workforce growth and productivity declines will put downward pressures on GDP growth

Questions remain whether structural reforms (tax, infrastructure, spending, healthcare) proposed by the new administration will push GDP growth back

to its historical average

In the US, Eurozone, Asia, and the emerging markets, for the first time since a brief rebound in 2010, all the cylinders are firing at once. The IMF

increases its global growth forecast to 3.5%

Labor Markets

(US)

(International)

The U3 unemployment dips towards the lower-bound of its estimated natural rate, while the U6 rate is inching towards its pre-crisis levels. Yet, where

there is labor slack, it is highly correlated with lower levels of educational attainment

Average hourly earnings increase by 2.5% YoY and aggregate hours worked increase by a solid 1.7% YoY, pointing to gains in private consumption

Fears about Chinese overcapacity and of Yuan devaluation recede. The European commission’s economic sentiment index hits its highest level, and

Eurozone unemployment its lowest level, since 2011

Inflation The FOMC still expects that inflation will rise to its long-run level of 2%, once oil and import prices stop falling. US services inflation fluctuates around 3% as goods inflation hovers in negative territory

While market-based measures of inflation (5Y out 5Y inflation swap) trend down, survey- based inflation expectations (U. of Mich.) hover around 2.5%

Global overcapacity, primarily due to China, and technology-enabled disruption will be the main focus that will push inflation downwards

Monetary Policy

(Fed)

(International)

The Fed estimates that the equilibrium real rate, r*, is near zero in the short-term and 1% in long-term

As the unemployment and inflation gaps disappear, the Fed affirms its Fed Funds rate projections of one more 25 bps hike in 2017 and to 3% in the

long-term, while announcing that the tapering of its balance sheet will commence as soon as late 2017

Recent trends of international capital flows into the US—lifting the dollar and lowering US bond yields—may be reversing at the end of the quarter

Fiscal Policy Business and household surveys begin to reflect expectations of pro-growth fiscal and economic reforms. Hard data will lag these expectations as the passing and end-effects of new legislation will take time

Government debt and unfunded entitlements will pose a problem, particularly as interest rates start going up

Fed estimates suggest that the US is underinvested in infrastructure by about $3-4 trillion

The Markets

As 10-year rates increase by about 60 bps through 2016YE, equally divided between increases in inflation expectations and the real rate, they remain at approximately 2016YE levels. Equity markets show optimism

While broad-based stress indicators fall since the beginning of the year, the VIX and the bond market MOVE index still hover around historically low levels, despite episodic spikes possibly reflecting fears about the Trump administration

Source: Wall Street Research, Bloomberg, Calculations by Ramirez.

US Government Rates Outlook, 3Q17 – 2Q18

Surveyed Projections, 3Q 2017 Surveyed Projections, 4Q 2017

Surveyed Projections, 1Q 2018 Surveyed Projections, 2Q 2018 All (medians)

3Q17 (%) 4Q17 (%) 1Q18 (%) 2Q18 (%)

FF 1.00-1.25 1.25-1.50 1.25-1.75 1.50-2.00

2Y 1.55 1.75 1.83 1.98

10Y 2.40 2.50 2.60 2.70

30Y 2.95 3.05 3.20 3.20

Historical Rates

3/31/2017 (%) 6/30/2017 (%) 7/7/2017 (%)

FF 0.75-1.00 1.00-1.25 1.00-1.25

2Y 1.25 1.38 1.40

10Y 2.39 2.30 2.39

30Y 3.01 2.83 2.93

Each of the major banks remain confident that there will be another rate hike in 2017 (three total), while the

markets place the chance of at least one more hike at just below 60% (measured by option implied probability)

Expected increases on the short end of the yield curve have not been equally reflected in the long end, i.e. further

flattening is still expected

Pessimistic and base case projections about the economy expect the year-end 10Y rate to increase up to 15 bps

from the current rate (three banks). Optimistic projections about the economy see an increase in the year-end 10Y

rate up to 25-35 bps (two banks).

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(1) Spread-Based Source: Wall Street Research

Asset Allocation Survey as of 1Q 2017

GDP forecasts point to the 2.0% - 2.2% range

Inflation forecasts jump to 2.4% - 2.9%

US and European fixed income is UW

Plurality of forecasts are OW in US TIPs, US credit and USD

Fixed Income Credit (1) Equities Forex Commodities Alternatives US Macro

(Left axis)

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Neutral Overweight Underweight Flatten

Source: Bloomberg

US GDP and its Components, 2Q 2016 – 1Q 2017

The US Economy, 2Q 2016 – 1Q 2017

Quarterly fluctuations not withstanding, economic

activity continues to expand at a moderate pace

(~2.0%)

Consumption and real personal disposable

income grow significantly faster than the GDP

growth rate (~3%)

Investment increases at about the same rate as

GDP (~2.1%), with business fixed investment

appearing to have rebounded significantly (~3.2%)

Government expenditures decline significantly

(~ -1.6%)

Exports grow by 3.6%, while imports increase by

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Consumption InvestmentNet Exports Government Expenditures

06/30/16 09/30/16 12/31/16 03/31/17

Real GDP (QoQ, SAAR) 1.4% 3.5% 2.1% 1.4%

Personal consumption 4.3 3.0 3.5 1.1

Goods 7.1 3.5 6.0 0.5

Durables 9.8 11.6 11.4 (1.6)

Nondurables 5.7 (0.5) 3.3 1.6

Services 3.0 2.7 2.4 1.4

Gross private domestic investment (7.9) 3.0 9.4 3.7

Fixed investment (1.1) 0.1 2.9 11.0

Nonresidential 1.0 1.4 0.9 10.4

Structures (2.1) 12.0 (1.9) 22.6

Equipment (2.9) (4.5) 1.9 7.8

Intellectual Property Products 9.0 3.2 1.3 6.4

Residential (7.7) (4.1) 9.6 13.0

Government expenditures & gross investment (1.7) 0.8 0.2 (0.9)

Federal spending (0.4) 2.4 (1.2) (2.0)

State and local spending (2.5) (0.2) 1.0 (0.2)

Net exports of goods & services

Exports 1.8 10.0 (4.5) 7.0

Imports 0.2 2.2 9.0 4.0

Addenda

Final sales of domestic product (a)

2.6 3.0 1.1 2.6

Gross domestic income (GDI) (b)

0.7 5.0 (1.4) 1.0

Gross national product (GNP) (c)

2.2 3.4 2.9 1.1

Disposable personal income 2.90 2.90 (0.30) 1.70

Contributions to % Change in GDP

Personal Consumption 2.88 2.03 2.40 0.75

Gross Private Domestic Investment (1.34) 0.50 1.47 0.60

Change in Private Inventories (1.16) 0.49 1.01 (1.11)

Government Consumption and Investments (0.30) 0.14 0.03 (0.16)

Net Exports of Goods and Services 0.18 0.85 (1.82) 0.23(a) GDP less change in private inventories (b) GDI-GDP = statistical discrepency (c) GDP plus net

foreign payments for US factors of production

* Graphic from https://www.frbatlanta.org/cqer/research/gdpnow.aspx as of 7/10/2018. Note: GDPNow forecasts pertain to the most recent quarter with no reported GDP number; once an advance number is reported for a particular quarter, GDPNow switches to predicting the subsequent quarter. All GDP numbers are quarter-on-quarter percent change in real GDP, seasonally adjusted and annualized. Source: Bloomberg, Atlanta Federal Reserve Bank

Nowcasting GDP: The Atlanta Fed’s GDPNow

Reported Real GDP Growth vs GDPNow Forecast, 4Q14 – 2Q17 GDPNow Forecast vs Consensus for 2Q 2017*

Following the report of the advance number for GDP growth in April, the GDPNow forecast for

2Q17 has steadily declined from about 4% to nearly 2.7%

The GDPNow forecast falls roughly in line with Blue Chip consensus forecasts and below

Bloomberg median consensus of 3%

1Q17

4Q16

3Q16

2Q16 1Q16

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https://www.frbatlanta.org/cqer/research/gdpnow.aspxhttps://www.frbatlanta.org/cqer/research/gdpnow.aspx

Notation: Est. = Establishment Survey by BLS, HH = Household Survey by BLS, DoL = US Department of Labor, BLS = Bureau of Labor Statistics. ** YoY, 1Q17, according to US Census Bureau’s quarterly services survey Source: Bloomberg

US Macroeconomic Indicators , March 2017 – June 2017

US consumer spending continues to

expand at annualized rate of ~3.6%

Both U3 and U6 unemployment rates

approach approximate pre-crisis levels,

while slack remains among less educated

workers

US industrial production grows at an

annualized rate of 0.8%, while non-

manufacturing activities increase by a

nominal 6.3%**

Different measures of inflation including

CPI (1.9%, YoY), core CPI (1.7%, YoY),

core PCE (1.4%, YoY) remain somewhat

below the Fed’s 2% target, yet:

Services inflation reaches 2.6%,

while

Goods inflation trends downwards

to -0.8%

3/31/2017 4/30/2017 5/31/2017 6/30/2017⁽¹⁾ LTM Max LTM Min

State of the Consumer

US Consumer Spending (SA, MoM%) 0.4 0.4 0.1 -- 0.7 0.1

US Auto Sales (SAAR, mil.) 16.5 16.8 16.6 16.4 18.3 16.4

New One Family Houses Sold (SAAR, 000's) 644.0 593.0 610.0 -- 644.0 548.0

Existing Homes Sold (SAAR, mil.) 5.7 5.6 5.6 -- 5.7 5.3

Housing Starts (SAAR , 000's) 1,189.0 1,156.0 1,092.0 -- 1,328.0 1,062.0

Housing Permits (SAAR, 000's) 1,260.0 1,228.0 1,168.0 -- 1,300.0 1,168.0

U. of Mich. Consumer Confidence 96.9 97.0 97.1 95.1 98.5 87.2

Conference Board Consumer Confidence 124.9 119.4 117.6 118.9 124.9 96.7

US Pending Home Sales Index (SA, 2001=100) 111.3 109.4 108.5 -- 112.3 106.4

US Personal Income(SA, MoM%) 0.2 0.3 0.4 -- 0.6 (0.1)

US Retail Sales (SA, MoM%) 0.1 0.4 (0.3) -- 1.0 (0.3)

Labor Market*

Unemployment (SA, %), HH 4.5 4.4 4.3 4.4 4.9 4.3

Unemployed and Part Time (SA, %), HH 8.9 8.6 8.4 8.6 9.7 8.4

Change in Non-Farm Payroll (SA, 000's), Est. 50.0 207.0 152.0 222.0 291.0 50.0

Unemployed Workers Total (SA, 000's), HH 7,202.0 7,056.0 6,861.0 6,977.0 7,904.0 6,861.0

Labor Participation Rate (SA, %), HH 63.0 62.9 62.7 62.8 63.0 62.6

Civilian Labor Force Level (SA, 000's), HH 160,201.0 160,213.0 159,784.0 160,145.0 160,213.0 159,295.0

US Civilian Noninstitutional Population Total (SA, 000's), HH 254,414.0 254,588.0 254,767.0 254,957.0 254,957.0 253,620.0

Employed in Civilian Labor Force, Net Change (SA, 000's), HH 472.0 156.0 (233.0) 245.0 472.0 (233.0)

ADP National Employment Report (SA , 000's) 255.0 148.1 230.2 158.0 268.4 61.7

US Initial Jobless Claims (SA, 000's, weekly )⁽³⁾, DoL 235.0 238.0 255.0 248.0 266.0 227.0

US Average Hourly Earnings (SA, YoY%), Est. 2.6 2.5 2.4 2.5 2.9 2.4

Employment Cost Index (SA, QoQ%, quarterly ), BLS 0.8 -- -- -- 0.8 0.5

US Avg. Weekly Hr. Worked, Nonfarm Private, Nonsupervisory (SA), Est. 33.6 33.7 33.6 33.7 33.7 33.6

Production

US Industrial Production MoM (SA, %) 0.1 1.1 0.0 -- 1.1 (0.3)

US Services Revenue Total YoY (NSA, %, quarterly ), Census 6.3 -- -- -- 6.3 5.2

US Durable Goods New Orders MoM (SA, %) 2.4 (0.8) (0.8) -- 6.1 (4.6)

US Durable Goods New Orders Ex Transportation MoM (SA, %) 0.9 (0.4) 0.3 -- 1.7 (0.4)

ISM Manufacturing PMI (SA, %) 57.2 54.8 54.9 57.8 57.8 49.4

ISM Non-Manufacturing PMI (%) 55.2 57.5 56.9 57.4 57.6 51.7

Philadelphia Fed Business Outlook Survey (SA, %) 32.8 22.0 38.8 27.6 43.3 (0.9)

Empire State Manufacturing Survey (SA, %) 16.4 5.2 (1.0) 19.8 19.8 (5.5)

Chicago Purchasing Manager Index (SA, %) 57.7 58.3 59.4 65.7 65.7 50.3

Prices

CPI (YoY%) 2.4 2.2 1.9 -- 2.7 0.8

Core CPI (YoY%) 2.0 1.9 1.7 -- 2.3 1.7

CPI Consumer Services ex. Energy (YoY%) 2.9 2.7 2.6 -- 3.2 2.6

CPI Consumer Commodities ex. Food/Energy (YoY%) (0.6) (0.6) (0.8) -- (0.2) (0.8)

PCE Core (SA, MoM%) (0.1) 0.1 0.1 -- 0.3 (0.1)

PCE Core (SA, YoY%) 1.6 1.5 1.4 -- 1.8 1.4

U. of Mich. Expected Change in Prices During the Next Year: Median (%) 2.5 2.5 2.6 2.6 2.7 2.2

U. of Mich. Expected Change in Prices During the Next 5-10 Years (%) 2.4 2.4 2.4 2.5 2.6 2.3

US Personal Consumption Expenditures Chain Type (SA, MoM%) (0.2) 0.2 (0.1) -- 0.4 (0.2)

US Personal Consumption Expenditures Chain Type (SA, YoY %) 1.8 1.7 1.4 -- 2.1 0.9

PPI Final Demand (SA, MoM%) (0.1) 0.5 0.0 -- 0.6 (0.2)

Case-Shiller Composite-20 City (YoY%) 5.9 5.7 -- -- 5.9 5.0

TIPs Break Even 5Y (daily )⁽⁴⁾ 2.0 1.8 1.8 1.7 2.0 1.3

⁽¹⁾ most recent number for the period 5/31/17 - 7/7/17, ⁽²⁾ preliminary number, ⁽³⁾ For past months numbers are end-of-period; for current month, all available numbers are

listed ⁽⁴⁾ For past months numbers are end-of-period; for current month, most recent number available

Notes: Each index reflects, at a moment in time, the surprise of various economic indicators, measured in standard deviation. They are further modified by adjusting for importance of the indicators and the recency of the latest report of those indicators. Citi’s index is reported in basis points. Source: Bloomberg

Economic Surprises

Citi Economic Surprise Indicators, Jun 2016 – Jun 2017 Bloomberg Economic Surprise Indicators, Jun 2016 – Jun 2017

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In the US, economics indicators are recently reporting below expectations

In Europe and Emerging Markets, indicators surprise to the upside

On a monthly basis, economic surprise indicators have a statistically significant, positive

influence on treasury rates, but only explain about 15% of the variance

Note: All GDP data are reported quarterly. Inflation-adjusted numbers are based on headline CPI. Source: U.S. Bureau of Economic Analysis, U.S.

Bureau of Labor Statistics, Bloomberg

Statistical Properties of US GDP and the Real Interest Rate

Real GDP Growth, Q2 1953 – Q1 2017 30 Year Real Interest Rates, Feb 1977 – May 2017

Composition of US GDP, Q1 1981 – Q1 2017

In equilibrium, real interest rates

converge towards real GDP

Over the years, US consumption has

crept up from about 60% of GDP to

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March 2017: 1.40% Mean: 3.05%

Median: 3.05%

Standard Deviation: 3.63%

Kurtosis: 1.40%

Skewness: -0.20%

Std Error of Mean: 0.23%

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May 2017: 4.15% Mean: 3.13%

Median: 3.16%


Kurtosis: 2.55%

Skewness: 0.18%

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Consumption/GDP Investment/GDP

Government Expenditures/GDP Net Exports/GDP

The Fed’s Reaction Function and the Taylor Rule, May 1972 – May 2017

Source: Bloomberg.

The Fed’s Reaction Function: The Taylor Rule

The Taylor reaction function is widely used to explain Fed Funds target rates

Target Rate = Real Rate (r*)

+ Core Inflation

+ ½ • (Inflation-Target Inflation)

+ ½ • Okun Factor • (Normal Unemployment – Unemployment)

+ f(Global Market Conditions)

+ f(Financial Stress)

The Fed seems to incorporate global market conditions and financial stress in its decision making

Though the natural real rate is not directly observable, many economists believe that it is presently near zero

James Bullard of the St. Louis Fed believes that the natural real rate will remain near zero in the long run, as reflected in

his “Fed dot”

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Note: The Laubach-Williams estimation of the natural real rate is determined via the Kalman filter and is hence not directly observable. For each point in time for the one-sided estimate, only data from prior to that moment is used; for the two-sided estimate, both future and prior information is incorporated.

* The Economist Estimate Source: The Economist, Bloomberg

Real Interest Rates

Estimations of the Natural Real Rate, Mar 1971 – Mar 2017 World Real Interest Rate, 1985 – 2016

Persistently low US and Global real interest rates generate heated debates, and continue to puzzle

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Natural Real Rate (Laubach-Williams est., 1-sided)

Natural Real Rate (Laubach-Williams est., 2-sided)

Target Fed Funds Rate

Overlay of Fed Funds Forecasts

Fed Dots From Python Fed Dots From Python

FOMC Outlook, Meeting by Meeting, Jun 2016 – Mar 2017 Outlook on Pace of Policy Firming as of Mar 2017

Source: Federal Reserve; Bloomberg

The Fed Funds Rate

Option-Implied Probability of Target by FOMC Meeting as of 7/7/2017 Various Fed Funds Forecasts as of Jun 2017

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Meeti

ng

Date

7/26/2017 0 100 0 0 0 0 0 0

9/20/2017 0 78 22 0 0 0 0 0

11/1/2017 0 77 23 0 0 0 0 0

12/13/2017 0 42 48 10 0 0 0 0

1/31/2018 0 41 47 11 0 0 0 0

3/21/2018 0 25 45 25 4 0 0 0

5/2/2018 0 25 45 25 5 0 0 0

6/13/2018 0 18 40 31 10 1 0 0

8/1/2018 0 18 39 31 11 2 0 0

9/26/2018 0 13 34 33 16 4 1 0

11/8/2018 0 13 32 33 17 5 1 0

12/19/2018 0 9 26 33 22 9 2 0

1/30/2019 0 9 26 33 22 9 2 0

Probability of Target Rate (%) at Meeting

FO

MC

Meeti

ng

Date

US Wage Growth

Historical US Inflation & Wages

Historical US Inflation & Wages

Source: Federal Reserve; Bloomberg

Inflation Indicators

US Wages & Inflation Indicators, May 2014 – May 2017

Inflation measured by core PCE runs consistently below the Fed’s 2% target

Goods inflation dips below zero, while services inflation fluctuates around 3%

US Goods & Services, May 1988 – May 2017

US Wage Growth, Jun 2006 – Jun 2017 Headline CPI, Apr 1953 – May 2017

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Yo

Y %

Ch

an

ge

US Recessions

US CPI Urban Consumers Services Less Energy Services

US CPI Urban Consumers Commodities Less Food & Energy SA YoY%

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Yo

Y %

Ch

an

ge

US Avg. Hourly Earnings Empl Cost IndexPCE Defl. PCE ex Food/EnergyCPI Services ex. Energy CPI Commodities ex. Food/Energy

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

Mo

M, %

Ch

an

ge

US Avg. Hourly Earnings, Nonsup. Private Nonfarm Payrolls (Nom. Dollars, SA)

12-month Geom. MA

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

16.0

%

15.0

%

14.0

%

13.0

%

12.0

%

11.0

%

10.0

%

9.0

%

8.0

%

7.0

%

6.0

%

5.0

%

4.0

%

3.0

%

2.0

%

1.0

%

0.0

%

-1.0

%

-2.0

%

-3.0

%

-4.0

%

-5.0

%

-6.0

%

-7.0

%

-8.0

%

Fre

qu

en

cy

May 2017: -1.19% Mean: 3.57%

Median: 2.43%


Kurtosis: 3.79%

Skewness: 0.64%

Source: The Federal Reserve Bank of New York. US Treasury. Bloomberg.

Maturity Profile of US Treasury Securities & Fed Holdings

SOMA Holding of Treasuries as Percent of Outstanding Treasuries

0

5

10

15

20

25

30

35

40

45

50

Less than3 years

3-6 Years 6-10 Years 10-30Years

TIPS FRNsFe

d H

old

ing

s a

s %

of

En

tire

M

ark

et

2014 2015 2016

US Treasury: Marketable Securities Outstanding

0

2

4

6

8

10

12

14

16

Ma

r-9

7

Ma

r-9

8

Ma

r-9

9

Ma

r-0

0

Ma

r-0

1

Ma

r-0

2

Ma

r-0

3

Ma

r-0

4

Ma

r-0

5

Ma

r-0

6

Ma

r-0

7

Ma

r-0

8

Ma

r-0

9

Ma

r-1

0

Ma

r-1

1

Ma

r-1

2

Ma

r-1

3

Ma

r-1

4

Ma

r-1

5

Ma

r-1

6

Ma

r-1

7

Am

ou

nt

Ou

tsta

nd

ing

($

, T

rill

ion

s)

Bonds Notes Bills FRN TIPS

US Treasury: Current Maturity Profile of Marketable Securities

0

500

1000

1500

2000

2500

3000

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

2035

2036

2037

2038

2039

2040

2041

2042

2043

2044

2045

2046

2047

Am

ou

nt

Ou

tsta

nd

ing

($,

bil

lio

ns

)

Calendar Year

Bill Note Bond TIPS FRN

The Fed’s SOMA Portfolio: The Drawdown

0

10

20

30

40

50

60

70

80

Oct-

17

Jan

-18

Ap

r-18

Jul-

18

Oct-

18

Jan

-19

Ap

r-19

Jul-

19

Oct-

19

Jan

-20

Ap

r-20

Jul-

20

Oct-

20

Jan

-21

Am

ou

nt

($, b

illi

on

s)

Treasuries Maturing in Month Proposed Reinvestment Cap

Amount to be retired

Amount to be reinvested

Source: Bloomberg, Federal Reserve, ECB

Balance Sheet of the Fed & ECB

Federal Reserve Assets, Jun 2006 – Jun 2017 Federal Reserve Liabilities, Jun 2006 – Jun 2017

ECB Assets, Jun 2006 – Jun 2017 ECB Liabilities, Jun 2006 – Jun 2017

Contraction Path

Start Increment Final

UST $6bln / Mo. $6bln / 3Mo. $30bln / Mo.

MBS $4bln / Mo. $4bln / 3Mo. $20bln / Mo.

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Ju

n-0

6

Ju

n-0

7

Ju

n-0

8

Ju

n-0

9

Ju

n-1

0

Ju

n-1

1

Ju

n-1

2

Ju

n-1

3

Ju

n-1

4

Ju

n-1

5

Ju

n-1

6

Ju

n-1

7

Assets

(€ b

illio

ns)

Gold and Gold Receivables Other Assets

Securities of Euro Area Residents Lending to Euro Area Credit Institutions

0

1,000

2,000

3,000

4,000

5,000

Ju

n-0

6

Ju

n-0

7

Ju

n-0

8

Ju

n-0

9

Ju

n-1

0

Ju

n-1

1

Ju

n-1

2

Ju

n-1

3

Ju

n-1

4

Ju

n-1

5

Ju

n-1

6

Ju

n-1

7

Assets

($ B

illio

ns)

Mortgage-Backed Securities Held Outright US Treasury Securities Held Outright

Other Assets Commercial Paper Funding Facility

Term Auction Faciliity Loans (Incl. Term Asset-Backed Securities Loan Facility)

Federal Agency Debt Securities Held Outright

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Ju

n-0

6

Ju

n-0

7

Ju

n-0

8

Ju

n-0

9

Ju

n-1

0

Ju

n-1

1

Ju

n-1

2

Ju

n-1

3

Ju

n-1

4

Ju

n-1

5

Ju

n-1

6

Ju

n-1

7

Lia

bili

ties (

€ B

illio

ns)

Liabilities to Euro Area Credit Institutions Other Liabilities

Liabilities to other residents in Euro Liabilities to other residents in foreign currency

Currency In Circulation

0

1,000

2,000

3,000

4,000

5,000

Ju

n-0

6

Ju

n-0

7

Ju

n-0

8

Ju

n-0

9

Ju

n-1

0

Ju

n-1

1

Ju

n-1

2

Ju

n-1

3

Ju

n-1

4

Ju

n-1

5

Ju

n-1

6

Ju

n-1

7

Lia

bili

ties (

$ B

illio

ns)

Reserve Balances with Federal Reserve Banks Other Factors Absorbing Reserve Funds

Currency In Circulation

Note: Interbank rates are provided by Bloomberg and are often provided without indication of which bank listed the quote. In top charts, Fed (resp. ECB) ratio is defined at the size of the Fed’s (ECB’s) assets divided by the US (Eurozone) GDP; “Fed/ECB” is the ratio of these two ratios. “$M2” and “€M2” are defined similarly but central bank assets are replaced with M2 money supply. Source: Bloomberg, Federal Reserve, ECB

Balance Sheet of the Fed & ECB (cont’d)

Central Bank Assets, Fed vs ECB, Jun 2001 – Jun 2017 Money Supplies, Fed vs ECB, Jun 2001 – Jun 2017

Interbank Lending Rates by Country, Jun 2007 – Jun 2017 Benchmark Policy Rates by Country, Jun 2008 – Jun 2017

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

US

D/E

uro

Ex

ch

an

ge

Rate

Cen

tral B

an

k A

ss

ets

to

GD

P

Fed ratio ECB ratio Fed/ECB USD / Euro

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

US

D/E

uro

Ex

ch

an

ge

Rate

Mo

ne

y S

up

ply

to

GD

P

$M2 ratio €M2 ratio $M2/€M2 USD / Euro

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Ju

n-0

7S

ep

-07

De

c-0

7M

ar-

08

Ju

n-0

8S

ep

-08

De

c-0

8M

ar-

09

Ju

n-0

9S

ep

-09

De

c-0

9M

ar-

10

Ju

n-1

0S

ep

-10

De

c-1

0M

ar-

11

Ju

n-1

1S

ep

-11

De

c-1

1M

ar-

12

Ju

n-1

2S

ep

-12

De

c-1

2M

ar-

13

Ju

n-1

3S

ep

-13

De

c-1

3M

ar-

14

Ju

n-1

4S

ep

-14

De

c-1

4M

ar-

15

Ju

n-1

5S

ep

-15

De

c-1

5M

ar-

16

Ju

n-1

6S

ep

-16

De

c-1

6M

ar-

17

Ju

n-1

7

Ra

te (

%)

United States ECB SwizerlandDenmark Japan Sweden

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Ju

n-0

7S

ep

-07

De

c-0

7M

ar-

08

Ju

n-0

8S

ep

-08

De

c-0

8M

ar-

09

Ju

n-0

9S

ep

-09

De

c-0

9M

ar-

10

Ju

n-1

0S

ep

-10

De

c-1

0M

ar-

11

Ju

n-1

1S

ep

-11

De

c-1

1M

ar-

12

Ju

n-1

2S

ep

-12

De

c-1

2M

ar-

13

Ju

n-1

3S

ep

-13

De

c-1

3M

ar-

14

Ju

n-1

4S

ep

-14

De

c-1

4M

ar-

15

Ju

n-1

5S

ep

-15

De

c-1

5M

ar-

16

Ju

n-1

6S

ep

-16

De

c-1

6M

ar-

17

Ju

n-1

7

Ra

te (

%)

United States ECB SwitzerlandDenmark Japan Sweden

Matt-Employment Data Labor Market Conditions Index

Nonfarm Payrolls vs Moving Average

* Part-time workers (those who worked 1 to 34 hours during the survey reference week and excludes employed persons who were absent from their jobs for the entire week) divided by the civilian labor force. Source: Bloomberg, FRED

Labor Market Conditions

Fed’s Labor Market Conditions Index, May 1988 – May 2017

The BLS measure of US job growth shows strength

in June with payrolls growing by 222K. Unlike the

BLS, ADP’s estimate of private payrolls is less

sensitive to swings and reports a respectable 158K

gain in March.

The 6-month moving average of payroll gains falls

to ~175K from ~250K, an expected result as we

move closer to full employment

Monthly Payroll Gains, Jun 2013 – Jun 2017

Unemployment Rate, Jun 1995 – Jun 2017

-50

-40

-30

-20

-10

0

10

20

30

40

50

Recession Fed Labor Market Conditions Index

50

55

60

65

70

0

5

10

15

20 Pa

rticip

atio

n R

ate

(%)

Em

plo

ym

en

t/U

ne

mp

loym

en

t (%

)

U3 Unemployment RateU6 Unemployment RateEmployment Rate: Part-Time for Economic Reasons, Nonagricultural Industries*US Labor Force Participation Rate (RA)

0

50

100

150

200

250

300

350

400

Net

Ch

an

ge (

Mo

M, 1000s)

Nonfarm Payrolls (MoM, net change, thousands) 6M Moving Average

Historical US Financial Conditions Indicators

Historical US Financial Conditions Indicators

Source: Bloomberg

Financial Stress Indicators and GDP

TED Spread (3M LIBOR – 3M UST), Jun 2010 – Jun 2017 US Financial Conditions Indexes, Jun 2007 – Jun 2017

Response of GDP to Goldman Sachs Financial Stress Index, Mar 2005 – Dec 2015

-10

-8

-6

-4

-2

0

2

4

6

8

-10

-8

-6

-4

-2

0

2

4

6

8

Ma

r-05

Jun

-05

Se

p-0

5

Dec-0

5

Ma

r-06

Jun

-06

Se

p-0

6

Dec-0

6

Ma

r-07

Jun

-07

Se

p-0

7

Dec-0

7

Ma

r-08

Jun

-08

Se

p-0

8

Dec-0

8

Ma

r-09

Jun

-09

Se

p-0

9

Dec-0

9

Ma

r-10

Jun

-10

Se

p-1

0

Dec-1

0

Ma

r-11

Jun

-11

Se

p-1

1

Dec-1

1

Ma

r-12

Jun

-12

Se

p-1

2

Dec-1

2

Ma

r-13

Jun

-13

Se

p-1

3

Dec-1

3

Ma

r-14

Jun

-14

Se

p-1

4

Dec-1

4

Ma

r-15

Jun

-15

Se

p-1

5

Dec-1

5

% Δ

, Qo

Q %

Δ, Q

oQ

GDP

GDP w/o Financial Shocks

94

96

98

100

102

104

106

-15

-10

-5

0

5

10

15

Le

vel

Bloomberg Financial Conditions Index St Louis Fed Financial Stress Index

GS Financial Conditions Index

0

20

40

60

80

100

120

0

0.2

0.4

0.6

0.8

1

1.2

Sp

read

(bp

s)

Yie

ld (

%)

TED (bps, right) LIBOR 3M (%) UST 3M (%)

Political Risk Scores from The Economist, Apr 2005 – Apr 2017

Note: According to The Economist’s methodology, “Political risk evaluates a range of political factors relating to political stability and effectiveness that could affect a country’s ability and/or commitment to service its debt obligations and/or cause turbulence in the foreign exchange market.”

According to the Economic Policy Uncertainty methodology, the uncertainty index is based on newspaper coverage, number of tax-codes set to expire, and disagreement among economists.

Source: The Economist; Bloomberg, "An Index of Global Economic Policy Uncertainty” by Steven J. Davis

at www.PolicyUncertainty.com

Political Risk Around the World

Political risks rise globally, but economic policy uncertainty falls

France dodges a Le Pen presidency and bucks the populist trend by electing Macron

Broad corruption scandals erupt in Brazil, sparing few

Risks in Hong Kong continue to rise as China extends its influence and reneges on the 1984 Sino-British Joint

Declaration

Gauged by economic policy uncertainty, global risks have fallen from recent heights

Global Economic Policy Uncertainty (EPU), Jun 1997 – Jun 2017

0

10

20

30

40

50

60

70

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10

Ap

r-11

Ap

r-12

Ap

r-13

Ap

r-14

Ap

r-15

Ap

r-16

Ap

r-17

Sco

re

France Germany UK ItalyBrazil China Hong Kong USA

0

50

100

150

200

250

300

350

Ind

ex L

evel

United StatesGlobal EPU, Weighted by Current Prices GDPGlobal EPU, Weighted by PPP-Adjusted GDP

Source: Bloomberg.

Overseas Economies World GDP Map World Unemployment Map

Selected

Countries

Name Real GDP YoY Unemployment Name Real GDP YoY Unemployment

% Date % Date % Date % Date

North America Europe (cont.)

Canada 3.2 3/17 6.6 5/17 Spain 3.0 3/17 17.8 4/17

US 2.0 3/17 4.3 5/17 United Kingdom 2.0 3/17 4.6 4/17

Mexico 2.8 3/17 3.5 5/17 Asia

Europe China 6.9 3/17 4.0 12/16

France 1.1 3/17 9.5 4/17 Japan 1.3 3/17 2.8 4/17

Germany 1.7 3/17 3.9 4/17 Emerging Markets

Greece 0.4 3/17 22.5 3/17 Brazil -0.3 3/17 13.6 4/17

Italy 1.2 3/17 11.1 4/17 Russia 0.5 3/17 5.2 5/17

Portugal 2.8 3/17 9.8 4/17 Turkey 3.1 6/16 11.5 3/17

Table of Contents:

1. The Quarterly Macroeconomic Outlook

Appendix. Thoughts on Ultra-Long Treasury Bonds

* https://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspx

Main Points

On May 3, 2017, the Treasury Borrowing Advisory Committee released a statement* indicating interest in selling ultra-long bonds:

“…the Committee commented on the demand for ultra-long debt, noting that the regular and predictable issuance policy should

remain the central consideration to minimize Treasury’s funding cost over time”

The statement continued: “…the Committee recommended that Treasury consider issuing a zero coupon 50-year bond, and coupon

maturities between 10- and 30-years, preferably the reintroduction of the 20-year. Finally, the Committee recommended against

issuing a 100-year bond due to limited pension or insurance cash flows beyond 50-years and the preferable attributes of stripped

30-year bonds to meet a similar duration as a 100-year coupon bond.”

We have heeded the Treasury’s call, “The Committee recommended that further work be done to study these demand dynamics to

get a better sense of where an ultra-long bond might price, which could be above or below the longest maturity debt issuance based

on the pricing of domestic ultra-long derivatives, ultra-long bonds abroad, and theoretical models”, and examined the potential cost

benefits to the Treasury enjoyed by issuing a 50-year bond and use a breakeven analysis.

We conclude that if the Treasury had to choose between a 50-year funding realized through one 50-year tranche versus a 50-year

funding realized through a 30-year tranche followed by a subsequent 20-year tranche, then the single 50-year tranche is cheaper to

the Treasury if the 20-year rate rises more than 212 bps from today’s rate over the course of 30 years

We have noted other reports which take into consideration the market’s ability to absorb and sustain this sort of issuance. We offer

no comment on those concerns here. We are strictly concerned with the cheapest options available to the Treasury.

https://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspxhttps://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspxhttps://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspxhttps://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspxhttps://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspxhttps://www.treasury.gov/press-center/press-releases/Pages/current_TBACMinutesPressRelease.aspx

Source: The Economist, Bloomberg.

Our Chief Economist on Ultra-Long Sovereign Debt

Excerpts from the Economist, May 6th 2017

When introducing a factor for rates, utilities reflect a strong, consistent effect. Also, it appears that the influence of the S&P 500 is heightened (beta = .75)

“…In some countries, such as Britain, interest rates on long-term debt are not much higher—or are even lower—than on shorter-term borrowing. For them, borrowing at ultra-long maturities is likely to be cheaper than medium-term debt, so it makes sense to replace some mid-length bonds with ultra-long ones, says Niso Abuaf of Samuel A. Ramirez & Company, a New York brokerage. This helps to explain why the WAM of British sovereign debt is unusually long, at 14.9 years (see chart).”

Government debt

Taking the ultra-long view

Excerpts from the Bloomberg, May 16th 2017

Bond Math Tells One Analyst Ultra-Long Issuance Would Save Money • Weighing 50-year bond versus a 30-year rolled into a 20-year • Average maturity of U.S. debt remains under six years By Elizabeth Stanton (Bloomberg) -- There are plenty of reasons why the U.S. Treasury may eventually decide against introducing an ultra-long bond. But cost shouldn’t be one of them, according to Niso Abuaf, a Wall Street financial strategist since the mid-1980s. A basic exercise in bond math shows that the government would likely save money by stretching its yield curve to the 50-year mark, said Abuaf, who heads the financial strategy group at Ramirez & Co. in New York. The analysis involves comparing the theoretical cost of issuing a 50-year bond today with the expense of alternatives such as issuing a 30-year bond and then rolling that into a 20-year obligation. The approach requires an interpolated 50-year Treasury yield and the zero-coupon yield curve. It determines the net present value of a 50-year Treasury and the coupon rate for a 20-year bond issued 30 years from now that would…

US Treasury Yields as of

6/14/2017

20 Year* 2.45

30 Year 2.77

50 Year (estimated**) 3.17

BE Rate (20 Year) 4.57

Δ to BE (bps) 212

Source: Ramirez & Co. calculations, Bloomberg.

The Numbers: Issuing 50Y vs. 30Y Plus 20Y

If the 20Y rate

increases to

4.57% and

beyond in 30

years, a

current 50Y

funding would

be more cost

efficient

This

represents a

212 bps

increase from

today’s 20Y

level

This analysis

assumes that

the current 20Y

rate is the best

forecast of the

20Y rate 30

years from now

50Y Financing vs. 30Y and Subsequent 20Y: Break-Even Rate

* 20Y rate is the arithmetic average of the 10Y and 30Y rates. ** The 50Y rate is estimated by adding 40 bps to the 30Y rate; this is inspired by the premium on 50Y TVA bond issued in 2015

Firs

t 3

0 y

ears

Fo

llow

ing

20 y

ears

Year Cash Flow

Discount Rates

(Zero-Coupon)

Discounted

Cash Flow

1 $2.77 1.19% $2.74

2 2.77 1.33% 2.70

3 2.77 1.47% 2.65

… … … …

29 2.77 2.91% 1.21

30 4.57 2.95% 1.91

31 4.57 2.98% 1.84

32 4.57 3.01% 1.77

… … … …

49 4.57 3.68% 0.78

50 104.57 3.73% 16.74

$100.00

To compare the advantages (or disadvantages) of a strategy of a 50-year funding of $100 with a single

50-year tranche versus a strategy of a 50-year funding of $100 with a 30-year tranche followed by a 20-

year tranche, we compare the discounted cashflows

By definition, the discounted cashflows of the single 50-year tranche strategy must be $100. The

discounted cashflows of the other strategy will depend on the 20-year rate 30 years from today. If that

20-year rate* rises sufficiently high, then a single 50-year tranche will be less expensive to the Treasury.

Otherwise, a 30-year + 20-year strategy is cheaper

Where are Long-Term Rates in The Long Run?

We offer our long-term forecasts of US Treasuries and anchored them on:

the Fed’s median forecast for the Fed Funds rate

long-term tendencies of interest rates with respect to US real GDP growth and inflation

The Fed’s median forecast of the Fed Funds rate centers around 3% for 2019 and beyond. This forecast suggests

a 1% real rate and 2% inflation rate

Theory suggests that the risk free nominal interest rate equals the real rate plus inflation

Theory and empirical evidence suggest that the real rate of interest converges to US real GDP growth

Since the 1950s, US real GDP growth and the real interest rate center around 3%

Currently the base-case forecast for real GDP growth is around 2%, suggesting a 4% base-case forecast for the

10-year UST (2% real + 2% inflation)

Optimistic forecasts of the US economy suggest 3% real growth rate, indicating a 5% long-term 10-year UST rate

(3% real + 2% inflation)

International conditions and excess savings over investment needs may point to downside risks for the

forecasts

Bottom line:

Base-case 10-year UST: 4% in the long term

Optimistic 10-year UST: 5% in the long term

Pessimistic 10-year UST: less than 4% in the long term

Risk: inflation diverging from 2%, international macroeconomic and political risk, US political risk

Academic and Fed forecasters suggest that the most prudent forecasting strategy would be a smooth glide path

from current levels to long-term equilibrium levels

As the Fed suggests, we expect normalization of the Fed Funds rate to be completed by the end of 2019 and

normalization of the 10Y rate to be completed with the paring of the Fed’s balance sheet

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