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Global Investment Strategy Weekly Report, “Seven Structural Reasons for a Lower Neutral Rate in the U.S.,” Dated March 13, 2015, Available at Gis.Bcaresearch.Com

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Global Investment Strategy Weekly Report, “Seven Structural Reasons for a Lower Neutral Rate in the U.S.,” Dated March 13, 2015, Available at Gis.Bcaresearch.Com GLOBAL INVESTMENT STRATEGY WEEKLY REPORT Edge RESEARCH DISCOVERY ACTION What Happened To The Growth The interface of investment research May 22, 2015 Periodical Dividend From Lower Oil Prices? In this Issue: CHART 1 F Market Overview: F The boost to global growth from Unlike In The Euro Area, Bond Selloff It’s All About The falling oil prices has been smaller In U.S. Not Driven By Liftoff Expectations... Terminal Rate ............1 Months Months than most anticipated. F Focus Section: MONTHS TO HIKE*: The Underwhelming F Public anxiety that gasoline prices U.S. Economic Response 50 EURO AREA 50 To Lower Oil Prices ....3 will rise again, a higher willing- F What Does This Mean ness to save the windfall from For Investors? ..........11 lower oil prices, a larger-than- expected hit to energy capex, 40 40 worries that falling oil prices will exacerbate deflationary pressures, 30 30 and higher fuel taxes have all re- strained aggregate demand. 20 20 F In addition, higher heating bills owing to the cold winter in the U.S., along with a jump in health 10 10 care spending, appear to have eaten up about 40% of the gains © BCA Research 2015 from lower oil prices. JAN APR JUL OCT JAN APR JUL 2014 2015 F * NUMBER OF MONTHS TO FIRST RATE HIKE, AS DISCOUNTED IN THE Concerns about the environmental OVERNIGHT INDEX SWAP CURVE. SERIES SHOWN SMOOTHED EXCEPT consequences of increased oil FOR LATEST DATAPOINT. production may limit the supply- Editorial Board side benefits of lower crude Market Overview: Peter Berezin prices. It’s All About The Terminal Rate Managing Editor F The recent run-up in Treasury ne of the recurrent themes of this publi- Mathieu Savary Senior Editor yields will ultimately be reversed. cation has been the idea that the precise Investors should expect the dollar O Jim Mylonas timing of the liftoff date for the fed funds Editor/Strategist to strengthen modestly against the rate is a less important driver of long-term Melanie Kermadjian euro, but more so against the cur- Senior Analyst rencies of oil-exporting economies bond yields than how high rates ultimately Isabelle Ng such as Brazil and Russia. go. The past few weeks have reinforced this Research Analyst view. Chart 1 shows that unlike in the euro [email protected] • TEL 514.499.9550 • www.bcaresearch.com Copyright © 2015 BCA Research Inc. All Rights Reserved. Refer to last page. 1 Laura Pfeiff GWM Advisory Services 249247 BCA RESEARCH INC. GLOBAL INVESTMENT STRATEGY - WEEKLY REPORT MAY 22, 2015 CHART 2 CHART 3 …But Rate Expectations Household Deleveraging: Further Out Are Rising No Longer The Main Culprit %%% Of % Of GDP U.S. PRIVATE NONFINANCIAL DEBT GDP U.S. FED FUNDS RATE 170 170 3.2 3.2 165 165 2.4 2.4 160 160 155 155 1.6 1.6 150 150 MARKET EXPECTATIONS*: CURRENT 145 145 APRIL 17, 2015 .8 JANUARY 30, 2015 .8 % Of % Of GDP CONSUMER CREDIT* GDP 18.5 18.5 0 © BCA Research 2015 0 2014 2016 2018 2020 2022 2024 * BASED ON OVERNIGHT INDEX SWAPS. 18.0 18.0 area, “months to hike” in the U.S. has barely budged. What has changed is the terminal rate, 17.5 17.5 which has risen by 60 basis points since April 17 (Chart 2). 17.0 17.0 Many pundits have argued that despite the recent selloff, bond yields are still unnaturally low, supported only by the Fed’s printing press. 16.5 16.5 However, this reasoning reveals a fatal conceit. © BCA Research 2015 The fed funds rate has been close to zero for 04 06 08 10 12 14 * INCLUDES AUTO LOANS, CREDIT CARDS, STUDENT LOANS, AND OTHER seven years now, yet growth has remained ane- NON-HOUSING RELATED FORMS OF CONSUMER CREDIT. SOURCE: FEDERAL RESERVE BANK OF NEW YORK. mic and inflation has been dormant. One can no longer blame the deleveraging cycle. Chart 3 shows that private nonfinancial debt has been flat as a share of GDP since 2012 while consumer credit has actually been rising. Admittedly, fiscal restraint and the sluggish recovery in home construction have weighed on growth. As government spending returns to normal and housing starts rebound, the Fed will be able to dial back monetary stimulus. Yet, it is highly unlikely that the Fed will be able to restore rates anywhere close to pre-crisis levels. In part, this is because a variety of structural factors – ranging from slower [email protected] • TEL 514.499.9550 • www.bcaresearch.com Copyright © 2015 BCA Research Inc. All Rights Reserved. Refer to last page. 2 Laura Pfeiff GWM Advisory Services 249247 BCA RESEARCH INC. GLOBAL INVESTMENT STRATEGY - WEEKLY REPORT MAY 22, 2015 The Fed will potential growth, the shift to a capital-lite econ- CHART 4 Increased Supply Has Accounted For The need to keep omy, higher income inequality, and the lack of 1 Bulk Of The Drop In Oil Prices Since October real rates a major asset bubble – will restrain spending. %5 lower than It is also because a stronger dollar will curb 0 they would domestic demand. It is critical to note that otherwise be while the impact of a stronger dollar on infla- -5 to offset the tion is temporary, the impact on the level of -10 loss in de- real GDP is permanent. This, in turn, implies that the Fed will need to keep real rates lower -15 CUMULATIVE CHANGE IN OIL mand from a PRICES* FROM JULY 2014 TO larger trade than they would otherwise be to offset the loss OCTOBER 2014 EXPLAINED BY: in demand from a larger trade deficit. -20 SUPPLY (3.7%) deficit. DEMAND (96.3%) Six months ago one might have hoped that the -25 JUL AUG SEP OCT decline in oil prices would compensate for a 2014 stronger dollar. However, as we discuss in this 10% week’s focus section, while we expect the eco- 0 nomic benefits from lower oil prices to become more apparent in the months ahead, the overall -10 impact appears to be smaller than anticipated. -20 CUMULATIVE CHANGE IN OIL Focus Section: -30 PRICES* FROM OCTOBER 2014 The Underwhelming Economic TO JANUARY 2015 EXPLAINED BY: -40 SUPPLY (58%) Response To Lower Oil Prices DEMAND (42%) © BCA Research 2015 As oil prices began to swoon last autumn, many -50 OCT NOV DEC JAN observers predicted that the global economy 2014 2015 would receive a substantial growth dividend. * USING LOG OF DAILY PRICES. NOTE: MODEL ASSUMES A POSITIVE DEMAND SHOCK IS ASSOCIATED WITH AN INCREASE IN BOTH STOCK PRICES AND OIL PRICES, WHILE A The rationale was straightforward: unlike in POSITIVE SUPPLY SHOCK IS ASSOCIATED WITH A DECREASE IN OIL PRICES AND AN INCREASE IN STOCK PRICES. 2008, the drop in oil prices since last October SOURCE: IMF WORLD ECONOMIC OUTLOOK (APRIL 2015). largely reflected increased oil supply rather than weaker demand, a point that the IMF documented in its most recent World Economic Outlook (Chart 4). Conceptually, increased oil production should expand the global economy’s productive capacity, helping to lift growth. At the same time, since the marginal propensity to spend tends to be higher for oil consumers than for producers, a shift in disposable income towards the former should have raised overall global aggregate demand. Of course, we do not know what would have happened in the counterfactual scenario where Saudi Arabia chose to cut production in order to keep prices elevated. However, given that consensus 1 Please see Global Investment Strategy Weekly Report, “Seven Structural Reasons For A Lower Neutral Rate In The U.S.,” dated March 13, 2015, available at gis.bcaresearch.com. [email protected] • TEL 514.499.9550 • www.bcaresearch.com Copyright © 2015 BCA Research Inc. All Rights Reserved. Refer to last page. 3 Laura Pfeiff GWM Advisory Services 249247 BCA RESEARCH INC. GLOBAL INVESTMENT STRATEGY - WEEKLY REPORT MAY 22, 2015 Discover CHART 5 CHART 6 Global Growth Estimates Households Have Saved what you Have Been Pared Back Much Of The Oil Windfall %%US$/ % can do BLOOMBERG CONSENSUS U.S. 4.8 4.8 Bbl with BCA GDP GROWTH FORECAST: WTI* OIL PRICE (LS) 2014 SAVING RATE (PERCENT OF 5.8 110 Analytics. 4.0 2015 4.0 DISPOSABLE INCOME) (RS) 2016 3.2 3.2 100 GLOBAL 2.4 2.4 5.4 %% EURO AREA 90 1.6 1.6 80 5.0 1.2 1.2 .8 .8 70 %% U.S. 4.6 3.0 3.0 60 2.6 2.6 2.2 2.2 50 4.2 1.8 1.8 © BCA Research 2015 %%JAN APR JUL OCT JAN APR JAPAN 2.0 2.0 2014 2015 * WEST TEXAS INTERMEDIATE. 1.5 1.5 1.0 1.0 .5 .5 global growth estimates have fallen steadily %%over the past six months, it does seem that the payoff from lower oil prices has not been 2.8 U.K. 2.8 as great as many had hoped (Chart 5). 2.4 2.4 2.0 2.0 We see seven reasons why this has been the 1.6 1.6 case: %%BRICs* 7 7 Reason 1: Households Expect Much 6 6 Of The Decline In Oil Prices To Be 5 5 Reversed Basic economic theory posits that people %%CHINA tend to save temporary increases in income. 8.0 8.0 The rise in the personal saving rate since 7.6 7.6 November suggests that households do not 7.2 7.2 6.8 6.8 expect the windfall from lower gasoline prices © BCA Research 2015 to last (Chart 6). Survey data confirm this 2013 2014 2015 * INCLUDES BRAZIL, RUSSIA, INDIA, AND CHINA.
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