Tag: USA

Trump inauguration marks ‘whole new world’

From InvestorDaily.

Investors should prepare for more volatility and political uncertainty as the new President of the United States commences in his role, says Eaton Vance.

Equity markets enjoyed a rally following Donald Trump’s successful campaign for the presidency, benefitting from the then president-elect’s pro-growth policy proposals, but Eaton Vance co-director of global income Eric Stein notes this has recently paused.

“Equity markets have been in a bit of holding pattern recently after their post-election rally, while Treasury yields and the US dollar have fallen somewhat from post-election highs,” he said.

“Yet the big question is how markets will react after Trump takes the Oath of Office as the 45th US president, and investors start to get more details on his administration’s policies and agenda.”

Mr Stein cautioned investors not to discount the potential downside risks that may appear should Mr Trump focus on his more protectionist policies than his pro-growth reforms, but equally that they should not “underestimate the chance for a transformational positive economic environment” his proposed fiscal and regulatory reforms could create.

“Both outcomes are very possible, but I think it’s almost as important to watch tone and messaging as it is to watch the specifics of policy proposals,” he said.

“The inauguration speech is obviously an opportunity for Trump to act more presidential, and investors will be watching and listening closely. They will also focus on the communication style after the inauguration, and any details on what Trump plans to tackle first and how.”

Some of Mr Trump’s policy goals however could take longer to implement than many expect, said Pimco head of public policy Libby Cantrill.

“Many of the items that President-elect Trump and congressional Republicans are looking to tackle in 2017 – a healthcare overhaul, tax reform, infrastructure – are inherently complex and time-consuming, even with Republican majorities in both chambers of Congress,” she said.

Ms Cantrill said Mr Trump’s stance on Obamacare was one such example of this, noting that the Republicans controlling the house are split on whether to repeal and replace the legislation, or repeal and delay it.

“Healthcare policymaking is notoriously complex and time-consuming; it took Congress 14 months to pass Obamacare after holding more than 100 hearings in the Senate and 80 in the House,” she said.

Infrastructure spending, trade negotiations, and whether to cut or reform taxes were other policy decisions likely to be met with difficulty, Ms Cantrill said, noting that many of these may not be completed or implemented prior to 2018.

“The bottom line is that governing is harder than campaigning,” she cautioned.

“While we expect policymakers to focus on advancing the Trump agenda, there is a good chance that some of these agenda items slip into 2018 given the realities of Washington.”

‘Threat of protectionism’ poses serious risks

From InvestorDaily.

The global economy is improving, but investors must avoid complacency as the risks associated with US trade policy and its effects on emerging markets increase, according to Standard Life Investments.

Global activity is picking up and supporting corporate earnings growth, the company said, and fears of deflation are beginning to subside due to improving headline inflation rates and commodity prices.

“Meanwhile, other than the attack on the Mexican peso, market participants have so far shrugged off the potential for the trade policies of the incoming Trump administration to weigh on global growth, instead choosing to focus on the benefits of possible corporate tax reform and broader US fiscal easing,” the company said.

Despite the improved economic conditions, Standard Life Investments cautioned that “investors need to be wary of complacency”, noting that the current global manufacturing cycle was being led by emerging markets off the back of China’s stimulus efforts, and that President-elect Donald Trump’s proposed policies could undermine productivity and corporate margins, putting investors in “an unusual position”.

“On the one hand, the recent run of strong data suggests that there are upside risks to our global growth forecasts for 2017,” the company said.

“On the other, left-hand tail risks are also clearly higher. Trump’s first 100 days in office, together with the early year Chinese credit figures, will tell us more about which force will win out.”

Investors should also watch for developments in US-China relations, the company said, as “tensions are running high” in several areas, including trade.

“Investors would be wise to take the threat of protectionism seriously,” the company said.

“While it is unclear how far Trump’s team will go in changing trade policy, it is also unclear how other countries would react, particularly an emboldened China. Chinese official press have denounced the threats of across-the-board tariff increases and indicated their intention to retaliate.”

US Deregulation Seen to Spur to Growth, Trim Risk

Moody’s says Washington’s transfer of power is complete. Very high probabilities can now be assigned to lowering the 35% corporate income tax rate, easing federal business regulations, and a major overhaul of the US government’s role in health insurance.

Deregulation will supply stimulus at no immediate cost to the taxpayer. Nevertheless, deregulation reintroduces systemic risks that could prove costly over time.

A relaxation of federal business regulations and changes in government-mandated health care programs may supply an unexpectedly large lift to business activity. Not only will overhead costs decline, but businesses will be able to allocate a greater portion of their scarce resources to an enhancement of their product offerings. Success at the latter will expand attractive job opportunities.

Regarding a possible reformulation of Dodd-Frank, diminished regulatory burden will increase the supply of mortgage credit and business credit. Mortgage yields and business borrowing costs may be lower than otherwise, helping to offset the upward pressure put on private-sector borrowing costs by a higher fed funds rate and higher Treasury bond yields.

In addition, a softening of Dodd-Frank would enhance the ability of banks to make markets in corporate bonds and leveraged loans, where the availability of buyers for riskier debt is of critical importance during episodes of systemic financial stress. Corporate credit spreads have been wider than otherwise because of worry surrounding market depth in a time of stress.

Paradoxically, despite fears that a relaxation of regulations will add to systemic risk, a widely followed measure of business credit risk — the high-yield bond spread — has narrowed considerably from an election day, or November 8, close of 515 bp to a recent 409 bp. Indeed, high-yield bonds have far outperformed higher-quality bonds since Election Day. Unlike the 10-year Treasury yield’s jump from November 8’s 1.86% to a recent 2.43% and the rise by an investment-grade corporate bond yield from 3.00% to 3.34%, a composite speculative-grade bond yield sank from November 8’s 6.53% to a recent 5.96%.

As inferred from the high-yield bond market’s upbeat response to the Republican sweep, the outgoing administration’s efforts to reduce systemic financial risk may have weighed so heavily on business activity and the efficient functioning of financial markets that they increased perceived default risk on a company by company basis. How ironic that an anticipated relaxation of financial and other business regulations has lessened perceived default risk considerably.

Room for growth may still go unfilled

And there is plenty of room to expand business activity without the risk of a potentially destabilizing upturn by price inflation. Rates of resource utilization are now exceptionally low for the seventh year of an economic recovery. If demand materializes, the Trump administration’s goal of 3% to 4% real growth for the US economy may at least be temporarily achievable.

However, given the financially stressed condition of many households both at home and abroad, as well as the diminished spending proclivities of the aging populations of advanced economies, spending may fall short of what is needed to sustain 3% to 4% growth over a yearlong span.

Moreover, real GDP growth of at least 3% may not be a recurring phenomenon. Long-term economic growth may be constrained to a pace closer to 2% if both the labor force and productivity continue to rise at rates that are well below their respective long-term trends.

Consensus outlook for profits requires faster than forecast GDP growth

Early January’s Blue Chip consensus projection of a 5.0% annual increase for 2017’s pre-tax profits from current production may be incompatible with the accompanying forecast of a 4.4% annual increase by 2017’s nominal GDP. Only if employment costs slow from their 4.7% annual climb of the year-ended September 2016 might nominal GDP growth of 4.4% deliver profits growth of 5.0%. However, if the recent 4.7% unemployment rate correctly indicates rising wage pressures, a deceleration by employment costs seems unlikely.

As inferred from the strong 0.87 correlation between the annual yearlong growth rates of corporate gross value added and nominal GDP, the consensus prediction of 4.4% nominal GDP growth favors a 4.1% annual gain for 2017’s corporate gross-value-added, where the latter is a proxy for corporate revenues.

In terms of moving yearlong averages, the percentage point difference between the annual growth rates of gross value added less corporate employment costs generates a strong correlation of 0.86 with the annual growth rate of pretax profits from current production.
Combining 2017’s prospective annual increase of 4.1% for gross value added with 4.7% employment cost growth predicts a 2.5% midpoint for the annual increase of 2017’s pretax operating profits. To the contrary, the equity and high-yield bond markets may be pricing in faster growth rates of 4.9% for gross-value-added and 5% for employment costs, where such assumptions support a predicted midpoint of 5% for core profits growth. However, 4.9% growth by gross-value-added may require faster-than-forecast nominal GDP growth of 5%.

Profits growth is likely if capacity use rises

Fourth-quarter 2016’s comparatively low industrial capacity utilization rate of 75.3% amplifies 2017’s upside potential for earnings growth. After declining from a year earlier in each of the last seven quarters including Q4-2016, the capacity utilization rate is expected to increase annually in each quarter of 2017. If true, the return of profits growth in 2017 is practically assured.

The yearly percent change by pretax profits from current production shows a highly asymmetrical response to the capacity utilization rate’s yearly percentage point change. Since early 1979, 68, or 85%, of the year-to-year increases by the capacity utilization rate have been joined by a year-to-year increase for profits. In stark contrast, only 32, or 46%, of the span’s 70 yearly declines by the capacity utilization rate were accompanied by lower profits.

The fuller use of production capacity also bodes well for corporate credit. In terms of yearly changes, the high-yield bond spread narrowed for 63% of the months since mid-1987 showing an increase by the capacity utilization rate, while the spread widened for 66% of the months showing a decline by capacity utilization.
Still low rates of resource utilization suggest that the current recovery may prove to be a late bloomer in terms of realizing its full potential.

Does a Strong Dollar Slow the Growth Rate of GDP?

From The St. Louis Fed Blog.

Over the past several months, a new episode of appreciation of the dollar began. The dollar spiked noticeably Nov. 9 and 10 (the two days following the U.S. presidential election) and again on Dec. 15 (the day after the Federal Reserve announced its most recent rate hike).

This appreciation has renewed concern of a slowdown in U.S. economic growth through the channel of international trade. The appreciation of the dollar implies that U.S. goods become more expensive abroad, and hence tends to reduce U.S. exports.

Meanwhile, a strong dollar makes foreign goods cheaper to U.S. consumers, which tends to increase imports. The forces of increasing imports and decreasing exports both deteriorate the trade balance and could slow down the growth rate of the U.S. economy. This article reviews the impact a stronger dollar had on gross domestic product (GDP) growth from 2014 to the beginning of 2016, the previous significant episode of appreciation.

Previous Dollar Strengthening Episode

How much does international trade, in conjunction with such a sharp appreciation of the dollar, slow down the GDP growth rate? The Bureau of Economic Analysis reports international trade’s contribution to the GDP growth rate each quarter. The figure below plots the GDP growth rate, the trade component’s contribution to GDP growth and the appreciation of the dollar from the second quarter of 2014 to the first quarter of 2016.1

TradeGDPGrowth

It is clear that a strong dollar is associated with net exports contributing negatively to GDP growth. During the sample period’s two-year span, trade contributed positively to GDP growth in only one quarter.

The negative impact was particularly strong over the first half of the appreciation period. For example, during the fourth quarter of 2014 and the first quarter of 2015, the contributions to the GDP growth rate from net exports were -1.14 percent and -1.65 percent, respectively. The negative effects diminished by the end of 2015, standing at -0.5 percent despite the dollar’s increase in value of another 10 percent.

Imports and Exports

The next figure further decomposes international trade’s contribution to GDP growth into exports and imports.

ExpImpGDPGrowth

In response to the strength of the dollar, the contributions from imports played a much more significant role than that of exports. The cumulative contribution of imports to GDP growth was -4.6 percent, while the cumulative contribution of exports was slightly positive at 0.85 percent. This suggests an asymmetric reaction between exports and imports in response to increases in the dollar’s exchange rate. Thus, it is reasonable to conclude that the slowdown in GDP growth was associated more with the growth of imports rather than the reduction in exports.

In sum, the new episode of appreciation of the dollar that began over the past several months is likely to hurt the current growth rate of GDP through an increase in imports rather than a decrease in exports if the trend from the previous period of appreciation holds.

Notes and References

1 We used the real broad trade weighted U.S. dollar index, indexed to its average over the sample period.

FED Affirms Future Rate Rises

Federal Reserve Chair Janet L. Yellen spoke at the the Commonwealth Club, San Francisco, California on “The Goals of Monetary Policy and How We Pursue Them.” She reaffirmed the expectation of future rate rises – a few times a year until, by the end of 2019, it is close to its longer-run neutral rate of 3 percent.

https://youtu.be/ktBgb4xHKGY

The extraordinarily severe recession required an extraordinary response from monetary policy, both to support the job market and prevent deflation. We cut our short-term interest rate target to near zero at the end of 2008 and kept it there for seven years. To provide further support to American households and businesses, we pressed down on longer-term interest rates by purchasing large amounts of longer-term Treasury securities and government-guaranteed mortgage securities. And we communicated our intent to keep short-term interest rates low for a long time, thus increasing the downward pressure on longer-term interest rates, which are influenced by expectations about short-term rates.

Now, it’s fair to say, the economy is near maximum employment and inflation is moving toward our goal. The unemployment rate is less than 5 percent, roughly back to where it was before the recession. And, over the past seven years, the economy has added about 15-1/2 million net new jobs. Although inflation has been running below our 2 percent objective for quite some time, we have seen it start inching back toward 2 percent last year as the job market continued to improve and as the effects of a big drop in oil prices faded. Last month, at our most recent meeting, we took account of the considerable progress the economy has made by modestly increasing our short-term interest rate target by 1/4 percentage point to a range of 1/2 to 3/4 percent. It was the second such step–the first came a year earlier–and reflects our confidence the economy will continue to improve.

Now, many of you would love to know exactly when the next rate increase is coming and how high rates will rise. The simple truth is, I can’t tell you because it will depend on how the economy actually evolves over coming months. The economy is vast and vastly complex, and its path can take surprising twists and turns. What I can tell you is what we expect–along with a very large caveat that our interest rate expectations will change as our outlook for the economy changes. That said, as of last month, I and most of my colleagues–the other members of the Fed Board in Washington and the presidents of the 12 regional Federal Reserve Banks–were expecting to increase our federal funds rate target a few times a year until, by the end of 2019, it is close to our estimate of its longer-run neutral rate of 3 percent.

The term “neutral rate” requires some explaining. It is the rate that, once the economy has reached our objectives, will keep the economy on an even keel. It is neither pressing on the gas pedal to make the car go faster nor easing off so much that the car slows down. Right now our foot is still pressing on the gas pedal, though, as I noted, we have eased back a bit. Our foot remains on the pedal in part because we want to make sure the economic expansion remains strong enough to withstand an unexpected shock, given that we don’t have much room to cut interest rates. In addition, inflation is still running below our 2 percent objective, and, by some measures, there may still be some room for progress in the job market. For instance, wage growth has only recently begun to pick up and remains fairly low. A broader measure of unemployment isn’t quite back to its pre-recession level. It includes people who would like a job but have been too discouraged to look for one and people who are working part time but would rather work full time.

Nevertheless, as the economy approaches our objectives, it makes sense to gradually reduce the level of monetary policy support. Changes in monetary policy take time to work their way into the economy. Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road–either too much inflation, financial instability, or both. In that scenario, we could be forced to raise interest rates rapidly, which in turn could push the economy into a new recession.

The factors I have just discussed are the usual sort that central bankers consider as economies move through a recovery. But a longer-term trend–slow productivity growth–helps explain why we don’t think dramatic interest rate increases are required to move our federal funds rate target back to neutral. Labor productivity–that is, the output of goods and services per hour of work–has increased by only about 1/2 percent a year, on average, over the past six years or so and only 1-1/4 percent a year over the past decade. That contrasts with the previous 30 years when productivity grew a bit more than 2 percent a year. This productivity slowdown matters enormously because Americans’ standard of living depends on productivity growth. With productivity growth of 2 percent a year, the average standard of living will double roughly every 35 years. That means our children can reasonably hope to be better off economically than we are now. But productivity growth of 1 percent a year means the average standard of living will double only every 70 years.

Economists do not fully understand the causes of the productivity slowdown. Some emphasize that technological progress and its diffusion throughout the economy seem to be slower over the past decade or so. Others look at college graduation rates, which have flattened out after rising rapidly in previous generations. And still others focus on a dramatic slowing in the creation of new businesses, which are often more innovative than established firms. While each of these factors has likely played a role in slowing productivity growth, the extent to which they will continue to do so is an open question.

Why does slow productivity growth, if it persists, imply a lower neutral interest rate? First, it implies that the economy’s usual rate of output growth, when employment is at its maximum and prices are stable, will be significantly slower than the post-World War II average. Slower economic growth, in turn, implies businesses will see less need to invest in expansion. And it implies families and individuals will feel the need to save more and spend less. Because interest rates are the mechanism that brings the supply of savings and the demand for investment funds into balance, more saving and less investment imply a lower neutral interest rate. Although we can’t directly measure the neutral interest rate, it is something that can be estimated in retrospect. And, as we have increasingly realized, it has probably been trending down for a while now. Our current 3 percent estimate of the longer-run neutral rate, for instance, is a full percentage point lower than our estimate just three years ago.

You might be thinking, what does this discussion of rather esoteric concepts such as the neutral rate mean to me? If you are a borrower, it means that, although the interest rates you pay on, say, your auto loan or mortgage or credit card likely will creep higher, they probably will not increase dramatically. Likewise, if you are a saver, the rates you earn could inch higher after a while, but probably not by a lot. For some years, I’ve heard from savers who want higher rates, and now I’m beginning to hear from borrowers who want lower rates. I can’t emphasize strongly enough, though, that we are not trying to help one of those groups at the expense of the other. We’re focused very much on that dual mandate I keep mentioning. At the end of the day, we all benefit from plentiful jobs and stable prices, whether we are savers or borrowers–and many of us, of course, are both.

Economics and monetary policy are, at best, inexact sciences. Figuring out what the neutral interest rate is and setting the right path toward it is not like setting the thermostat in a house: You can’t just set the temperature at 68 degrees and walk away. And, because changes in monetary policy affect the economy with long lags sometimes, we must base our decisions on our best forecasts of an uncertain future. Thus, we must continually reassess and adjust our policies based on what we learn.

Trump’s brand of Carrier-style dealmaking won’t work

From The Conversation.

In late November, President-elect Donald Trump announced that he had reached a deal with Carrier to keep about 800 manufacturing jobs in Indiana from moving to Mexico. After the announcement, we learned that the Indiana Economic Development Corporation would give US$7 million in tax credits and grants to Carrier’s parent company in exchange for keeping the jobs in the state.

Trump proudly praised the agreement as a “great deal for workers” and said that it was part of a larger approach to keep jobs at home, saying “this is the way it’s going to be.”

Having the chief executive of the United States negotiate individualized deals with corporations is certainly a new approach to economic policy nationally, though it is not without precedent. In fact, state governments have been negotiating targeted incentives with corporations for decades.

My research focuses on why states use incentives to attract and retain investment from corporations and whether they are effective. My work, as well as that of many others, shows that these deals do not create the jobs and economic growth they are purported to.

A common economic tool

Every year, states spend billions of dollars to entice companies to create jobs within their borders. These inducements include some combination of property, sales and income tax credits and rebates, tax abatements, cash grants and cost reimbursements.

The deals are meant to reduce costs for the businesses that receive them in order to encourage their investment and job growth in a particular location. The most prominent packages usually grab headlines nationally.

In 2013, for example, Boeing received $8.7 billion in tax breaks from Washington state to secure the production of the 777x. This record-breaking package came shortly after Boeing had received $900 million from South Carolina for opening a new 787 assembly plant in Charleston.

Other examples include Tesla receiving $1.3 billion from Nevada in 2014 to subsidize a battery factory outside Reno and the Los Angeles Rams collecting $180 million in sales tax revenue from Inglewood for relocating there from St. Louis this year.

Just as Carrier threatened to move jobs to Mexico and promptly received a tax break, so too did Sears receive millions from Illinois to keep its headquarters in Chicago back in 1989.

From 1984 to 2012, incentive spending increased in the states from about $500 million per year to about $13 billion per year, according spending data gathered by the Good Jobs First Subsidy Tracker.

Has it worked?

Despite the hundreds of billions of dollars in incentives thrown their way, many companies have still decided to move more manufacturing jobs and corporate headquarters overseas.

This is because corporations consider many other factors when making decisions about where to build a factory or establish a tax home. In a 2016 survey, incentives lagged behind skilled labor, labor costs, highway access, corporate tax rates, available buildings, construction costs, proximity to markets and quality of life as important factors for location decisions.

For example, scholars have found that the Sun Belt has been able to attract investment away from the Rust Belt because it has lower wages but similar access to the interstate highway system.

In other words, jobs move (or don’t) based on the overall range of costs facing employers, which are determined by larger economic trends and policies and not necessarily by individually negotiated deals. When subsidies do matter is when corporations are choosing between equally strong locations. In those situations, incentives serve as “deal sweeteners” but don’t change the fundamental reasons for why the location was considered in the first place.

In light of the realities of corporate location decisions, there is scant evidence to support the arguments that targeted incentives produce economic growth. Rather, the evidence shows that they tend to fail to achieve their intended goals.

Often, subsidies fall short of job creation targets and fail to create growth, even if they retain jobs. As University of Iowa scholars Alan Peters and Peter Fisher argue, based on a review of several studies of their impact, “incentives work about 10 percent of the time and are simply a waste of money the other 90 percent.”

One reason why scholars have struggled to measure the impact of incentives is because of the complexity of the economy. Economic growth is affected mostly by national and international forces. State economic development strategies have little effect when compared with broad national economic policies.

The wrong kind of impact

Subsidies still can have an effect on economic behavior, just not in the way they were intended, such as by encouraging rent-seeking.

Critics of the Carrier deal have already noted that Trump may have opened the federal government up to increased threats from companies to move overseas unless they receive more incentives (aka rent-seeking). In the days following the Carrier deal, Ford Motor (already one of the largest recipients of state-level spending) expressed a willingness to make a deal with Trump to retain jobs scheduled to move overseas. In a first move, Ford announced that it had canceled a planned investment in Mexico and will instead invest $700 million in its Flat Rock, Michigan, plant.

There is also some evidence that incentives can exacerbate economic inequality.

Incentives, when used to influence location decisions, tend to be awarded to the largest and wealthiest corporations. These corporations need the money the least of all businesses and usually receive the money for making investments they likely would have made anyway in order to remain competitive. The result is that fewer resources are available for education, workforce training and social services. As a result, the gap between rich and poor tends to grow.

Raising red flags

While it is laudable that several hundred Indianans get to celebrate the holiday season with their jobs secure, evidence from the states raises red flags on the viability of targeted incentives as a national policy for growth.

Not only would Trump be needing to negotiate several packages per week in order to have a noticeable effect on the U.S. economy, doing so opens the government up to increased demands for subsidies, most likely from the wealthiest corporations, and could exacerbate income inequality in America.

Author: Joshua Jansa, Assistant Professor of Political Science, Oklahoma State University

Have The U.S. Stock Bulls Got It Wrong?

From Bloomberg.

Amundi SA, Europe’s largest money manager, says investors who have driven U.S. stock markets to record highs in expectation of fiscal stimulus from the Trump administration may be in for a surprise.

 

While a pivot to government spending and tax cuts may prolong the economic expansion in the U.S., Republican lawmakers will insist that fiscal measures don’t push up the deficit, Didier Borowski, the Paris-based asset manager’s head of macroeconomics, said in an interview. Even if President-elect Donald Trump succeeds in delivering stimulus, it won’t have an impact before next year, he said.

“Following the vote for Trump, markets have reacted as if there were only upside risks,” Borowski said in an interview in Munich. “U.S. equity markets could go further into bubble territory as risks are becoming increasingly asymmetric. That would be an opportunity to reallocate funds to bond markets.”

Trump’s surprise victory in the U.S. presidential election in November has driven investors out of bonds and into equities, accelerating a massive flow of funds that some investors say may last for years and spell the end of the multi-decade rally in bonds. The value of global equities climbed to $68 trillion from about $65 trillion the day before the election. Bonds have lost about $2 trillion in that time.

Financial market observers and investors are split about the continuation of that trend, sometimes named the “great rotation” from bonds to stocks, with Charles Schwab Corp.’s chief global strategist Jeffrey Kleintop anticipating the it has years to run. Amundi, which is controlled by Credit Agricole SA, says a more likely scenario is that bonds may rebound because growth will probably continue at a slow pace.

“Global uncertainties are at an unprecedented level with Brexit, Trump and elections in Europe,” Borowski said, adding the biggest risk would be a trade war between the U.S. and China. “The bond market isn’t dead yet. There are many unpredictable risks still looming and that’s why we really doubt that bond yields can jump that much. Investors will keep an exposure to U.S. Treasuries as a safe haven.”

Investors may also return to Europe, once the outcome of elections removes political uncertainty in the region, he said.

“Some investors have stayed clear of Europe following Brexit,” Borowski said. “At some point in the coming months we will be reassured concerning the political risks in Europe, especially in France, where we don’t expect French National Front leader Marine Le Pen to be elected.”

Amundi was created in 2010 when Credit Agricole and Societe Generale SA combined their asset-management businesses. It went public in 2015 to fund its international expansion as Societe Generale sold its stake.

Amundi agreed in December to buy Pioneer Investments from Italy’s UniCredit SpA for about 3.5 billion euros ($3.7 billion) in cash, bringing assets to more than $1.3 trillion and making it the world’s eighth-largest asset manager.

US Mortgage Rates Add Stress for Millennial Homebuyers

Fitch Ratings says the recent rise in US interest rates adds another obstacle for millennials seeking to enter the housing market.

Based on our calculations, the rate increase means the average US millennial borrower now has lost 9% in mortgage capacity since the beginning of October 2016. This leaves more millennials out of what has historically been one of the most important wealth-creation mechanisms, and could contribute to long-term shifts in savings and consumption.

Mortgage rates nearly hit a two-year high during the week of Jan. 5, 2017 according to Freddie Mac. The interest rate on a 30-year mortgage at the beginning of October 2016 was 3.42%. Last week, the rate climbed to 4.20%. The maximum loan a homebuyer could afford in September 2016 was $120,000 (the current median mortgage for borrowers under 35 according to the Federal Survey of Consumer Finances), all else being equal, the size of that loan would have dropped to approximately $109,000 by last week.

Historically low rates have been one of the few factors that have helped young adults to buy homes. If rates continue to rise, particularly if the rise occurs rapidly over a short time period, this could add yet another obstacle to homeownership. Many first-time homebuyers have seen mortgage capacity eroded by tight loan underwriting standards, rising student loan payments, high rents and stagnant wages.

The growth in the cost of higher education outpaced consumer price inflation for several decades. This led to an increase in both the number of student loan borrowers and the average amount owed. The median student loan monthly payment in 2016 was $203, according to the Federal Reserve Bank of Cleveland.

Tight underwriting played a significant role. Banks remain vigilant over regulatory risk, repurchase risk and the increased cost of servicing of delinquent loans. This means FICO scores for conventional loans to first-time homebuyers remain notably above the 720-730 range level typical prior to the crisis, although the scores have begun trending back toward historical averages.

The stresses are reflected in the US homeownership rate and increases in the portion of millennials who live at home. The homeownership rate for under 35-year-olds experienced a large drop, declining to 35% in 2016, from 41% in 2000, according to the US Census Bureau. During this time, rental costs increased faster than the incomes millennials earn.

For younger Americans forced to defer or abandon plans to buy a first home, the long-term financial effect of missing out on home-equity creation could be significant. Long-lasting shifts in savings and consumption patterns, while difficult to isolate now, will likely emerge more prominently in the coming years. This could mean other long-run affects including downward pressure on durable goods consumption, urban population growth and a decline in affluence, translating into lower birth rates and less secure retirements.

Credit Looks for US to Realise Potential

Moody’s says today’s still underperforming US economy leaves plenty of room for significant improvement in 2017 without the unwanted side effect of significantly faster price inflation. The US economy may be far from realizing its full potential.

January 2017 marks the 91st month of the current economic recovery and yet the US economy’s rates of resource utilization leave considerable room for additional production. In terms of the latest three-month averages, only 75.2% of industrial capacity was in use, while payrolls approximated a relatively low 57.0% of the working-age population. When previous upturns were of similar vintage in October 1998 and June 1990, the industrial capacity utilization rate averaged 82.7% and payrolls averaged 59.9% of the working age population.

Will this be the first economic recovery since the 1930s where the capacity utilization rate’s moving three month average fails to reach the 80% mark, where the latter is typically associated with the sufficient utilization of potential industrial output? Thus far in the current upturn, this version of capacity utilization has risen no higher than the 78.6% of Q4-2014. Figure 1 indicates a good deal of room to grow for industrial capacity utilization and, thus, lends support to the possibility of faster than 3% real GDP growth. By comparison, real GDP has risen by only 1.8% annualized, on average, for the current recovery to date and not since 2005’s 3.3% has growth managed to reach 3% for an entire calendar year. (Figure 1.)

In a similar vein, late 2016’s relatively low ratio of jobs to the working-age population preserves the possibility of a fuller utilization of US labor resources that could supply a noticeably faster rate of economic growth. However, the recent absence of labor productivity growth limits the extent to which faster jobs growth can quicken economic growth. (Figure 2.)

Yes, late 2016’s comparatively low rates of resource utilization hint of considerable upside potential for US business activity. Nevertheless, whether such potential is realized depends on a far from assured quickening of expenditures. For one thing, the recent strengthening of the dollar exchange rate heightens the importance of an acceleration by US household spending, which requires improved prospects for employment income.

The critical role of household expenditures cannot be overemphasized. Regardless of the more favorable tax treatment of capital outlays, businesses are only likely to significantly increase their production capabilities if they are convinced of sufficiently profitable markets for new and existing products.

Thus, businesses are likely to heed the warning of slower household spending growth implicit in the dip by payrolls’ annual increase from Q1-2015’s cycle high of 2.2% to Q4-2016’s 1.6%. The last two times payrolls decelerated in a similar manner, recessions arrived within 18 months.

Jobs outlook suggests spreads are too thin

Corporate credit is now very much priced for faster economic growth that will require the fuller utilization of US productive resources. The correlation between the high-yield bond spread and the moving three-month average of payrolls’ monthly percent change is a strong 0.78. Fourth-quarter 2016’s average monthly increase by payrolls of 0.11% predicts a 531 bp midpoint for the high-yield bond spread.

Accordingly, January 11’s far thinner high-yield bond spread of 405 bp implicitly expects faster jobs growth. However, as inferred from the Blue Chip consensus expectation of a drop by payrolls’ average monthly increase from 2016’s 180,000 jobs to 2017’s 161,000 jobs, the high-yield spread may soon be closer to 500 bp than to 400 bp.

Unemployment rate overstates labor market tightness

As opposed to the unemployment rate, the ratio of payrolls to the working-age population may now be the better estimate of labor market utilization, owing to the current recovery’s large number of labor force dropouts. For example, when the unemployment rate previously first fell to Q4-2106’s 4.7% in March 2006 and November 1997, payrolls averaged 60.2% of the working age population, which was well above Q4-2016’s 57.0%.

As inferred from the unemployment rate’s statistical relationship with the ratio of payrolls to the working-age population since 1988, Q4-2016’s ratio of 57.0% is ordinarily accompanied by a jobless rate of 6.8%. Even after allowing for how an aging workforce exerts a downward bias to the ratio of payrolls to the working-age population, the 4.7% unemployment rate still probably overstates the degree of labor market tightening. (Figure 3.)

In addition to an atypically low labor force participation rate, the 4.7% unemployment rate overstates labor-market tightness because of a relatively high U6 unemployment, or under-employment, rate. When the jobless rate’s moving three-month average previously first fell to 4.7% in March 2006 and November 1997, the U6 under-employment rate averaged 8.4%, considerably lower than Q4-2016’s 9.3%.

Nevertheless, the US labor market is firming up, as seen in the yearly increase of the average hourly wage from the 2.5% of Q4-2015 to Q4-2016’s 2.7%. However, when the unemployment rate’s three-month average last fell to 4.7% in Q1-2006, average hourly earnings posted a comparable increase of 3.4%. During the previous cycle, the yearly increase of the average wage’s moving three-month average peaked at the 3.8% of Q3-2006. By the time the moving three-month averages of the jobless rate and the U6 under-employment rate bottomed simultaneously in May 2007 (at 4.4% and 8.1%, respectively), the average hourly wage’s annual increase had slowed to 3.4%.

Despite an earlier acceleration by the hourly wage’s moving yearlong average from the 2.0% of the span-ended September 2004 to the 3.7% of the span-ended March 2007, the annual rate of growth for the core PCE price index peaked at a relatively modest 2.4%. By comparison, the core PCE price index rose by 1.7% annually during the three-months-ended November 2016. The possibly unfinished strengthening of the dollar exchange rate will limit the upside for US price inflation and just might intensify the price deflation still afflicting a number of internationally traded goods.

Ratio of jobs to the working-age population outshines other possible inflation indicators

The market’s recent obsession with December’s 2.9% yearly jump by average hourly earnings may have been unwarranted. After all, the annual rate of core PCE price index inflation generated a meaningless correlation of 0.04 with the yearly percent change of the average hourly wage.

By contrast, the ratio of payrolls to the working-age population again offers useful insight regarding labor market tightness and inflation risk. Since 1992, the year-to-year percentage point change for the ratio of payrolls to the working-age population shows a correlation of 0.31 with the annual rate of core PCE price index inflation, where this and forthcoming comparisons employ moving three-month averages.

As far as predicting core PCE price index inflation, the ratio of jobs to the working-age population also outperforms both the unemployment and U6 under-employment rates. For example, the jobless rate and its year-to-year percentage point change showed weaker correlations of -0.22 and -0.24 with the annual rate of core PCE price index inflation, while the U6 under-employment rate posted comparably measured correlations of -0.23 and -0.22, respectively. Thus, expectations of a continued mild rise by the ratio of payrolls to the working-age population suggest only a limited upside for core PCE price index inflation.

Consensus views on employment and industrial production favor a continuation of the Great Underutilization. Unless payrolls zoom ahead of recent forecasts, the midpoint for fed funds may finish 2017 no higher than 1.125%, while the 10-year Treasury yield spends most of the year under 2.5%. Only if the demand for US output delivers a big enough upside surprise might a substantially fuller utilization of resources help make America great again.

US Housing Finance Agencies Will Benefit from Cut in FHA Mortgage Insurance Premiums

Moody’s says on Monday, the US Department of Housing and Urban Development (HUD) announced that the Federal Housing Administration (FHA) will reduce by 25 basis points insurance premiums that borrowers pay on single-family mortgages. The premium cut is credit positive for US state Housing Finance Agencies (HFAs) because it will make FHA-insured mortgage loans more affordable to borrowers and increase HFA loan originations. The premium reduction will apply to new loans closing on or after 27 January.

HFAs are charged with providing and increasing the supply of affordable housing in their respective states for first-time homebuyers. The FHA, unlike other mortgage insurance providers, insure loans with loan-to-value ratios of up to 97%, which is key to the HFA lending base, given that first-time homebuyers often have limited funds for down payments.

The 25-basis-point decrease in the FHA’s insurance premium, which we expect will save new homeowners as much as $500 a year, also increases the competitiveness of HFA mortgage products. A lower FHA cost will attract more borrowers and stimulate stronger FHA loan originations at a time when mortgage interest rates are rising. As of 30 June 2016, FHA mortgage insurance provided the biggest share of the insurance on HFA pools, constituting approximately 38% of Moody’s-rated HFA whole-loan mortgages (see Exhibit 1), compared with 17% of mortgages utilizing private mortgage insurance.

HFA portfolio performance will strengthen because more loans will benefit from FHA insurance coverage. FHA insurance offers the deepest level of protection against foreclosure losses relative to other mortgage insurers because they cover nearly 100% of the loan principal balance plus interest and foreclosure costs. Additionally, the FHA provides the strongest claims-paying ability relative to private mortgage insurers. Although private mortgage insurers maintain ratings of Baa1 to Ba1, FHA insurance is backed by the US government.

The reduced FHA premiums will also benefit HFA to-be-announced (TBA) loan sales, which are secondary market sales using the Ginnie Mae TBA market. All loans utilizing Ginnie Mae must have US government insurance, and the FHA provides a substantial share of this insurance. Higher TBA sales will increase in HFA margins given that TBA sales have been a major driver of loan production and volume, contributing to an all-time high 17% margin in fiscal 2015, which ended 30 June 2015 (see Exhibit 2).