Eng 2015 11 us by ABN AMRO

Global Ou utlook – 25 November 2015 2

US – Good-b ye zero interest i rate poli cy

Marritza Cabezas Sen nior Economist Tel:: +31 20 343 5618 8 marritza.cabezas@nl..abnamro.com

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GDP P growth to be around 2.5% in 2016 and 2.3% in 2017 Infla ation to reac ch the 2% ta arget end-20 016 Fed d to start rate e hike cycle e in Decemb ber Slow w pace of ra ate hikes in 2016 and 20 017

US econ nomy ready fo or a rate hike US econ nomic growth h has been quite decent in 2015 5. It’s perhaps not as strong as a at the beginnin ng of previous rrate hike cycles s, but slack has been diminisshing and this is s likely one of the t major reasons why we think the Fed will hike in Dec cember. Privatee consumption n has been drivving growth this year. A rob bust labour marrket and cheap per gasoline priices are giving consumers an n impulse.. Meanwhile, bu usiness fixed investment has s been growingg at a moderate e pace, despite e the weaker capex c in the en nergy sector, due d to low oil prrices. As for neet export growth, this has bee en at best neutral n for grow wth this year. This T is the result of the slowdoown in emergin ng markets, particula arly China and the strong dollar. In the coming years, we eexpect GDP gro owth will grow at somewh hat-above-trend d rates, mainly driven by rising consumer sppending.

Consu umption grow wth driving ec conomy contribu ution to GDP grow wth in %

6 4 2 0 -2 -4 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q Q2 Q 20 013 2013 2013 2014 2014 20 014 2014 2015 2015 2015 Consumptio on

Investmentt

Governmeent

Inventory

Net trade

GDP grow wth

Source: Thomson Reuters D Datastream

Consum mer spending to remain rob bust… Lower oil prices are co ontributing to higher disposable income and this should be a support for er spending forr some time. On O top of this, a robust labour market and inc creasing wealth consume effects frrom rising housse prices have also been sup pportive. Howevver, at the beg ginning of the year, consume ers preferred to o save. The pe ersonal savings s rate increasedd from 4.6% in n August to 5.4% % in the firs st quarter, but has been slow wly declining sin nce then (4.8% % in Septemberr). In the past tw wo quarters, this has been n changing and d we expect consumer spend ing to remain robust. r a rate hike e …even after Indeed, we think wage growth will inc crease moderately in line withh the diminishin ng labour markket W expect that this will offset the reduction in wealth that w will occur as the e interest rate hike h slack. We filters thrroughout the e conomy. ment needs co nfidence boos st Investm Housing activity has be een showing so ome expansion n in the past moonths. Residen ntial investmen nt growth, for f instance, iss consistent witth a recovery of the housing m market. Howev ver, forward looking data, d including housing starts s and permits have h been mixeed. Meanwhile, non-residentia al investme ent has been a bit below expe ectations and there t are downnside risks, if oil prices fail to

Global Ou utlook – 25 November 2015 2

regain th heir footing as w we expect. Low wer oil prices are a already resuulting in a conttraction of enerrgyrelated investments. In ndeed, in the pa ast few months s structure inveestments has sharply s declined d. o hand, equ uipment investment has been n stronger, but below expecta ations. We thinkk On the other that therre is some room m for an improv vement in investment growth.. A rate hike will do more goo od than harrm to business sentiment. It will w confirm thatt the economy is solid enough to support a rate hike, boo osting investorr sentiment. We e are forecastin ng that residenntial and non-re esidential investme ent will slowly iimprove in the coming years, on the back off a decent economic outlook coupled with only a slo ow pace of rate e hikes after the e lift-off. xport growth… … the worst is s over Weak ex Since the end of 2014,, net trade has been a drag on growth. This is partly explained by slowerr ade growth and ed, the trade weeighted value of o the US dollar, global tra d a stronger US dollar. Indee one of th he metrics whicch compares th he exchange ra ate of a countryy against that of o its major trad ding partners s has appreciatted by 13% ove er the past year. This represeents a loss of competitivenesss for US expo orting firms. Acccording to the S&P Dow Jone es indices, aboout 40% of US firms’ revenues comes frrom abroad. M Manufacturing activity, a which accounts a for a llarge chunk of US exports, ha as been fee eling this presssure, hurt also by b the impact from f the contraaction of energy y-related investme ent. As the glob bal economy grows g a little bitt faster in 20166 and 2017 than currently, we e expect th his to offset so ome of the impa act of a stronge er dollar on tradde. At least, we e expect net tra ade to be les ss of a drag forr the economy in the coming quarters. q n, looking bey yond lower oil prices… Inflation A concern this year ha as been whethe er the decline in n oil prices andd a stronger do ollar will preven nt progress back towards t the Fe ed’s inflation gooal. Indeed, infllation has been n inflation from making p 2% target. Headline inflation has h fallen by 2pppts since oil prices p began th heir running far below the 2 nces, we find itt is more approopriate to focus s on core inflation decline. Under the currrent circumstan ss any potentia al risks of inflation falling too fa ar below its 2% % target. Core inflation, i which h to asses excludes s food and ene ergy has been trending t up rec cently. This is tthe result of hig gher prices of services s (medical serv ices, professio onal care and re ecreation). Thee rise in disposable income ha as increase ed the demand for services. This T has offset the fall in pricees of goods, wh hich have been n pulled do own by a stron ng dollar and lo ower transport costs. c We see the impact on inflation of falling oil prices s as temporaryy, that is as long as oil prices stabilise at som me point. m into dimi nishing slack k …and more The pace at which infla ation will increa ase will depend d on diminishinng slack in the economy. e Labo our market slack s has been n rapidly diminis shing. So far th his year, total nnonfarm payroll employment has been expanding at an a average of aro ound 200K. The e unemployme nt rate is now at a 5%, close to o the rate of 4.9% that iss considered co onsistent with inflation at 2%. Rising wage growth g would be a hat the labour m market is gettin ng closer to ach hieving its empployment mandate. We think that t signal th we may be getting closser to the turnin ng point in wag ge growth. The re is more evid dence that certain business ses are facing increasing cha allenges in hirin ng and robust joob turnover continues to show w increasin ng momentum in the labour market. m Expectations of low innflation will be challenged, if wage gro owth starts piccking up. We ex xpect the core measure of infflation targeted d by the Fed to increase e gradually in th he second halff of the year, re eaching the 2% % target in 2016 6. This is in line e with the Fed’s objective e.

Global Ou utlook – 25 November 2015 2

Diminishing g labour mark ket slack…

… to lift subdu ued wage gro owth

000s

600 400 200 0 -200 -400 -600 -800 -1000

4 2 0 06

1 10

Non farm payrolls (lh hs) Source: S Thomson R Reuters Datastrea am

% yoy

1 0 Employmen nt cost Unit la abour costs index x

Uneemployment (rhs)

Lon ng-term average

Average hourly earnings

Last quarter average a

Sou urce: Thomson Re euters Datastream m

ous Fed at the e forefront of the t rate hike… … A cautio Hence th he economy se eems to be rea ady for a rate hike after sevenn years of near zero interest rates. Th he normalisatio on process will take place at a time when otther central ban nks, including the t ECB, the e BoJ and the People’s Bank k of China are easing. e Althouggh the mandate e of the Fed reffers to full em mployment and d price stability,, policy diverge ence has raisedd concerns abo out the spill-ove er effects to o the global ecconomy of tightter financial con nditions in the US, which is partly the result of a strong US dollar. We e think that this has made the Fed more cauutious. es to reduce risks r … calls for a slow pac ce of rate hike htening cycles suggest that th he US economy is generally ssolid at the time e of the lift-off and a Past tigh that infla ation is trending g up. This time, fundamentals s of the US ecoonomic activity are solid and, in time, sho ould lead to a p pick-up in grow wth and inflation n. Nonethelesss, the current soft inflation and d as alread dy mentioned tthe recent financial stress call for a slow pacce of rate hikes. But there are e other rea asons that sup pport a gradual pace of rate hikes. The markket-implied prob bability of a ratte hike in December D has increased sinc ce the October FOMC meetingg this year, but around a qua arter of investtors still expectt a later rate hike later than December. To aavoid surprises s, communicatio on of a soft path of rate hi kes in Decemb ber may reduce e potential streess in financial markets. er, within the FO OMC, despite the differences s in the timing oof the rate hike e most seem to o Moreove agree on n the slow pace e of rate hikes thereafter. w on the Fed’s s normalizatio on policy Our view We think k that after the lift-off in December, the pace e for rate hikes will be slow. In ndeed, the divergen nce in policies a across central banks and fina ancial tighteninng in the US req quires a cautious approach to ensure tha at the actions do d not result in unnecessary ttensions. We expect e the Fed d policy ra ate (the interestt rate on exces ss reserves or IOER) I to reachh 0.5% in Dece ember 2015. Th hen the next hike will be in June, giving th he Fed a bit mo ore time to asseess the impactt for the US y and thereafte er hikes every other o meeting reaching 1.25% % at year-end 2016. 2 economy

Global Ou utlook – 25 November 2015 2

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