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John E. Silvia, Chief Economist February 12, 2015 The Great Inflation: Once in a Lifetime The Economic Club of Las Vegas.

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Presentation on theme: "John E. Silvia, Chief Economist February 12, 2015 The Great Inflation: Once in a Lifetime The Economic Club of Las Vegas."— Presentation transcript:

1 John E. Silvia, Chief Economist February 12, 2015 The Great Inflation: Once in a Lifetime The Economic Club of Las Vegas

2 Las Vegas 2 Where Are We Now? Source: Five benchmarks for good decision making Inflation Interest Rates Growth Profits The Dollar

3 Las Vegas 3 Expectations for the Future Wells Fargo vs. Consensus How do we differ from consensus?  Sustained-trend growth  Employment—cyclical and structural change  Still cautious on consumer segments  Housing improving—multifamily especially  State and local governments—still restructuring  Unsustainable long-run fiscal policy  Europe weak growth path  China growth sub 7 percent

4 Las Vegas 4 Sustained Growth in 2015 Following a poor start to the year, GDP growth has rebounded smartly. Solid growth prospects in the year ahead. Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

5 Las Vegas 5 Manufacturing & Services Indexes on business activity suggest an improving near-term outlook Source: Institute for Supply Management and Wells Fargo Securities, LLC

6 Las Vegas 6 Small Businesses Small Businesses: A full recovery in small business optimism is still distant, taxes and regulation the two big issues Source: National Federation of Independent Businesses, Gallup, Wells Fargo Bank and Wells Fargo Securities, LLC

7 Las Vegas 7 Initial Unemployment Claims: Cyclical Signaling continued, moderate job gains ahead Source: U.S. Department of Labor and Wells Fargo Securities, LLC

8 Las Vegas 8 Wages & Salaries Wages & salaries are best associated with consumer spending Source: U.S. Department of Labor, U.S. Department of Commerce and Wells Fargo Securities, LLC

9 Las Vegas 9 Wages vs. Quit Rate The rising quit rate indicates that workers are feeling confident about opportunities available in the labor market Source: U.S. Department of Labor and Wells Fargo Securities, LLC

10 Las Vegas 10 Consumer Spending Faster job growth, asset appreciation and more access to credit are supportive to the consumer spending outlook Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

11 Las Vegas 11 Consumer Confidence: By Income Group Confidence improves with income, but remains historically low across all income ranges Source: Bloomberg LP and Wells Fargo Securities, LLC

12 Las Vegas 12 Auto Lending: Slippery Slope There has been an increase in auto sales to sub and near-prime buyers Source: CNW Research and Wells Fargo Securities, LLC

13 Las Vegas 13 Auto Lending: Slippery Slope The rise in sub-prime auto sales has been most prevalent in the used auto sales market Source: CNW Research and Wells Fargo Securities, LLC

14 Las Vegas 14 Auto Lending: Slippery Slope Auto delinquency rates remain at historically low levels, but have seen a recent uptick Source: American Bankers Association and Wells Fargo Securities, LLC

15 Las Vegas 15 Household Debt Delinquencies: Student Loans the Exception Tighter credit standards and a strengthening economy have helped to improve the credit position of households over the past 3 years Source: Federal Reserve Bank of New York and Wells Fargo Securities, LLC

16 Las Vegas 16 Inflation & Interest Rates Inflation Interest Rates Growth Profits The Dollar Core Inflation Monetary Policy Yield Curve Real Interest Rates Wage-Price Spiral Market Expectations Key Drivers

17 Las Vegas 17 Inflation: Rising – Not Low Inflation remains historically low, but has picked up as growth accelerates and excess slack lessens Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

18 Las Vegas 18 Prices - Industrial Metals Falling oil prices have spilled over into other commodity prices, notable industrial metals Source: Bloomberg LP and Wells Fargo Securities, LLC

19 Las Vegas 19 Inflation Services continue to underpin overall inflation, led by rising shelter costs as the housing market has recovered. Between 2008 and 2013, total prices are up 8.2 percent vs percent for medical care. Source: U.S. Department of Labor and Wells Fargo Securities, LLC Shelter CostsServices vs. Goods

20 Las Vegas 20 Inflation The Fed anticipates a gradual firming of inflation, but for slack in the labor market to keep inflation from overshooting in the medium term Source: U.S. Department of Commerce, Federal Reserve Board and Wells Fargo Securities, LLC

21 Las Vegas 21 Pace of Policy Firming The FOMC Committee downshifted its expectations for the Federal Funds rate path in the recent meeting, but still expects a fed funds rate of above 1 percent at the end of 2015 Source: Federal Reserve Board and Wells Fargo Securities, LLC

22 Las Vegas 22 Treasury Curve The short-end remains the steepest part of the curve, while the long-end has flattened considerably Source: Bloomberg LP and Wells Fargo Securities, LLC

23 Las Vegas 23 Yield Curve: Rates Rise Without Fed The Fed will begin to raise the funds rate in mid-2015 Source: Bloomberg LP and Wells Fargo Securities, LLC

24 Las Vegas 24 Yield Spread Flight to safety and search for yield from foreign investors has caused the 10-year yield to drop to historical lows Source: Bloomberg LP and Wells Fargo Securities, LLC

25 Las Vegas 25 Corporate Spreads: Positive for Issuance Spreads have returned to a more normal level; bond issuance is strong Source: Federal Reserve Board and Wells Fargo Securities, LLC

26 Las Vegas 26 Easier Lending Standards More than a third of firms eased lending standards for student and auto loans last year. Source: Office of the Comptroller of the Currency and Wells Fargo Securities, LLC

27 Las Vegas 27 Interest Coverage Ratio Small manufacturers are most able to cover their debt obligations, while mining corporations exhibit the lowest coverage ratio. Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

28 Las Vegas 28 Debt Financing Nonfinancial corporations are exposed to rising short-term interest rates as the Fed rate hike draws nearer Source: Federal Reserve Board and Wells Fargo Securities, LLC

29 Las Vegas 29 Investment Grade Corporate Bonds Businesses are taking advantage of low interest rates Source: IFR Markets and Wells Fargo Securities, LLC

30 Las Vegas 30 High Yield Corporate Bonds As investors search for yield among exceptionally low interest rates, bond issuance has gained momentum Source: IFR Markets and Wells Fargo Securities, LLC

31 Las Vegas 31 M&A Volume U.S. M&A and the S&P 500 remain correlated over time Source: Thomson Reuters, Capital IQ and Wells Fargo Securities, LLC

32 Las Vegas 32 Business Lending Commercial and industrial lending has surged over the past quarter, helped by easier credit and increased demand Source: Federal Reserve Board and Wells Fargo Securities, LLC

33 Las Vegas 33 Corporate Profits: Increasing Role of Global Profits Profits as a percentage of GDP are historically high and are being boosted by profits earned abroad post NAFTA Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

34 Las Vegas 34 After-Tax Profits Profit margins continue to improve Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

35 Las Vegas 35 Interest Expense Corporate interest expenses remain low amid the low-rate environment Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

36 Las Vegas 36 Net Interest Margin v. Yield Curve Net interest margin has followed a secular decline and has decoupled from the yield curve in recent years. Source: Federal Financial Institutions Examination Council, Federal Reserve Board and Wells Fargo Securities, LLC

37 Las Vegas 37 Corporate Profit Growth Corporate profit growth remains firm—typical mid-cycle slowdown Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

38 Las Vegas 38 Corporate Profits: Domestic Profits Big gains in profits have been from nonfinancial corporations Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

39 Las Vegas 39 Fed Balance Sheet: Challenge to Asset Values We have seen a strong correlation in the expansion of the Fed’s balance sheet and the rise in the S&P 500 Source: Federal Reserve Board and Wells Fargo Securities, LLC

40 Las Vegas 40 Economic Conditions in the Eurozone The Eurozone Economy What can we expect moving forward?  Growth  Exports via euro depreciation  Companies, not countries  Euro Stoxx: up since 2012  Potential Growth  Long-term: weaker  Labor force growth  Productivity  Eurozone share of Global GDP: 12% in 2014  Risks  Russia: Service external debt  Greece: Cash

41 Las Vegas 41 Global Economies: European Equity The anticipation of the ECB’s policy move may have helped to life equity prices in Europe in recent months. Source: Bloomberg LP and Wells Fargo Securities, LLC

42 Las Vegas 42 Global Economies: A Stronger Dollar The dollar has appreciated against the euro, pound and yen recently. Source: Bloomberg LP and Wells Fargo Securities, LLC

43 Las Vegas 43 Global Economies: A Stronger Dollar The Canadian dollar and Mexican peso have both seen recent depreciation against the U.S. dollar Source: Bloomberg LP and Wells Fargo Securities, LLC

44 Las Vegas 44 Federal Fiscal Policy: When Will We Discount Future Liabilities? The federal government faces some significant fiscal challenges—the current path is not sustainable Source: Congressional Budget Office and Wells Fargo Securities, LLC

45 Las Vegas 45 Federal Government Spending: Entitlements in the Driver’s Seat The unfunded liabilities of the entitlement programs reflect a commitment to spend in the future Source: Congressional Budget Office and Wells Fargo Securities, LLC

46 Las Vegas 46 Federal Fiscal Policy The composition of federal spending has shifted dramatically. The CBO projects that the debt-to-GDP ratio will reach nearly 80 percent by Source: Congressional Budget Office and Wells Fargo Securities, LLC Federal Debt Continues to Rise Composition of Federal Spending

47 Las Vegas 47 Potential Challenges to the Outlook Outlook Risks What are the primary risks to the outlook?  Fitful Fed exit brings questions for the dollar, inflation and interest rate outlook/ volatility/ confidence  Fiscal policy: tax increases and/or spending cuts face unsustainable long-run outlook  Housing: able to sustain growth on its own if rates rise?  European debt crisis weighs on global growth, interest rates and global credit stagnation over the long-run  China/global trade weakness hits U.S. exports, foreign earnings of U.S. corporations  Sustained lower oil prices– risk for overleveraged businesses and countries

48 Las Vegas 48 U.S. Forecast Wells Fargo U.S. Economic Outlook Source: U.S. Department of Commerce, U.S. Department of Labor, Federal Reserve Board, Freddie Mac and Wells Fargo Securities, LLC

49 Appendix

50 Las Vegas 50 Recent Special Commentary Wells Fargo Economics Group Publications To join any of our research distribution lists please visit our website: economics

51 Las Vegas Wells Fargo Securities, LLC Economics Group 51 John E. Silvia … … Global Head of Research and Economics Diane Schumaker-Krieg ………………… …… Global Head of Research & Economics Chief Economist Mark Vitner, Senior Economist……………....………... Jay H. Bryson, Global Economist …………………....…… …. Sam Bullard, Senior Nick Bennenbroek, Currency Eugenio J. Alemán, Senior Economist… …………. Anika R. Khan, Senior Economist …. Senior Economists Zachary Griffiths, Economic Analyst Mackenzie Miller, Economic Analyst Erik Nelson, Economic Analyst Alex Moehring, Economic Analyst Economists Azhar Iqbal, Econometrician………………… Tim Quinlan, Economist …………………… Eric J. Viloria, Currency Strategist Sarah Watt House, Economist …………… Michael A. Brown, Economist ……………… … Michael T. Wolf, Economist ………………… …. Economic Analysts Administrative Assistants Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. ("WFS") is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. ("WFBNA") is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. WFS and WFBNA are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC’s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company © 2015 Wells Fargo Securities, LLC. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority’s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. Donna LaFleur, Executive Assistant. Cyndi Burris, Senior Administrative Assistant


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