credit suisse, us economics digest, march 13, 2013
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US Economics Digest US ECONOMICS
FOMC Meeting Preview –
If You Like the Show, Don’t Change the Channel Federal Reserve officials presumably are pleased with market and economic
developments since QE3 commenced in September. Equities have rallied,
job growth has strengthened, and household confidence is building.
Admittedly, the direct influence of QE3 on these welcome trends is difficult to
quantify. And several FOMC participants have voiced increasing discomfort
with continued easing. But the core members of the Committee have already
signaled their preference for more asset purchases, and the majority of
voting members likely will support them.
The FOMC meets March 19-20. We expect no change in the $85bn monthly
asset purchase pace for now, especially with sequester layoffs a reasonable
consensus forecast. The Committee likely will reaffirm the policy thresholds it
introduced in December. An update to the exit strategy is possible, too.
We are finally seeing building evidence that the household risk aversion that
persisted through the post-recession period is diminishing. Consumers have
stepped up their pace of borrowing and are venturing out the risk curve in
choosing their investments.
Bernanke said in recent Congressional testimonies that if QE3 appears to be
working, the Fed will keep purchasing assets. If not, the Central Bank will try
something different. The circumstantial evidence suggests that the low
interest rates engineered by the Fed are, slowly but surely, having their
desired effect. This implies that it’s still full speed ahead for QE3.
Exhibit 1: US Households Beginning to Take On More Risk Change in debt outstanding, household sector*, SAAR, $bn
-600
-300
0
300
600
900
1200
1500
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
Mortgages
Consumer Credit
Source: Federal Reserve, Credit Suisse * Sector includes domestic hedge funds, private equity funds, and personal trusts.
13 March 2013
Economics Research
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Neal Soss
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Dana Saporta
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13 March 2013
US Economics Digest 2
FOMC Meeting Preview – If You Like the Show, Don’t Change the Channel
Federal Reserve Chairman Bernanke said in his Congressional testimonies last month
that if QE3 appears to be working, the Fed will keep purchasing assets. If not, he asserted,
the Central Bank will try something different.
Fed officials presumably are pleased with market and economic developments since the
current asset purchase program commenced in September 2012. The S&P 500 equity
index has rallied some 6% in six months. Job growth has strengthened. And, as we
explore in more detail below, household risk aversion – so evident throughout the sluggish
recovery – is finally showing signs of thawing.
Admittedly, the direct influence of QE3 on these welcome trends is difficult to quantify. And
it is true that several vocal FOMC participants are becoming increasingly uncomfortable
with continued easing. But the core members of the Committee – including Bernanke and
Vice Chair Yellen – have already signaled their preference for still more balance sheet
expansion, and the majority of voting members likely will support them.
The FOMC next meets on March 19-20. We expect the Committee’s March 20 policy
statement to convey the Fed’s intention to continue purchasing MBS and long-term
Treasury debt. We see no changes in the $85bn/month asset purchase pace for now,
especially with sequester-related layoffs a reasonable consensus forecast.
The FOMC likely will reaffirm the economic thresholds it introduced in December. An
update to the Fed’s exit strategy – first laid out in June 2011 – is also possible as soon as
March 20. We expect any new policy normalization plan to retain the potential for – but
downplay the inevitability of – outright asset sales from the Fed’s portfolio.
Results of next week’s meeting will be released in three stages. The FOMC policy
statement will hit the newswires at about 12:30pm EDT on Wednesday, March 20. This
will be followed by updated FOMC economic and fed funds rate projections at 2:00.
Chairman Bernanke will then hold a press briefing at 2:15.
Policy slowly gaining traction
We still anticipate the Fed’s open-ended purchase program (QE3) will persist through
2013 and perhaps into early 2014, though probably not in its current form. QE3 allows for
flexibility in the size of the monthly purchases, and it may be that the Fed will choose to
decrease the size of its purchases later this year, say to $30bn each in Treasuries and
MBS. Such a scenario would bring us to just over the $1.1 trillion mark in balance sheet
expansion by March 2014 (if we include all 2012 MBS purchases).
Exhibit 2: FOMC to Continue Purchasing $85bn/month, At Least for Now Credit Suisse forecasts, $bn
Quarter MBS purchases Treasury purchases Total
Q3 2012 23 0 23
Q4 2012 40/mo 0 120
Q1 2013 40/mo 45/mo 255
Q2 2013 40/mo 45/mo 255
Q3 2013* 40/mo thru mid-Sep. 45/mo thru mid Sep. 180
Q4 2013 30/mo 30/mo 180
Q1 2014 0 30/mo 90
TOTAL 588 583 1171
Source: Federal Reserve, Credit Suisse * Forecasted cut in asset purchase size at the September 17-18, 2013 FOMC meeting.
13 March 2013
US Economics Digest 3
A look back at the initial objectives of the Fed’s asset purchases, beyond the emergency
restarting of paralyzed markets in 2008-09, suggests that the monetary policy medicine is
working largely as desired, albeit slowly. As Bernanke explained in August 2010:
“I see the evidence as most favorable to the view that [the Fed’s asset] purchases work
primarily through the so-called portfolio balance channel, which holds that once short-term
interest rates have reached zero, the Federal Reserve's purchases of longer-term
securities affect financial conditions by changing the quantity and mix of financial assets
held by the public.”
Or, in other words, by pursuing extremely low yields for relatively “safe” assets, the Fed
sought to encourage more risk-taking behavior among both institutional and individual
investors. Appreciation in corporate bond and equity prices, it was theorized, would in turn
promote a virtuous cycle in which demand, investment, and – importantly – job growth
would strengthen.
The US recovery from the great recession is already nearly four years old, and we are
finally seeing building evidence that the household risk aversion that persisted
through the post-recession period is diminishing. Consumers have stepped up their
pace of borrowing and are venturing out the risk curve in choosing their investments. Data
released just over the past few weeks – from the New York Fed, the Federal Reserve
Board, and the Investment Company Institute – illustrate this point.
In its Q4 report on Household Debt and Credit, the NY Fed announced that aggregate
consumer debt increased slightly in Q4-2012, by $31bn, a reversal from the downward
trend that has been in place since late 2008. As of December 31, 2012, total consumer
indebtedness was $11.34tr, 0.3% higher than its level in Q3. (But overall consumer debt
remains considerably below its peak of $12.68tr in Q3-2008.)
Exhibit 3: Total Household Debt Balance and its Composition
$ trillions
Source: FRBNY Consumer Credit Panel/Equifax, Credit Suisse
13 March 2013
US Economics Digest 4
This modest increase in consumer debt was driven by the third consecutive quarterly rise
in non-housing-related debt, with auto loans up by $15bn; student loans up by $10bn (to
$966bn), and credit card balances up by $5bn. Mortgages, the largest component of
household debt, were roughly flat, and home equity lines of credit (HELOC) declined in the
fourth quarter (Exhibit 3).
The report noted that overall, delinquency rates continued to improve in Q4. As of
December 31, 8.6% of outstanding debt was in some stage of delinquency, compared with
8.9% in 2012Q3. About $978bn of debt is delinquent, with $712bn seriously delinquent (at
least 90 days late or “severely derogatory”).
While overall delinquency rates are now back to pre-recession levels—around 8-1/2%—
they are still well above the 3-5% rates that prevailed in the first half of the 2000s.
A glaring exception to the delinquency improvement is student loans (Exhibit 4). The 90+
day delinquency rate on student loans continues to rise and now stands at 11.7%. Note
that according to the NY Fed, “these delinquency rates for student loans are likely to
understate actual delinquency rates because almost half of these loans are currently in
grace periods, in deferment, or in forbearance and therefore temporarily not in the
repayment cycle. This implies that among loans in the repayment cycle, delinquency
rates are roughly twice as high.”
NY Fed Director of Research James McAndrews cast the data in a positive light. He said,
along with some positive economic developments, “there has been a notable increase in
risk appetite among financial market participants over recent months, although there was
some pull-back and volatility this week following the election results in Italy.”
McAndrews added that “data indicate that the recent improvement in the housing market
was accompanied by a slight increase in the level of household debt. While it is too soon
to conclude that a trend has been established in which households are beginning to
increase their debts again, there are signs that the four-year long contraction is slowing.”
Exhibit 4: Loan Delinquencies Trending Lower with One Glaring Exception
Percent of household loan balance 90+ days delinquent
Source: FRBNY Consumer Credit Panel/Equifax, Credit Suisse
13 March 2013
US Economics Digest 5
Back Where We Started
The Federal Reserve Board’s “Flow of Funds” report, released on March 7, tells a similar
story. Households in the aggregate continued to pay down mortgages through 2012. But
mortgage debt in Q4 contracted at the slowest pace since 2009. Meanwhile, consumer
credit growth is gaining momentum, although again the student loan aspect of this debt
increase is worrisome.
Exhibit 5: Household Beginning to Take On More Risk
Change in debt outstanding, household sector*, SAAR, $bn
-600
-300
0
300
600
900
1200
1500
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
Mortgages
Consumer Credit
Source: Federal Reserve, Credit Suisse * Sector includes nonprofits, domestic hedge funds, private equity funds, and personal trusts.
How do we explain this increase in household borrowing? For one, increased access to
credit may be playing a role. Faster income growth is probably another factor. A third
possible explanation is the fact that households, in the aggregate, have nearly regained
the wealth they lost during the Great Recession.
Exhibit 6: Household Wealth Nearly Back to 2007 Peak
Household sector net worth*, $ trillions
0
10
20
30
40
50
60
70
'72 '75 '78 '81 '84 '87 '90 '93 '96 '99 '02 '05 '08 '11
Source: Federal Reserve, Credit Suisse * Sector includes nonprofits, domestic hedge funds, private equity funds, and personal trusts.
13 March 2013
US Economics Digest 6
The difference between household assets and liabilities at the end of December 2012 was
reported at $66.1 trillion, some $1.2tr more than at the end of the previous quarter. In
comparison, the $2.9tr rise in Q1-2012 was the biggest jump in household wealth since
Q4-1999 ($3.5tr).
Exhibit 7: Selected Household Sector Asset Values*
$ trillions
0
11
22
33
44
55
'72 '75 '78 '81 '84 '87 '90 '93 '96 '99 '02 '05 '08 '11
Financial assets
Real estate
assets
Source: Federal Reserve, Credit Suisse * Sector includes nonprofits, domestic hedge funds, private equity funds, and personal trusts.
In Q4, the value of corporate equities and mutual funds owned by households increased
by about $130bn, and there was a $480bn increase in the value of real estate owned by
households. This was the largest jump in real estate values since Q1-2006. Household
wealth is just $1.3tr (or 2%) below its Q3-2007 peak. Assuming home prices don't fall this
quarter and equities hold on to most of their gains for another two weeks, wealth likely will
hit a new high in Q1-2013.
How recent increases in household wealth will translate into near-term spending is an
interesting question. Our recent work on the wealth effect suggests that changes in
housing wealth have a greater influence on consumer spending than changes in stock
market wealth. But wealth effects appear to have shrunk since the 2007-2008 financial
crisis, and more so for housing wealth than for stock market wealth.
One implication of this result is that the Federal Reserve will need to “engineer” even
larger bull markets in house prices and stock prices for any given desired pick-up in
economic growth. (See our February 13, 2013 US Economics Digest: Honey, I Shrunk the
Wealth Effect.)
There are several potential explanations for our estimate of a smaller housing wealth
effect since the last financial crisis, including the following:
Since the housing bubble burst in early 2006, housing wealth volatility has remained
elevated at levels well above its historical norm. Households will be less likely to view
gains in asset prices as permanent, and their willingness to spend will thus be restrained
(Exhibit 8).
13 March 2013
US Economics Digest 7
Exhibit 8: Household Real Estate Values Become More Volatile
Q/Q % changes, +/- one standard deviation
-6
-4
-2
0
2
4
6
'53 '56 '59 '62 '65 '68 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10
Source: Federal Reserve, Credit Suisse
Mortgage equity withdrawals, once the main channel through which consumers generated
the cash flow to spend beyond their current take-home pay, show no sign of recovery
following the collapse from 2006-2008. Less cash from monetized home equity implies
less purchasing power and consumer expenditures, and hence a smaller housing wealth
effect (Exhibit 9).
Exhibit 9: Freddie Mac: Total Home Equity Cashed Out
Prime conventional mortgages, $ billions
0
15
30
45
60
75
90
'98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
Q2-2006: $84bn
Q4-2012: $8bn
Source: FHLMC, Credit Suisse
Also, and perhaps most important for the outlook, is the unprecedented bifurcation of
households who contributed to lower aggregate debt-to-asset ratios by default/foreclosure/
charge-offs and those who contributed to the same statistical result by continuing to
service their debt (Exhibit 10).
13 March 2013
US Economics Digest 8
Exhibit 10: Aggregate Household Financial Ratios Mask Underlying Divergence
Household credit debt/assets
5%
8%
11%
14%
17%
20%
23%
'52 '55 '58 '61 '64 '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09 '12
1990s avg:
14.2%Q4-2012:
16.9%
Source: Federal Reserve, Credit Suisse
Sudden inflows into equity mutual funds
Mutual fund flow data from the Investment Company Institute also are consistent with
the theme of moderating household risk aversion. (Since mutual funds are largely a retail
investment vehicle, we use ICI data as one proxy for household attitudes toward risk.)
Hungry for returns but wary of equities, retail investors in recent years have deemed bond
funds an acceptable compromise between the competing desires for yield and safety
(Exhibit 11). Demographics are also playing a role in household portfolio allocation
decisions, as an aging population tends to desire less risk.
Exhibit 11: Hungry for Returns but Wary of Equities
Cumulative net inflows by year, $bn
-300
-150
0
150
300
450
'06 '07 '08 '09 '10 '11 '12
Equity funds
Bond funds
Source: Investment Company Institute, Haver Analytics®, Credit Suisse
13 March 2013
US Economics Digest 9
But, as weekly data in Exhibit 12 suggest, there was an abrupt change in this pattern
recently, as retail investors began making net new investments in both bond and equity
mutual funds. It is not uncommon to see stronger net inflows into equity mutual funds at
the start of each calendar year, but inflows in early 2013 were particularly dramatic.
Exhibit 12: A Sudden Surge of Inflows into Equity Mutual Funds
Weekly net mutual fund flows, $ billions
-15
-10
-5
0
5
10
15
1/4/12 2/29/12 4/25/12 6/20/12 8/15/12 10/10/12 12/5/12 1/30/13
Equity mutual funds
Bond mutual funds
Feb 27
Source: Investment Company Institute, Haver Analytics®, Credit Suisse
The question remains whether this retail investment behavior heralds a more protracted
portfolio shift or if it will prove to be a temporary, short-lived adjustment. Net inflows into
equity mutual funds persisted for the eighth consecutive week of the new year, but
they have been shrinking in size. It is too soon to draw a firm conclusion. (We explore
this question in our February 10 US Money Matters: Mutual Funds: Seismic Shift or Short-
Term Pop?)
FOMC participants’ economic projections
The March 20 post-meeting announcements will include updated FOMC economic
projections and participants’ latest preferences for the path of the fed funds rate target.
Now that the FOMC revises its economic projections during the third month of each
quarter, the estimates Committee members make in December for the same year should
be fairly accurate. As it turned out, the nearly flat growth result for Q4-2012 (+0.1%)
apparently took the Committee – as well as private forecasters -- by surprise. Real GDP
grew just 1.5% last year on Q4/Q4 basis, below the FOMC central tendency range of
1.7%-1.8%.
The FOMC may downgrade its 2013 growth forecast, since it now needs to factor in the
headwinds created by the budget sequester. The 2.3%-3.0% range submitted in
December for 2013 real GDP growth may be shaved by as much as 0.5 percentage point.
What FOMC members decide to do with their unemployment rate forecasts will be of
particular interest, given this statistic’s multiple moving parts. A slower growth forecast
ordinarily would be associated with raised unemployment rate projections. But if the labor
force participation rate is expected to keep declining, we may see little or no adjustment to
the FOMC’s 7.4%-7.7% range for 2012 (Exhibit 13).
13 March 2013
US Economics Digest 10
Exhibit 13: FOMC Economic Projections as of December 12
GDP and PCE price indexes (Q4/Q4%), unemployment rate (Q4 average)
2012 2013 2014 2015 Longer run
Change in real GDP 1.7 to 1.8 2.3 to 3.0 3.0 to 3.5 3.0 to 3.7 2.3 to 2.5
Sep'12 projection 1.7 to 2.0 2.5 to 3.0 3.0 to 3.8 3.0 to 3.8 2.3 to 2.5
Jun'12 projection 1.9 to 2.4 2.2 to 2.8 3.0 to 3.5 -- 2.3 to 2.5
Apr'12 projection 2.4 to 2.9 2.7 to 3.1 3.1 to 3.6 -- 2.3 to 2.6
Unemployment rate 7.8 to 7.9 7.4 to 7.7 6.8 to 7.3 6.0 to 6.6 5.2 to 6.0
Sep'12 projection 8.0 to 8.2 7.6 to 7.9 6.7 to 7.3 6.0 to 6.8 5.2 to 6.0
Jun'12 projection 8.0 to 8.2 7.5 to 8.0 7.0 to 7.7 -- 5.2 to 6.0
Apr'12 projection 7.8 to 8.0 7.3 to 7.7 6.7 to 7.4 -- 5.2 to 6.0
PCE inflation 1.6 to 1.7 1.3 to 2.0 1.5 to 2.0 1.7 to 2.0 2.0
Sep'12 projection 1.7 to 1.8 1.6 to 2.0 1.6 to 2.0 1.8 to 2.0 2.0
Jun'12 projection 1.2 to 1.7 1.5 to 2.0 1.5 to 2.0 -- 2.0
Apr'12 projection 1.9 to 2.0 1.6 to 2.0 1.7 to 2.0 -- 2.0
Core PCE inflation 1.6 to 1.7 1.6 to 1.9 1.6 to 2.0 1.8 to 2.0 --
Sep'12 projection 1.7 to 1.9 1.7 to 2.0 1.8 to 2.0 1.9 to 2.0 --
Jun'12 projection 1.7 to 2.0 1.6 to 2.0 1.6 to 2.0 -- --
Apr'12 projection 1.8 to 2.0 1.7 to 2.0 1.8 to 2.0 -- --
FOMC's central tendency Variable
Source: Federal Reserve, Credit Suisse
FOMC participants’ fed funds rate preferences
Diagrams of potential future paths for the funds rate target will also be updated next week.
In the histogram showing preferred rate hike dates, there was in December a modest
migration further into the future. The mean, median and mode were all in the 2015 rate
hike camp; 14 of 19 officials did not believe a rate hike is appropriate before 2015 (Exhibit
14). We expect to see a sizable majority in the 2015 column again on March 20.
Exhibit 14: FOMC: Appropriate Timing of Policy Firming Number of participants
3 3
5
4
2
3 3
7
4
3 3
7
6
1
3
2
12
1
2
3
13
1
0
2
4
6
8
10
12
14
2012 2013 2014 2015 2016
Jan
April
June
Sep
Dec
Source: Federal Reserve, Credit Suisse
13 March 2013
US Economics Digest 11
The Fed’s second chart will reflect the “appropriate pace” of tightening. The December
chart showed the distribution of FOMC estimates for the appropriate level of the funds rate
target at the end of 2012 and each of the following three calendar years.
Note that four of the 19 FOMC participants looked for rate hikes totaling 100bp or more by
year-end 2014. This was down from six in September. We assume that at least four of the
FOMC’s more hawkish participants (mainly among the Regional Fed Bank presidents)
have maintained similar preferences for tightening within the next 15 months.
Exhibit 15: Appropriate Pace of Policy Firming
Count of policymaker projections for fed funds rate target at year-end
0%
1%
2%
3%
4%
5%
2012 2013 2014 Longer Run2015
Source: Federal Reserve, Credit Suisse
Updated Exit Planning
Bernanke, in response to questions during his semiannual testimony to Congress, said the
exit strategy laid out in June 2011 needs to be reviewed. We see a small chance that an
updated strategy will be unveiled as soon as March 20 (although the Committee may need
a few more months to deliberate).
While the basic exit outline likely will be left intact, Bernanke suggested the timing of such
steps as outright asset sales may be revised. He noted that the Fed may decide to hold
securities longer than previously envisioned and perhaps not sell them at all – just let them
roll off the balance sheet as they mature (or, in the case of MBS, are amortized or pre-
paid).
Theoretically, the Fed should be able to tighten policy without actively shrinking its balance
sheet. It would do this by hiking the interest it pays on reserves, with the fed funds rate
presumably following IOR higher. In order to promote a tighter relationship between IOR
and the fed funds rate in this scenario, the Fed probably would need to neutralize large
swaths of excess reserves (perhaps several hundred billion dollars’ worth) via reverse RPs
and term deposit accounts.
13 March 2013
US Economics Digest 12
Exhibit 16: Bank Reserves Exhibit 17: Fed Funds vs. IOR
$bn Percent
0
350
700
1050
1400
1750
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Excess reserves
Required reserves
0.00
0.05
0.10
0.15
0.20
0.25
0.30
Dec-08 Aug-09 Apr-10 Dec-10 Aug-11 Apr-12 Dec-12
Federal funds effective rate
Interest on reserves (IOER)
Source: Federal Reserve, Credit Suisse Source: Federal Reserve, Credit Suisse
Echoing a comment in the January 29-30 FOMC meeting minutes, Bernanke also
suggested in testimony that holding securities longer may serve as a potential future
alternative to more asset purchases. The minutes noted the following:
“In this regard, a number of participants discussed the possibility of providing monetary
accommodation by holding securities for a longer period than envisioned in the
Committee's exit principles, either as a supplement to, or a replacement for, asset
purchases.
* * *
It is difficult to identify a direct causal link between the Fed’s QE initiatives and improving
trends in the economy (including the nascent normalization of risk appetite among
households). That said, circumstantial evidence suggests that the low interest rates
engineered by the Central Bank are, slowly but surely, having their desired effect. As a
result, the most likely monetary policy resulting from the March 19-20 FOMC meeting is
unchanged policy.
GLOBAL FIXED INCOME AND ECONOMIC RESEARCH
Dr. Neal Soss, Managing Director Chief Economist and Global Head of Economic Research
+1 212 325 3335 [email protected]
Eric Miller, Managing Director Global Head of Fixed Income and Economic Research
+1 212 538 6480 [email protected]
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Head of US Economics
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Disclosure Appendix
Analyst Certification I, Neal Soss and Dana Saporta, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.
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