U.S. Economic Review George Boyan, J.D., CFA January 2015 Growth Without Inflation Real GDP for the third quarter registered a gain of 5.0%, the fastest quarterly growth in more than a decade as U.S. consumers and business spent more than previously estimated. The economy has advanced at or above 3.5% for four of the last five quarters with the winter 2014 quarter being the notable exception. Employment gains and lower gasoline prices boost household confidence and buying power and has generated some upside momentum above the 3.0% trend growth entering 2015. Recent employment reports have been similarly strong. November nonfarm payrolls advanced 321k with upward revisions of 44k to the prior two months. Over the last year, nonfarm payrolls have averaged gains of over 220k per month. Meaningful growth in aggregate hours coupled with a rise in hourly earnings implies strong aggregate income gains to the private sector. The unemployment rate held steady at 5.8% as the participation rate remained unchanged at 62.8%. Inflation expectations remain tame, but continue to draw the attention of Fed officials. Over the past year, headline CPI inflation has increased 1.3% while core CPI has climbed 1.7%. As a result, the Fed dialed back their 2015 Core PCE inflation estimates to 1.0%-1.6%, and expect to reach their stated target of 2.0% in 2016. The Fed says that inflation is currently running below their goal partly due to the transitory decline in energy prices, and expects inflation to normalize as the impact of lower oil prices fade. The Fed remains accommodative despite its October announcement to end its Quantitative Easing program. The Fed will continue to reinvest the proceeds from maturities and paydowns which amount to approximately $20 billion per month. The Committee continues to indicate that the Fed Funds rate will not be raised for a “considerable time,” and that the Fed intends to be “patient” in its approach to raising rates. The steady drumbeat of positive economic news gives the Fed increasing comfort with a rate hike in mid-2015. Yet, with oil prices declining and inflation running below the Fed’s 2% mandate, rate increases are expected to be gradual. Domestic and international politics seem to have calmed, paving the way for a positive economic glide path. After the U.S. mid-term election cycle has passed, Washington D.C. is largely off the front page. Additionally, a Federal omnibus budget bill was adopted which removes angst over a government shutdown. On the world stage, the situation in Ukraine has seemingly reached a plateau and rebel gains in Iraq and Syria have slowed. Leaders of emerging market economies, including Russia, are wrestling with slowdowns in their domestic economies, partly due to lower oil prices, and as leadership focuses their attention internally, they are less able to incite tension on the world stage. Page 1 of 3 U.S. Economic Review Equity markets recovered from a negative 10% October swoon, and reached record highs in early November and have continued to rise through the end of the year. The DOW, S&P and NASDAQ returned +8%, +11% and +13% for the year, respectively. Corporate profits are at record highs, and takeovers have become nearly a daily occurrence. Share buybacks and dividend payments also reached a record level in 2014, all of which are supportive of equity valuations. Interest rates on long dated U.S. Treasuries remain stubbornly low and range bound. Ten year U.S. Treasuries have fluctuated between 2.06% and 2.44% during the fourth quarter. However, shorter maturities have broken out to new year-to-date highs with two-year U.S. Treasuries leaping to 0.74%. Three and five year maturities are approaching new highs at 1.17% and 1.76% respectively. But interest rates around the world remain unusually low, most notably in Europe where 10-year German bunds currently yield 0.53%, France at 0.78%, Italy at 1.82%, and Japan at 0.31%. The U.S. 10 year note’s yield advantage over Group of Seven peers was almost at an eight-year high. It was 97 basis points more than the average of its peers, after reaching 101 basis points on December 23rd, the most since November 2006. The U.S. Dollar continues to rally against most major currencies. The Dollar Index rallied 4% QTD and 12% YTD as investors fear a slowdown in Europe, Japan and China. WTI Crude Oil has tumbled to fresh five year lows, down 50% from the June highs. In the short run, this will provide a significant positive tailwind to consumer spending this holiday season, but in the long run, we worry about negative employment pressure, as energy remains a large driver of employment gains in the United States. Nevertheless, lower oil prices are equivalent to a large consumer tax cut which should be an overall positive to U.S. growth. In summary, we are encouraged with recent GDP growth especially without the harmful effects of inflation, and foresee additional positive trajectory as a result of resilient consumer spending in the United States. The Fed remains accommodative, insisting that they will remain patient before increasing the Fed funds rate. Geopolitical event risk seems to have subsided in Eastern Europe and the Middle East, and foreign central banks seem willing to combat any weakness in their respective regions. For these reasons, we remain constructive on the U.S. economy in 2015. George Boyan, J.D., CFA Vice President | Portfolio Manager 564 Fifth Avenue | New York, NY 10036 george.boyan@leumiusa.com Page 2 of 3 U.S. Economic Review Disclaimer Bank Leumi USA (BLUSA) is a subsidiary of Bank Leumi le-Israel, B.M., an Israeli bank founded in 1902. In the U.S., banking products and services are provided through BLUSA, and brokerage products and services are provided by Leumi Investment Services Inc (LISI). LISI is a member of FINRA (www.finra.org) and SIPC (www.sipc.org), and is a wholly-owned subsidiary of BLUSA. 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