Transcript Economic Outlook

Short-term Outlook
Presented by:
Garret Sloan, CFA, Short-term Fixed Income Strategist
October 2011
1
Current Markets – The New Era
Short Term Rates Remain Low
3-month U.S. T-bill
4
3
3
2
2
1
1
0
0
ug
-
11
11
A
pr
A
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-1
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-
10
10
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pr
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09
09
A
pr
A
ec
-0
D
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08
08
A
pr
A
ec
-0
D
ug
-
07
07
A
pr
A
ec
-0
D
0
4
9
5
8
5
7
6
6
Low rates and tighter spreads
are a function of the Fed’s
Economic view
3-month LIBOR
6
Source: BBA, Bloomberg
Source: BBA, Bloomberg and Wells Fargo Securities, LLC
2
The Great Recession in Perspective
The hole this recession dug was large and will take years to climb out
GDP
Output Gap
Real GDP Change in Recessions
Employment Cycles
Output Gap in the U.S.
Percentage Change Peak-to-Trough
1%
Labor Market
1%
0%
0%
$14.2
Trillions of Dollars, Potential vs. Actual GDP, Inflation Adjusted
$14.2
Output Gap = $860 Billion
$13.7
$13.7
Percent Change from Cycle Peak
10.0%
8.0%
6.0%
-1%
-1%
-2%
-2%
-3%
-3%
-4%
$13.2
$13.2
$12.7
$12.7
$12.2
$12.2
4.0%
$11.7
$11.7
$11.2
$11.2
-4%
-5%
-5%
19481949
Cycle
19531954
Cycle
19571958
Cycle
19601961
Cycle
19691970
Cycle
19731975
Cycle
1980
Cycle
19811982
Cycle
19891991
Cycle
2001
Cycle
20072009
Cycle
Potential GDP: Q3 @ $14.1 Trillion
10.0%
1948-1949 Cycle
1981-1982 Cycle
1989-1991 Cycle
2001 Cycle
2007-To-Date
Forecast
8.0%
6.0%
4.0%
2.0%
2.0%
0.0%
0.0%
-2.0%
-2.0%
-4.0%
-4.0%
-6.0%
-6.0%
Actual GDP: Q3 @ $13.3 Trillion
$10.7
2000
$10.7
2002
2004
2006
2008
2010
Source: U.S. Department of Commerce, Congressional Budget Office, U.S. Department of Labor and Wells Fargo Securities, LLC
3
-8.0%
-8.0%
0
4
8
12
16
20
24
28
32
36
40
44
48
What is the Fed Looking at?
Metrics continue to indicate that the Fed Policy will remain highly accommodative
Total Unemployment
1500
1000
1000
Total Decline: -6.57%
Non-Revolving: +2.4%
Revolving: -18.0%
500
-1
0
-0
6
D
ec
-0
2
D
ec
-9
8
D
ec
D
ec
-9
4
-9
0
D
ec
-8
6
D
ec
-8
2
D
ec
D
ec
Source: Federal Reserve
Single-Family Home Inventory
Existing New and Single Family Home Sales
Millions of Units
Seasonally Adjusted Annual Rate
8
7.5
1400
7
New Homes Inventory: August @ 164 thousand
Existing Homes Inventory: August @ 3.58 million
5
1200
6.5
4
1000
6
5.5
5
4.5
4
800
3
600
2
400
New Home Sales: Aug @ 295 thousand
1
Existing Home Sales: Aug @ 5.03 million
200
4
1
0
n1
Ja
9
n1
n0
Ja
Source: BLS, Federal Reserve, U.S. Department of Commerce, Federal Housing Finance Agency, National Association of Realtors, S&P Corp. and Wells Fargo Securities, LLC
Ja
8
Ja
n0
7
Ja
n0
6
5
n0
Ja
4
n0
Ja
Ja
n0
3
Ja
n0
2
n0
Ja
n0
Ja
n0
9
n9
Ja
Ja
11
Ja
n-
10
Ja
n-
09
08
Ja
n-
07
Ja
n-
Ja
n-
06
Ja
n-
05
Ja
n-
04
Ja
n-
03
Ja
n-
Ja
n-
1
0
0
02
3
0
3.5
Ja
n-
6
1600
500
0
-7
0
0
D
ec
9
7
ec
-0
ec
-0
5
1500
D
1
3
ec
-0
D
D
ec
-0
9
ec
-0
D
ec
-9
D
D
ec
-9
ec
-9
D
ec
-9
D
ec
-9
ec
-8
D
ec
-8
D
ec
-8
D
ec
-8
D
ec
-8
D
ec
-7
D
D
7
0
5
0
3
2
1
2
9
4
7
4
5
6
3
8
6
1
8
2000
D
ec
10
2000
-7
8
10
2500
-7
4
12
3000
2500
D
ec
14
12
($ billions)
3000
Source: BLS
99

14
01

16
Ja
n-

16
00

20
18
Ja
n-

Total Consumer Credit Outstanding
U3
18
9
 Slow progress in unemployment
continues to weigh heavily on Fed
policy.
Deleveraging of consumer balance
sheets has leveled off, but creditrelated spending is expected to
remain subdued.
Both new and existing home sales
plummeted following the
expiration of the homebuyer tax
credit program. The gap between
existing and new home sales is
widening.
The U.S. housing market is still
being weighed down by the
enormous supply of vacant homes
for rent and for sale.
Rising interest rates will make it
even more difficult for housing to
recover, making the Fed more
convinced that it needs to keep
rates lower for longer.
Regulatory uncertainty is causing
banks, companies and individuals
to become more risk-averse
U6
20
D
Highlights
The Unemployment Rate Remains Flat
Unemployment vs. Participation
The Unemployment Rate
remains above 9 percent.
Unemployment (LHS)
12
Labor Participation (RHS)
70
69
10
Meanwhile, participation rates
have risen slightly.
68
8
The flat unemployment rate,
coupled with a rising
participation rate likely means
that workers are accepting parttime employment.
67
6
66
65
4
Mar '84 = 64.1
Sep '11 = 64.2
2
63
9
7
D
ec
-0
5
D
ec
-0
3
D
ec
-0
1
D
ec
-0
9
D
ec
-0
7
D
ec
-9
5
D
ec
-9
3
D
ec
-9
1
D
ec
-9
9
D
ec
-9
7
D
ec
-8
5
D
ec
-8
3
ec
-8
D
D
ec
-8
1
62
ec
-8
D
ec
-7
9
0
D
64
Source: BLS
Source: BLS and Wells Fargo Securities, LLC
5
The Fed Continues to Exert Control
Excess Reserves
At Commercial Banks ($ billions)
1,800
$1,577B
1,600
1,600
1,400
1,400
1,200
1,200
1,000
1,000
.
800
800
QE2
600
400
9/11, 2001 - $38 billion
600
400
200
200
-
-
Ju
lJu 9 3
lJu 9 4
lJu 9 5
lJu 9 6
lJu 9 7
lJu 9 8
lJu 9 9
lJu 0 0
lJu 0 1
lJu 0 2
lJu 0 3
lJu 0 4
lJu 0 5
lJu 0 6
lJu 0 7
lJu 0 8
lJu 0 9
lJu 1 0
l11
The amount of cash sitting on
bank balance sheets is indicative
of a lack of credit demand, a
relative unwillingness by banks
to lend based on regulatory and
economic uncertainty and
highly accommodative Fed
monetary policy.
1,800
Source: Federal Reserve
Source: Federal Reserve and Wells Fargo Securities, LLC
6
The Fed Continues to Exert Control - QE2, Forward Rate Transparency and Operation Twist
Treasury Yield Curve
Current
15-Jul
QE2
1.8
The impact of the August change
in the Fed policy statement had
an immediate impact on the
shape of the yield curve.
1.6
1.4
1.2
1
After the August announcement,
the 3-year fell close to 2-year
levels and the 2-year closed in
on the 1-year yield.
0.8
37 bps
38 bps
0.6
23 bps
0.4
15 bps
0.2
0
1M
3M
6M
Source: Federal Reserve and Wells Fargo Securities, LLC
7
1Y
2Y
3Y
5Y
The Fed Continues to Exert Control –Operation Twist
Shape of Treasury Curve
Average Roll
140
Operation Twist began last week
with three purchases and one
sales operation. The impact has
been minimal as markets have
been more focused on other
influences.
The sales operation for shortdated Treasury collateral was
oversubscribed more than 30
times.
Current Roll
130
120
"Operation Twist" would likely
focus on flattening this area of
the curve
100
80
100
80
60
60
54
42
41
20
16
14
9
1
2.5
1-3 mo
3-6 mo
39
40
28
25
0
120
111
And possibly result in flattening this
area of the curve even further...
40
140
20
11
0
6M-2 Yr
2-3 Yr
3-5 Yr
5 -10 Yr 10 - 30 Yr
Source: Bloomberg
Source: Bloomberg and Wells Fargo Securities, LLC
8
Expectations of Short-term Rates
Futures-Implied Yields
Jun '12 Fed funds Futures
Jun '12 Eurodollars
2
2
1.8
1.8
Eurodollar and Fed funds
futures yields have moved
higher since the announcement
of Operation Twist.
1.6
The spread between Fed funds
futures and Eurodollar futures
also shows a risk premium is
being priced into credit markets.
0.8
0.8
0.6
0.6
0.4
0.4
0.2
0.2
Operation
Twist
1.4
1.2
1
10
ep
-1
O 0
ct
-1
0
N
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0
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0
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ar
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ep
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1
0
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ug
-
-1
0
0
A
1.4
1.2
1
Ju
l
1.6
Source: CBOT, CME
Source: Chicago Board of Trade, Chicago Mercantile Exchange and Wells Fargo Securities, LLC
9
Corporate Balance Sheets Remain Flush
Cash and Short-Term Investments
($ billions) through Q2
3,000
$3,000
$2.725 trillion
$2,500
2,000
$2,000
1,500
$1,500
1,000
$1,000
$500
-
$-
1
Q 9 99
4
1
Q 99
9
3
20
Q
00
2
20
Q
01
1
20
Q
02
4
20
Q
02
4
20
Q
03
2
20
Q
04
1
20
Q
05
4
20
Q
05
3
20
Q
06
2
20
Q
1 07
2
Q 0 08
4
2
Q 0 08
3
2
Q 0 09
2
2
Q 0 10
4
20
10
500
Q
1
Cash accumulation on corporate
balance sheets had begun to
decrease in Q4 2010, but cash
accumulation has accelerated in
2011, putting more downward
pressure on rates.
2,500
Source: Bloomberg, Wells Fargo Securities
Source: Bloomberg and Wells Fargo Securities, LLC
10
Constrained Short-term Issuance
Commercial Paper Outstanding
Total CP
ABCP
$2,500
$2,500
$2.18T
$2,000
$1,500
$1,500
$1.21T
$1,000
$1.025
T
$500
$1,000
$500
$350B
$-
n02
O
ct
-0
2
Ju
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Ap
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Ja
n05
O
ct
-0
5
Ju
l06
Ap
r07
Ja
n08
O
ct
-0
8
Ju
l09
Ap
r10
Ja
n11
O
ct
-1
1
$-
Ja
Commercial Paper issuance has
fallen sharply since June,
contributing to lower yields.
$2,000
Source: Federal Reserve
Source: Federal Reserve and Wells Fargo Securities, LLC
11
European Headwinds: Banks Hoarding Liquidity, Wholesale Funding Difficulties
Cash as a Percentage of Total Assets
(Foreign-related bank branches)
60%
50%
48.60%
40%
30%
20%
4.58%
10%
0%
1/
3/
1/ 73
3/
1/ 75
3/
1/ 77
3/
1/ 79
3/
1/ 81
3/
1/ 83
3/
1/ 85
3/
1/ 87
3/
1/ 89
3/
1/ 91
3/
1/ 93
3/
1/ 95
3/
1/ 97
3/
1/ 99
3/
1/ 01
3/
1/ 03
3/
1/ 05
3/
1/ 07
3/
1/ 09
3/
11
Percent
Wholesale funding difficulties
for foreign issuers continues to
mount, locking some firms out
of the U.S. dollar funding
markets…yet another supply
constraint for short-term
investors.
Source: Federal Reserve
Source: Chicago Board of Trade, Bloomberg and Wells Fargo Securities, LLC
12
European Headwinds: Banks Hoarding Liquidity, Wholesale Funding Difficulties
Wholesale Funding
(as a % of total assets/liabilities)
Large Time Deposits
100%
85%
80%
60%
44%
40%
20%
11%
0%
-20%
-40%
-47%
-60%
1/
3/
73
1/
3/
76
1/
3/
79
1/
3/
82
1/
3/
85
1/
3/
88
1/
3/
91
1/
3/
94
1/
3/
97
1/
3/
00
1/
3/
03
1/
3/
06
1/
3/
09
Large Time Deposit Funding has
declined significantly, while
balances owed to parent-related
entities has sharply increased.
Net Due to Foreign Parent
Source: Federal Reserve
Source: Federal Reserve and Wells Fargo Securities, LLC
13
Balance Sheet Headwinds: Deleveraging and Housing Difficulties Continue
U.S. Real Estate Assets, Liabilities and Equity
$30
Total Assets
OE
Mortgages
$25
$20
$ trillions
$1 5
$1 0
$5
De
c70
c7
De 2
c7
De 4
c76
De
c7
De 8
c8
De 0
c8
De 2
c8
De 4
c86
De
c8
De 8
c9
De 0
c9
De 2
c94
De
c9
De 6
c9
De 8
c0
De 0
c02
De
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De 4
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De 6
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De 8
c10
$-
De
Distress in the U.S. housing
market is likely causing a drag
on the economy regardless of
whatever monetary and fiscal
stimulus is provided.
Source: Federal Reserve
Source: Federal Reserve and Wells Fargo Securities, LLC
14
Regulatory Headwinds: Uncertainty Surrounding Regulatory Reform
Dodd-Frank Rulemaking Progress
Many business leaders feel that
Dodd-Frank is hindering
economic growth because of the
uncertainties surrounding the
mass of rulemaking that is yet to
be finalized, or in some cases,
even considered.
Missed, 130
Future
Deadline, 190
Finalized, 51
Proposed, 29
Source: Davis Polk and Wells Fargo Securities, LLC
15
The Fed’s Next Move
“U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is
at least stable or, preferably, declining over time. .”
- Ben Bernanke in Jackson Hole August 2011
Statements
Actions
 Unfortunately, the recession, besides being
extraordinarily severe as well as global in scope, was
also unusual in being associated with both a very deep
slump in the housing market and a historic financial
crisis.
 The Committee currently anticipates that economic
conditions--including low rates of resource
utilization and a subdued outlook for inflation over
the medium run--are likely to warrant exceptionally
low levels for the federal funds rate at least through
mid-2013.
 These two features of the downturn, individually and in
combination, have acted to slow the natural recovery
process.
 The Committee also will maintain its existing policy
of reinvesting principal payments from its securities
holdings. The Committee will regularly review the
size and composition of its securities holdings and is
prepared to adjust those holdings as appropriate.
 Although we expect a moderate recovery to continue
and indeed to strengthen over time, the Committee has
marked down its outlook for the likely pace of growth
over coming quarters.
 Operation Twist - the Committee decided today to
 The target for the federal funds rate would be held at its
extend the average maturity of its holdings of
securities. The Committee intends to purchase, by
the end of June 2012, $400 billion of Treasury
securities with remaining maturities of 6 years to 30
years and to sell an equal amount of Treasury
securities with remaining maturities of 3 years or
less. This program should put downward pressure
on longer-term interest rates and help make broader
financial conditions more accommodative.
current low levels for at least two more years.
 Without significant policy changes, the finances of the
federal government will inevitably spiral out of control,
risking severe economic and financial damage.
Source: Federal Reserve and Wells Fargo Securities, LLC
16
The Fed’s Exit Strategy
Federal Reserve Securities Holdings
US Factors Supplying Reserve Funds
3,000
A g en cy
MBS
Ot h er
2,500
2,000
1,500
1,000
500
5/
5/ 05
5/
9/ 05
5/
0
1/ 5
5/
5/ 06
5/
9/ 06
5/
0
1/ 6
5/
5/ 07
5/
9/ 07
5/
0
1/ 7
5/
5/ 08
5/
9/ 08
5/
0
1/ 8
5/
5/ 09
5/
0
9/ 9
5/
0
1/ 9
5/
5/ 10
5/
9/ 10
5/
1
1/ 0
5/
5/ 11
5/
11
-
1/
With recent discussions around
“Operation Twist” and clarity on
the path of short-term rates, the
timeline for reductions in the
Fed’s balance sheet have been
moved out further.
T r ea su r y
($ Billions)
The Fed eventually expects to
begin reducing the size of its
balance sheet and adjusting it
back to primarily Treasury
securities.
Sou r ce: Feder a l Reser v e. W ells Fa r g o Secu r it ies
Source: Federal Reserve and Wells Fargo Securities, LLC
17
Positioning Corporate Cash Portfolios
Framing the structure of a cash portfolio is important to determining the
appropriate investment strategy
Segmentation of the Corporate Cash Portfolio – For Illustrative Purposes Only
Liquidity,
Stability
of Principal
Operating Cash (Horizon - daily)
Reserve Cash (Horizon - Quarterly)
Less liquidity,
higher yields,
more price
volatility
Restricted Cash (Horizon - longer-term )
Strategic Cash (Horizon - longer-term )
Q1
Q2
Q3
Source: ICI, Wells Fargo Securities, LLC
18
Q4
Positioning Corporate Portfolios
There is little to no pickup in yield for taking on duration risk outside of the credit
markets.
Relative Value in the Money Markets – For Illustrative Purposes Only
45
40
A2/P2
35
UK
Nordics
30
Japanese
25
20
Aussies
EC R
VRDN
15
C anadians
10
5
Financials
Non-Financials
Discos
Bills
0
1-Day
7-Day
30-
Source: Wells Fargo Securities, LLC
19
60-
90-
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