Moving On Up – Today’s Economic Environment Prese… · Flattening Yield Curve (10-Yr vs. 3-Mo)...

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Moving On Up –Today’s Economic Environment

Gray Lepley, Senior Analyst, Portfolio StrategiesPresented by PFM Asset Management LLC

November 8, 2018

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Today’s Agenda

U.S. ECONOMY

MONETARY POLICY

GEOPOLITICAL FACTORS

INTEREST RATES

FIXED INCOME MARKETS

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Current Economic Conditions

Source: Bloomberg, latest data available as of 10/30/18. SAAR is seasonally adjusted annualized rate.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Sep '13 Sep '14 Sep '15 Sep '16 Sep '17 Sep '18

Inflation Measures(YoY)

Core CPI

Core PCE

Fed's Long Term Inflation Target

40

60

80

100

120

140

160


Consumer Confidence

7.2%

5.9%

5.0% 5.0%

4.2%3.7%

3%

4%

5%

6%

7%

8%


Unemployment Rate

3.1%

-2%

0%

2%

4%

6%

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

2014 2015 2016 2017 2018

U.S. Real GDP(QoQ, SAAR)

Rolling 4-QuarterAverage

3.5%

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5.1% 4.9%

2.3%2.2%

4.2%3.5%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q

U.S. GDP Contributors and DetractorsPersonal Consumption Fixed Investment Private InventoriesImports Exports Government Expenditures

2Q and 3Q GDP Grew at Fastest Pace Since 2014

Source: Bureau of Economic Analysis, as of October 2018. 3rd quarter contributions are based on the first GDP growth estimate.2014 2015 2016 2017 2018

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0

50

100

150

200

250

300

350

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Oct '16 Apr '17 Oct '17 Apr '18 Oct '18

Yiel

d

Flattening Yield Curve (10-Yr vs. 3-Mo)Spread 3-Month 10-Year

What We’re Watching…

Source: Bloomberg, yield spreads from ICE BofAML Indices, as of 10/29/18. Implied Fed Rate Hike Probability, as of 10/30/2018.

Metrics At or Near Multi-Year Bests

U.S. GDP (2018Q3) Unemployment Rate

Consumer Confidence Job Openings

Consumer Sentiment Avg. Hourly Earnings

U.S. Manufacturing Inflation (Core PCE)

505560657075808590

Oct '17 Jan '18 Apr '18 Jul '18 Oct '18

Bas

is P

oint

s

1-5 Year Corporate Spreads

Market Implied Fed Rate Hike Probability Economic Indicators are Strong

Spreads widened on a stock

market correction and concerns

about growth in Europe.

Target Rate

Flattest curvesince 2007: 78 bps

Recently, spreads have widen, amid

lackluster corporate earnings, Italy’s

budget, and U.S. – China trade tensions.

0%

20%

40%

60%

80%

100%

Dec '18 Mar '19 Jun '19 Sep '19

Impl

ied

Prob

abili

ty

Fed Meeting Dates

3.25-3.5%

3-3.25%

2.75-3%

2.5-2.75%

2.25-2.5%

2-2.5%

1

11 1

2

22

33

4

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The Fed: Dual Mandate or Dueling Mandate?

PRICE STABILITY

MAXIMUM EMPLOYMENT

FED

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Strong Labor Market Persists as Unemployment Rate Hits 49-Year Low

Source: Bloomberg, as of September 2018.

0k

100k

200k

300k

400k


Monthly Change in Nonfarm Payrolls

Nonfarm Payrolls 12-Month Moving Average

7.2%

5.9%

5.0% 5.0%

4.2%

3.7%

3%

4%

5%

6%

7%

8%


Unemployment Rate

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U.S. Employers Struggle to Find Qualified Workers

Source: Bloomberg, as of 8/31/18.

0.8

1.0

1.2

1.4

1.6

1.8

Aug '06 Aug '08 Aug '10 Aug '12 Aug '14 Aug '16 Aug '18

Ratio of Hires to Job Openings

2

4

6

8

10

12

14

16

Aug '06 Aug '08 Aug '10 Aug '12 Aug '14 Aug '16 Aug '18

Mill

ions

Job Openings vs. Unemployed Workers

Job Openings Unemployed

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Differences Between Inflation Indicators

CPIImport Prices

measures

PPI PCE

compositionGoods Food Energy ServicesGoods Food Energy Services Goods Food Energy Services Goods Food Energy Services

Price of goods or services purchased from abroad by U.S. residents

Selling prices received by domestic producers of goods and services

Prices paid by urban consumers for a market basket of goods and services

Prices paid for goods and services purchased by or on behalf of persons

release

MonthlyBefore the 15th of the month1-month lag



MonthlyEnd of month1-month lag

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Core Inflation Hits the Fed’s 2% Target

Source: Bloomberg, latest data available as of September 2018. Inflation expectations based on yield difference between 5-year Treasury note and 5-year Treasury Inflation Protected Securities (TIPS).

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%


Inflation Measures(YoY)

Core CPI

Core PCE

Fed's Long Term Inflation Target

0.5%

1.0%

1.5%

2.0%

2.5%


Expectations for Average InflationRate over Next 5 Years

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0%

1%

2%

3%

4%

3% 4% 5% 6% 7% 8% 9% 10%

current

Q4 ‘09

Q4 ‘10

Q4 ‘11

Q4 ‘12Q4 ‘13Q4 ‘14

Q4 ‘15

Q4 ‘16

Q4 ‘17

Has the Fed Achieved Its Dual Mandate?

Source: Federal Reserve Bank of Chicago, as of 9/26/18.

Cor

e PC

E In

flatio

n

Unemployment Rate

Fed’s long-term projection for unemployment rate

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FOMC’s September “Dot Plot” Projects One More Rate Hike in 2018

Source: Federal Reserve and Bloomberg. Individual dots represent each Fed members’ judgement of the midpoint of the appropriate target range for the federal funds rate at each year-end. Fed funds futures as of 9/26/18.

0%

1%

2%

3%

4%

5%

Fed Participants’ Assessments of ‘Appropriate’ Monetary Policy

Sept-18 FOMC Projections

Sept-18 Median

Fed Funds Futures

2018 2019 2020 Longer Term

Fed expects 1 more rate hike in 2018 & maintained

future projections

History of RecentFed Rate Hikes

Sept ‘18 2.00 – 2.25%

Jun ’18 1.75 – 2.00%

Mar ‘18 1.50 - 1.75%

Dec ‘17 1.25 - 1.50%

Jun ’17 1.00 - 1.25%

Mar ’17 0.75 - 1.00%

Dec ’16 0.50 - 0.75%

Dec ’15 0.25 - 0.50%

2021

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Divergence of Central Banks


-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

Jan '15 Jul '15 Jan '16 Jul '16 Jan '17 Jul '17 Jan '18 Jul '18

Central Bank Policy RatesFed Target Rate ECB Target Rate BOJ Target Rate Bank of England Target Rate

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Key changes to the proposed agreement include:

• Requires a larger portion of auto parts come from a high wage factory paying a minimum of $16/hour in salaries to production workers. This provision will likely force automakers to shift suppliers from Mexico to Canada or the U.S.

• Requires Canada to allow more dairyimports into their country as well as ends a program in which they assist Canadian sellers of dairy products domestically and abroad.

Source: Census Bureau data includes YTD figures as of August 2018.

USMCA: the Renegotiated NAFTA

$0 $100 $200 $300 $400 $500

ChinaCanadaMexicoJapan

GermanySouth Korea

United KingdomFrance

IndiaItaly

TaiwanBrazil

NetherlandsIreland

Switzerland

Top 15 Trading PartnersTotal YTD Trade ($ billions)

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Geopolitical Risks Around the Globe

North Korea tensions

South China Sea dispute

Russia-NATO conflictBrexit, Italy’s budget, and EU

fragmentation

Iran sanctions

U.S.- Mexico border tensions

U.S.-China trade tensions

Venezuela political crisis

Turkey currency crisis

Argentina currency crisis

U.S. mid-term elections

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IMF Outlook For Lower Global Growth

Source: IMF October 2018 Update. 2016 and 2017 rates represent actual growth; 2018 and 2019 rates are projections.

0%

2%

4%

6%

8%

United States Euro Area Japan China Emerging Market andDevelopingEconomies

World GDP Projections

2016 2017 2018 2019

- 0.2%- 0.4%- 0.1%

- 0.1%

- 0.2%- 0.4%

- 0.2%

Downward revisions from projections in April

(Actual) (Projected)

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2,550

2,600

2,650

2,700

2,750

2,800

2,850

2,900

2,950

Dec '17 Jan '18 Feb '18 Mar '18 Apr '18 May '18 Jun '18 Jul '18 Aug '18 Sep '18

Year-to-Date Change

Volatility Re-Enters the Market; S&P Down over Year


2017 close -0.6% YTD

High: +9.6% YTD

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U.S. Yield Curve Has Flattened

Tenor Current9/29/18

Year-End12/31/2017

Year-End12/31/16

3 month 2.30% 1.38% 0.45%

6 month 2.46% 1.53% 0.61%

1 year 2.63% 1.73% 0.82%

2 year 2.82% 1.88% 1.21%

3 year 2.87% 1.97% 1.47%

5 year 2.92% 2.21% 1.95%

10 year 3.08% 2.41% 2.48% 0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

3M

1Y

2Y

3Y

4Y

5Y

10Y

Yiel

d

Maturity

October 29, 2018

December 29, 2017

December 30, 2016

U.S. Treasury Yield Curve

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Spread Between 10-Year and 2-Year Treasuries Tight


0

50

100

150

200

250

300

350

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18

Yiel

d

Spread 2-Year 10-Year

Current: 28bps

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0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

-3%

-2%

-1%

0%

1%

2%

3%

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018

Recession

yield curve inverts

Yield Curve Inversions Historically Precede Recessions

Spread Between 10-Year and 2-Year Treasury Yields

worth watching


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What Does the Flattening of the Yield Curve Mean?

Source: LPL Research, FactSet.

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Where Are We in the Economic Cycle?

Different Indicators Give Differing Views

Source (left): Wall Street Journal; Deutsche Bank (as of July 2018). Source (right): Conference Board (as of October 2018).

The Conference Board Leading Economic Index Continues to Rise

Supports the continuing solid growth in the economy

Suggests no recession in the near-term

70

80

90

100

110

120

'98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18

The Conference Board Leading Economic Index (LEI) for the U.S.

The Conference Board Coincident Economic Index (CEI) for the U.S.

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Short-Term Credit Spreads Have Widened Due to Volatility

Source: Bloomberg, PFMAM Trading Desk, as of 10/29/18. Not a specific recommendation. 6-mo CP yield spread based on A1/P1 rated CP index.

2.00%

2.20%

2.40%

2.60%

2.80%

3.00%

3.20%

1 2 3 4 5 6 7 8 9 10 11 12Maturity in Months

Money Market Yield Curves

CD/CP Average

Agencies

Treasuries

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

0.60%

Oct '17 Dec '17 Feb '18 Apr '18 Jun '18 Aug '18 Oct '18

Yield Spread of 6-month Commercial Paper over T-Bill

+25 bps

12-Month Low: +10 bps

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Short-Term Treasuries Compensate Investors for Multiple Hikes in 2019

2.00%

2.10%

2.20%

2.30%

2.40%

2.50%

2.60%

2.70%

1 month 3 month 6 month 9 month 12 month

Treasury Yield Estimated Average Overnight Repo Yield

Source: Bloomberg, as of October 29, 2018. Average overnight repo yield assumes an initial repo rate of 2.13% and 25 basis point (0.25%) interest rate hikes in December of 2018 and March, June, and September of 2019; it is calculated by determining the average resulting yield over each time horizon.

+5 bps

+9 bps

+9 bps

+9 bps

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Federal Agency Spreads Remain Tight

Source: Bloomberg as of 10/29/2018.

-0.05%

0.00%

0.05%

0.10%

0.15%

1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0Years to Maturity

Federal Agency Yield SpreadsAgency 10/29/18 Agency 12 Mos Max

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-39 basis points

(“bps”)

+22 bps

2018Q1 2018Q2 +2

bps

2017

Source: Bloomberg, ICE BofA Merrill Lynch Indices, as of 10/29/2018.

Volatility in Corporate Securities

2018Q3 -10 bps

2018Q4

+9 bps

50

60

70

80

90

100

Dec '16 Feb '17 Apr '17 Jun '17 Aug '17 Oct '17 Dec '17 Feb '18 Apr '18 Jun '18 Aug '18 Oct '18

Bas

is P

oint

s

Yield Spread (OAS) of 1-5 Year Investment Grade Corporate Index

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Yield Environment as of October 29, 2018

Source: Bloomberg BVAL yield curves for Treasury and Corporate. TradeWeb for Federal Agency yields. 3 and 6 month corporate yields from commercial paper; A-1+ for AA and A-1 for A. Yields are for indicative purposes only; actual yields may vary by issue.

Maturity Treasury FederalAgency AA Corporate A Corporate

3-Month 2.31% 2.29% 2.45% 2.43%

6-Month 2.46% 2.42% 2.66% 2.71%

1-Year 2.63% 2.63% 2.83% 2.98%

2-Year 2.82% 2.87% 3.12% 3.26%

3-Year 2.87% 2.96% 3.24% 3.41%

5-Year 2.92% 3.07% 3.45% 3.60%

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Q3 Sector Returns Favor Spread Products

Source: ICE BofAML Indices. MBS and ABS indices are 0-5 year, based on weighted average life. As of 9/30/18.

0.04%

0.25%

0.66%

0.10%

0.55%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

U.S

. Tre

asur

y

Age

ncy

Cor

pora

te(A

-AA

A)

MB

S

AB

S (A

AA

)

2018 Q3 1-5 Year Sector Returns

0.49%0.19%

-0.16%-0.37%

-0.79%

-2.81%-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

0-1

Yea

rs

1-3

Yea

rs

3-5

Yea

rs

5-7

Yea

rs

7-10

Yea

rs

10+

Yea

rs

2018 Q3 Treasury Returns

Age

ncy

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Sector Returns over Time

Source: ICE BofA Merrill Lynch Indices. MBS index is 0-5 year, based on weighted average life. As of 9/30/2018. Returns greater than 1-year are annualized.

1-5 Year Treasuries

5-Year Return 1-Year Return3-Year Return

0.73%0.93%

1.75%

1.51%

1.22%

0.17%0.35%

1.47%

0.44%

0.73%

-0.58%

0.03% 0.06%

-0.82%

0.97%

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

U.S

. Tre

asur

y

Age

ncy

Cor

p (A

-AA

A)

Age

ncy

MB

S

AB

S (A

AA

)

U.S

. Tre

asur

y

Age

ncy

Cor

p (A

-AA

A)

Age

ncy

MB

S

AB

S (A

AA

)

U.S

. Tre

asur

y

Age

ncy

Cor

p (A

-AA

A)

Age

ncy

MB

S

AB

S (A

AA

)

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100%

50%

40%

25%

15%

15%

50%

50%

40%

40%

30%

25%

25%

25%

10%

10%

10%

10%

10%

10% 10%

Treasury Agency Corp A-AAA Mortgage-BackedSecurities

Supranationals Asset-BackedSecurities

Return Benefits of Diversification

Example portfolio returns are based on the ICE BofA Merrill Lynch 1-5 Year indices for all sectors except for Supranational which uses the 1-5 Year index and are annualized for trailing periods longer than one year. Source: ICE BofA Merrill Lynch Indices, as of 9/30/18.

0.65%

0.75%

0.82%

1.19%

1.29%

1.35%

0.73%

0.83%

0.86%

1.09%

1.17%

1.20%

1

2

3

4

5

6

5-Year Returns 2017 Returns

Example 1-5 Year PortfolioSector Allocation

Portfolio Return

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-2%

0%

2%

4%

6%

8%

10%

12%

Sep '95 Sep '97 Sep '99 Sep '01 Sep '03 Sep '05 Sep '07 Sep '09 Sep '11 Sep '13 Sep '15 Sep '17

1-5 Year Treasury Index Total Return 18 Month Moving Average S&P LGIP 7 Day

Total Return During Tightening Periods


Fed tightening

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Total Return vs. Yield During Tightening Periods

Source: Bloomberg, as of 8/31/18. Includes the 1-5 Year Treasury Index Total Return 18-month MA and the 5 Year Treasury Index Yield.

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%


1-5 Year Treasury Index Total Return 18-month MA 5 Year Treasury Index Yield

Fed tightening

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$10

$15

$20

$25

$30

$35


Mill

ions

1-3 Year Treasury Index Total Return 18 Month Moving Average 1-5 Year Treasury Index Total Return 18 Month Moving Average

1-10 Year Treasury Index Total Return 18 Month Moving Average S&P LGIP 7 Day

Long-Term Benefit of Longer Duration Investment Strategies


Fed tightening

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Disclosures

This material is based on information obtained from sources generally believed to be reliable and available to the public, however PFM Asset

Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not

intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are

based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events

occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past

performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to

purchase or sell any securities.

PFM is the marketing name for a group of affiliated companies providing a range of services. All services are provided through separate

agreements with each company. Investment advisory services are provided by PFM Asset Management LLC, which is registered with the

Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. The information contained is not an offer to purchase or

sell any securities. Financial advisory services are provided by PFM Financial Advisors LLC and Public Financial Management, Inc. Both are

registered municipal advisors with the SEC and the Municipal Securities Rulemaking Board (MSRB) under the Dodd-Frank Act of 2010.

Applicable regulatory information is available upon request. For more information regarding PFM’s services or entities, please visit

www.pfm.com.

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