January 5, 2015

LawryKnopp Economic Update Quarterly

Lawry Knopp, VP-Funding & Hedging

General market expectations are for interest rates to have an upward bias throughout 2015 as stronger domestic demand and continued improvement in employment push the Federal Reserve to contemplate increasing monetary policy rates sometime during the second half of 2015. Of course, tightening rates will be dependent on how well the economy performs during the first half of the year and the Fed has said it will be “patient” in its approach to raising rates. It would be the first change in policy rates since December 2008 when the Fed reduced the Federal Funds rate to a target range of 0.0-0.25 percent. Since then, the Fed has held rates steady while expanding its balance sheet from $800 billion to $4.5 trillion through several rounds of quantitative easing.

Talk of raising short-term rates by Federal Reserve officials in 2014 pushed shorter term interest rates up as the two-year Treasury rose nearly 30 basis points to 0.66 percent. At the same time, low inflation, a stronger dollar, economic weakness in the European and Asian economies and geopolitical uncertainty have increased demand for the safety of U.S. Treasury securities and pushed the 10-year Treasury yield to the low end of the one-year trading range of 2.04-3.01 percent. A year ago, the 10-year Treasury was yielding 3.01percent. Weakness in the equity markets is also adding downward pressure on interest rates as we start the new year.

The rate of inflation has slowed largely due to lower gasoline prices and the stronger dollar, which makes imports cheaper. The price of oil began falling in July 2014 on weaker global demand while major producers of crude maintained production, which contributed to excess oil supplies.

With the backdrop of decent U.S. economic growth, likely around 3.0 percent, and lower inflation, probably less than 2.0 percent, look for continued improvement in reported employment numbers during 2015. Also, lower gas prices are expected to provide a boost to consumer spending, which accounts for about 70 percent of Gross Domestic Product. Housing, business investment and government spending are expected to contribute to growth. The inventory component of GDP can be a source of volatility for growth and may influence market rates.

While the U.S. economy is expected to remain in positive growth territory, the Japanese economy is in recession. Weakness in the Chinese economy is a concern, and the threat of deflation in Europe is worrisome for the European Central Bank. So far, the unprecedented quantitative easing embarked on by the Bank of Japan has been unable to spur growth as tax hikes have slowed consumer spending. Weakness in the Chinese economy contributed to lower commodity prices and hurt economies dependent on providing raw materials to China. Look for fiscal stimulus and accommodative policy rates to help China achieve a GDP greater than 7.0 percent.

The European Central Bank is expected to ramp-up quantitative easing as it buys European government debt in an effort to fight deflation and stimulate growth. The threat of deflation and weak growth have pushed European bond rates down and widened the spread between U.S. and European government bond yields. This also has enhanced demand for U.S. Treasury debt and helped to lower longer-term yields.

View on Interest Rates
Interest rates are expected to move up from current levels in 2015 as oil prices find a bottom and European and Japanese economies regain positive momentum. Until these items are addressed we will likely see elevated market volatility and generally low yields. If the European Central Bank and Bank of Japan policy efforts begin to gain traction and their respective economies improve, the dollar may start to decline back to longer range levels which would help exports. Futures markets are expecting the Federal Reserve to tighten short-term rates, but not until sometime during the 2nd half of the year. Other events that may impact the view on rates include increased turmoil in the Middle East, greater uncertainty related to debt defaults by weaker economies in the Eurozone and significant movement in equity market prices.

The above commentary is a summary of select economic conditions prepared for Northwest FCS management. It is being shared as a courtesy. As with any economic analysis, it is based upon assumptions, personal views and experiences of those that provided the source material as well as those that prepared this summary. These assumptions, conclusions and opinions may prove to be incomplete or incorrect. Economic conditions may also change at any time based on unforeseeable events.  Northwest FCS assumes no liability for the accuracy or completeness of the summary or of any of the source material upon which it is based. Northwest FCS does not undertake any obligation to update or correct any statement it makes in the above summary. Any person reading this summary is responsible to do appropriate due diligence without reliance on Northwest FCS.  No commitment to lend, or provide any financial service, express or implied, is made by posting this information.