fed up fed war room slides
TRANSCRIPT
HiddenLevers War Room
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Market Update
Commodities Gains Stick
Home Prices Taking a Breather Chinese Economy Pooped
Markets Back in Black for 2014
Macro Snapshot
Are home prices about to shift down with rates, or vice-versa? Commodities are rebounding, but copper (global indicator) is weak. Unemployment and CPI A-OK.
Fed 2014 – Consensus is Over
Fed’s Lockhart: Expect a 2015 Rate Hike19Feb
Fed’s Fisher:No Rethinking Pace of Taper14Feb
Yellen inherits fractious Fed, minutes show19Feb
Fed’s Plosser: Taper Process Might Need To Be Quicker14Feb
Yellen stresses continued low-rate policy19Feb
Fed 2014 – View on Inflation
LOL – Fed worried about unemployment going to low:tight labor market = people get paid more = inflationary
Inflation in check
dollar stable
Inflation should be higher as growth is higher
Right now – softer spending + production
Low inflation = Fed can maintain stimulus
Focus on Core inflation, not short term commodities hijinks
No inflationary pressure from tech sector doing well
Core CPI
sources: HiddenLevers
Fed 2014 – View on Unemployment
sources: HiddenLevers, Fortune
already irrelevant to
retail
expect volatility on days when
data comes out
youth unemployment
20%(still rising)
headline number not a good snapshot
labor market is increasingly
complex
Unemployment Lever is losing relevancy
Fed – no more focus on top line unemployment for policy stance
Don’t bank on previous Fed statements about 6.5% threshold
Also losing relevancy in 2014
marijuana prohibitions
celebrities in advertising
Fed 2014 – View on Taper
source: BusinessInsider, Kiplinger, MarketWatch
Depending on market reaction, rates may rise at a measured .05% per QE reduction, or at a more anxious .1% per step
10b/month trimming in place until April/May at least
Given current trajectory, taper will finish by Q4 2014 (Goldman forecast)
Given disagreement rising at the Fed, tread carefully.
Fed 2014 – View on Interest Rates
FOMC Dec 2013 projections:
• 1 year until first rate hike
• 3 years until 2% fed rate.
2013 projection of 2015 rate hike still holds.
Economists’ median forecast is rate hike in March 2015.
source: Fed Reserve Bank SF, KKR
End of QE ---> rate hike3-6 months of lag likely
Inflation is good, but not too much
commodities 2014 rise = inflation? too early
Fed Up Fed – Recap
unemployment top line = irrelevant
Fed Stress Tests Overview
source: Federal Reserve
“The … Dodd-Frank Act (DFA) stress tests are regulatory tools the Federal Reserve uses to ensure that financial institutions have … adequate capital.”
Three scenarios released every Nov: • Baseline (Good)• Adverse (Bad)• Severely Adverse (Ugly)
2013 versus 2014 differences: • Equity downside risk much greater• Risk on = Loftier valuations • Baseline 10y yield forecast raised
Fed Stress Tests 2014: Baseline Scenario
source: Federal Reserve, HiddenLevers
Economic growth largely
unchanged
S&P up 10% from current
levels
10y rates up 120bp by Q1 2016
Q4 2016 rose 4% 4.4% YoY
Fed Stress Tests 2014: Adverse Scenario
Economy in slight recession
10y rates up almost 300bp by
Q1 2016
S&P drop raised-25% -34%
StagflationNot
Deflation
End of QE - Update
CPI lowerunemployment lower no stagflation
source: HiddenLevers
Goodbye Outlier Scenarios
Bond Exodus now priced in
Rates have risen, but so have markets
HL was wrong Bond Exodus based off
1994 bond crash
10y yields coming in
PIMCO dire straits: 2013 bond exodus, 2014 El-Erian exodus
10y yields
Scenario: End of QENot SureEasy Money,
No Hangover
GoodEconomy
Back on Track
BadDeflation
Strikes Back
Inflation needs to be monitored. We will introduce a runaway inflation scenario if needed. For now, it is imprudent re QE
We are back on track:10y target = 3%S&P target = 1900 Scenario priced in
Taper just began, and commodities spiking due to weather – deflation is paused
Winners + Losers (for the coming rate hike)
Losers• Intermediate + long bond funds• Mortgage REITs, BDCs, utilities
Winners• Individual bonds + bond ladders• Hold to maturity in HiddenLevers
Summer 2013bond funds sensitive to rates
source: HiddenLevers
HiddenLevers Use Cases
scenarioRising Interest
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scenarioFed Stress Tests
scenarioEnd of QE
Fed up Fed
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Product Update