Fed's first rate hike may not be far away but jobs and higher inflation are key, says Swiss Re Chief Economist, Kurt Karl
Article information and share options
After today’s decision by the Federal Reserve to maintain the target Fed funds rate at zero to 25 basis points, Swiss Re’s Chief Economist, Kurt Karl, believes that the Fed's first rate hike will be primarily dependent on incoming inflation, wage and jobs data.
Karl says: "The key data series to follow for forecasting the first Fed rate hike are core Personal Consumer Expenditure (PCE) inflation, wages and employment. The pace of improvement in these data suggest that the first rate hike is not far in the future."
The Fed's target for core PCE inflation, which excludes food and energy prices, is 2%, and though it was only 1.5% in August, this was up from 1.2% at the beginning of the year. On the wage side, wages for production and non-supervisory workers has risen to 2.3% from its low point of 1.3% in 2012. On jobs, employment growth accelerated to 1.9% in September, up from 1.6% in February. This has been pushing down the unemployment rate, which reached 5.9% in September, down from 7.2% a year ago.
Karl says: "The Fed can still afford to wait, core inflation is below target and wage gains are only pushing up inflation very slowly. However, if real GDP growth strengthens next year, these indicators should all accelerate and the Fed will need to move more quickly than the market is currently expecting."
The unemployment rate is declining rapidly with real GDP growth just over 2%, so 3.5% growth should lower it to 5% and even 4% rapidly, particularly if the potential workers who have not been participating in the labor force remain on the sidelines. Currently, real GDP growth is still expected to be 3.5% next year, based on employment growth fueling consumption and housing starts. The yield on the 10-year Treasury note is projected to be at 2.6% by end-2014 and 3.5% by end-2015.
Economic growth indicators for the Euro area have edged towards stagnation. Meanwhile, headline inflation fell to 0.3% in September, mostly due to energy price weakness. However, core inflation also declined to 0.8%.
Karl adds: "With growth weak and inflation declining, the ECB is increasingly likely to adopt a public Quantitative Easing policy in early 2015."
In Europe, a rate hike is unlikely until 2017. The European Central Bank's (ECB) policy will also be data dependent, but the economic prospects are much weaker. With the global economy facing divergent central bank policies, the US dollar and the UK pound are likely to become relatively strong. The relative weakness of the euro will help growth in the Euro area, but probably not be enough to quickly change monetary policy. Also, the low interest rates in Europe will constrain an upward movement in long-term US and UK yields, complicating their monetary policies.
Karl says: "After strong growth in the first half of the year, the UK manufacturing PMI declined to 51.6 from 52.5, while the services sector PMI declined to 58.7. The indicators for 3Q remain consistent with our growth outlook of 3.0% for this year and 2.5% next."
The latest economic data for China point to softer economic activity, partially from a deepening of the housing market correction. The government continues its targeted easing policy to support growth, with the People's Bank of China (PBoC) providing additional liquidity to banks and lowering down payment requirements and mortgage rates. Nevertheless, real GDP growth is now expected to be only 7.1% in 2015 – down from 7.4% last month – while it is still expected to be 7.4% this year.
Karl concludes: "Japan has weakened sufficiently for Prime Minister Shinzo Abe to review the upcoming sales tax hike. Without structural reforms, the Japanese economy is unlikely to have a robust expansion. This year it will grow by1.5%, while next year it will slow to 1.2% assuming Abe hikes the consumption tax."
The Swiss Re Group is a leading wholesale provider of reinsurance, insurance and other insurance-based forms of risk transfer. Dealing direct and working through brokers, its global client base consists of insurance companies, mid-to-large-sized corporations and public sector clients. From standard products to tailor-made coverage across all lines of business, Swiss Re deploys its capital strength, expertise and innovation power to enable the risk-taking upon which enterprise and progress in society depend. Founded in Zurich, Switzerland, in 1863, Swiss Re serves clients through a network of over 60 offices globally and is rated "AA-" by Standard & Poor's, "Aa3" by Moody's and "A+" by A.M. Best. Registered shares in the Swiss Re Group holding company, Swiss Re Ltd, are listed in accordance with the Main Standard on the SIX Swiss Exchange and trade under the symbol SREN. For more information about Swiss Re Group, please visit: www.swissre.com or follow us on Twitter @SwissRe.
For logos and photography of Swiss Re executives, directors or offices go to www.swissre.com/media
For media 'b-roll' please send an e-mail to [email protected]
Cautionary note on forward-looking statements
Certain statements and illustrations contained herein are forward-looking. These statements (including as to plans, objectives, targets, and trends) and illustrations provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to a historical fact or current fact.
Forward-looking statements typically are identified by words or phrases such as “anticipate”, “assume”, “believe”, “continue”, “estimate”, “expect”, “foresee”, “intend”, “may increase”, “may fluctuate” and similar expressions, or by future or conditional verbs such as “will”, “should”, “would” and “could”. These forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the Group’s actual results of operations, financial condition, solvency ratios, liquidity position or prospects to be materially different from any future results of operations, financial condition, solvency ratios, liquidity position or prospects expressed or implied by such statements. Such factors include, among others:
- instability affecting the global financial system and developments related thereto;
- deterioration in global economic conditions;
- the Group’s ability to maintain sufficient liquidity and access to capital markets, including sufficient liquidity to cover potential recapture of reinsurance agreements, early calls of debt or debt-like arrangements and collateral calls due to actual or perceived deterioration of the Group’s financial strength or otherwise;
- the effect of market conditions, including the global equity and credit markets, and the level and volatility of equity prices, interest rates, credit spreads, currency values and other market indices, on the Group’s investment assets;
- changes in the Group’s investment result as a result of changes in its investment policy or the changed composition of its investment assets, and the impact of the timing of any such changes relative to changes in market conditions;
- uncertainties in valuing credit default swaps and other credit-related instruments;
- possible inability to realise amounts on sales of securities on the Group’s balance sheet equivalent to their mark-to-market values recorded for accounting purposes;
- the outcome of tax audits, the ability to realise tax loss carryforwards and the ability to realise deferred tax assets (including by reason of the mix of earnings in a jurisdiction or deemed change of control), which could negatively impact future earnings;
- the possibility that the Group’s hedging arrangements may not be effective;
- the lowering or loss of one of the financial strength or other ratings of one or more Swiss Re companies, and developments adversely affecting the Group’s ability to achieve improved ratings;
- the cyclicality of the reinsurance industry;
- uncertainties in estimating reserves;
- uncertainties in estimating future claims for purposes of financial reporting, particularly with respect to large natural catastrophes, as significant uncertainties may be involved in estimating losses from such events and preliminary estimates may be subject to change as new information becomes available;
- the frequency, severity and development of insured claim events;
- acts of terrorism and acts of war;
- mortality, morbidity and longevity experience;
- policy renewal and lapse rates;
- extraordinary events affecting the Group’s clients and other counterparties, such as bankruptcies, liquidations and other credit-related events;
- current, pending and future legislation and regulation affecting the Group or its ceding companies and the interpretation of legislation or regulations;
- legal actions or regulatory investigations or actions, including those in respect of industry requirements or business conduct rules of general applicability;
- changes in accounting standards;
- significant investments, acquisitions or dispositions, and any delays, unexpected costs or other issues experienced in connection with any such transactions;
- changing levels of competition; and
- operational factors, including the efficacy of risk management and other internal procedures in managing the foregoing risks.
These factors are not exhaustive. The Group operates in a continually changing environment and new risks emerge continually. Readers are cautioned not to place undue reliance on forward-looking statements. Swiss Re undertakes no obligation to publicly revise or update any forward-looking statements, whether as a result of new information, future events or otherwise.
This communication is not intended to be a recommendation to buy, sell or hold securities and does not constitute an offer for the sale of, or the solicitation of an offer to buy, securities in any jurisdiction, including the United States. Any such offer will only be made by means of a prospectus or offering memorandum, and in compliance with applicable securities laws.