Commercial & Vendor
Annual Ozaukee County
Economic Business Luncheon
Watertown: Annual Economic Breakfast
The Extraordinary Among
Art Walk Brings Many to Watertown
Jennifer Mantooth awarded "Ladies who Lead" honor.
Wendy Wright Named Millston
Citizen of the Year
Doherty on Hunting Land Loans
Partnership Bank plans merger with Bank First
Partnership Bank receives Award for Banking Achievements
Bank receives Torch Award for Ethics from BBB
Annual Ozaukee County Economic Business Luncheon
February 26, 2019
Headwinds to Growth: The Fed, Rates, and Consumer Spending
Affect of Consumer Spending on GDP
“GDP is the broadest measure of economic growth. The strongest component for economic growth comes from the consumer; if the consumer is healthy, the economy will be healthy,” said Dimitri Delis, Ph.D., Managing Director, Senior Econometric Strategist for Piper Jaffray Companies at Partnership Bank’s recent Economic Luncheon. “During the last six quarters,” Delis continues, “Personal consumption has averaged 2.57, 2.37…overall, approximately 70% of GDP comes from consumer consumption.” Delis concludes, “as long as consumers keep spending, the U.S. economy will grow.”
“Over the past few years, household wealth (measured by stock holdings + housing) has surged to historically high levels,” he shows. And, the effect on GDP is positive, as the consumer tends to spend more when their household wealth increases.
Heading into 2019, we may see a different story. Wealth and personal spending may decline. Why? Delis suggests that the real affects of Fed rate hikes are typically not seen for approximately 9 months. He notes, “Prior to the 2000 dot-com crisis and 2008 housing crisis, the Fed was raising rates.” In the past 38 months, given the Fed’s rate hikes, the Prime Rate has gone from 3.25% to 5.50%. He concludes, Why may consumer spending now slow? It’s a result of the prior rate hikes. This headwind is now present in the economy and may begin to stifle economic growth.”
Corporate Debt -- Ability to Pay Back?
Corporations are currently carrying historic high levels of debt. Many of those corporations have financed their debt at historically low interest rates. “Currently, their debt is financed at around the 4% level. What happens when the Fed raises rates?” When interest rates rise, loans reprice at much higher rates, making it more expensive to pay off debt.
It is normal for a company to take on debt to purchase equipment and other means to increase production. An increase in production provides more income to pay down debt. Delis sees an uncomfortable trend with companies borrowing money to buy back stock and pay dividends (a.k.a. non-productive uses for money). Borrowing to buy back stock drives a company’s stock prices higher (supply and demand) yet doesn’t add value (ability to make profit).
“Looking at the stock market, we see stock prices moving higher,” Delis points out. Higher stock prices usually indicate financial strength (and a healthy economy). Delis warns that many stocks are overvalued which is giving us a false sense of financial strength. “The problem is, when corporations borrow money for non-productive purposes, how are they going to generate income? How are they going to service that debt? This money was borrowed in a very low rate environment, when Fed funds were at 0 to .25%. The Fed fund rate today is 2.50% or more. Going forward, near the end of 2019 and going into 2020, I see that a lot of corporations who will have trouble repaying debt,” he concluded.
Housing, Unemployment, Inflation
By raising or lowering rates, the Fed tries to keep inflation in check. The main indicators the Fed watches when determining rates are; the rate of inflation, the housing market and unemployment.
Housing: “One of the main components that goes into inflation is housing. Housing represents about 33% of the weight of the CPI (Consumer Price Index) and about 17% of PCE (Personal Consumption Expenditures). Those are big components. Last year home prices increased approximately 6.5%. Our view is that they increase approximately 5% in 2019. Eventually settling at an increase of around 3% in 2020. We don’t expect housing to contribute to inflation,” Delis explained.
Unemployment & Inflation: The Fed maintains that during cycles of low unemployment, wages typically go up. When wages go up, consumer spending goes up which is inflationary. This held true until about 1993. What happened in 1993? Hourly wages went up but personal consumption went down. “Where’s the inflation?” asks Delis. “There is none. The Fed, is using the Philips model…an outdated, broken model…to support their reasoning to adjust rates.”
Delis explains, “Prior to 1994, the U.S. had a closed economy. The Phillips model worked then. Now we have an open economy (globalization). What I mean by an open economy is that goods produced here compete on a price basis with goods produced in China and Brazil. Not only that, jobs are easily transported outside of the U.S. For example, a $100/hour IT job in the U.S. can be exported to India or China for $20/hour. The model the Fed is using is broken - their closed model no longer works in a global economy. If someone could figure out how to measure the world’s unemployment rate and the world’s inflation rate, then the Phillips model would work to forecast inflation in today’s world. Right now it doesn’t work.”
Using the Right Model to Determine Rates?
The Fed uses the Taylor Rule (umemployment minus inflation) to determine rates. Using this rule the Fed concludes that rates need to go up. “The Fed is wrong,” Delis states. Using the “new employment” model (number of people working + plus inflation) shows that the current rate is too high. Delis concludes, “for the economy to not fall apart, rates need to be lowered.”
“So, we have a challenge. Unemployment rates tell the Fed they should raise rates while the “new employment” model tells the Fed to cut rates. In my view, the Fed is not looking solely at the unemployment rate. Their focus is on the stock market and its overvaluation. Hence, they have raised rates to slow down the increase in asset valuations as indicated by the rise of the stock market. The Fed is hoping to deflate this false sense of wealth being created in the stock market.
Copper: A Barometer of Global Economic Growth
Copper is in everything. It’s used to build houses, used in autos…basically in everything. When this metal is in demand, the world is doing well. We can see that the 10 Year Treasury Rate tracks copper. Demand right now supports the argument that rates will be coming down as demand for copper has not risen much since mid 2017. A 3% rate for the 10 Year Treasury is just not sustainable going forward.
Delis doesn’t think the Fed should raise rates. He thinks the Fed will raise rates 2x in 2019, because the stock market is ahead of itself while corporations are seeing no substantive increases in productivity. (remember the stock buybacks and dividends) Looking at the other factors (inflation/employment/housing) there is no justification to raise rates. In addition, all indicators of a strong world economy (copper, oil, etc.) are in decline.
Partnership Bank’s Annual Economic Business Breakfast
Maranatha University, February 13, 2019
The panel discussion focused on economic and community development/redevelopment in Wisconsin. The major headwind businesses are facing is qualified employees.
What Makes Partnership Bank Team Unique video
The criteria behind the Partnership Bank Ordinary People, Extraordinary Citizens program is simple: “When we see extraordinary, we’ll know it.”
This year six organizations/individuals were recognized for their extraordinary efforts to make a difference in the lives of one or many. Recipients are (back row from left): Todd Lemke, Corporate Counsel Lawyer and Craig Dousharm, Engineering Manager with the Mercury Marine Clean Up Project; Marc Mrugala and Jesse Daily for the Thiensville Village Market; Ann Denk, Mentor with the CHS Robotics - Team 3197 - Hexhounds; Lion Dennis Corrigan, for the Cedarburg Community Blood Drive and its 5000th blood donation; (front row from left): Cathy Brunquell, President, Rose Harms Post 355 American Legion Auxiliary in Grafton and Boy Scout Lukas Schmeling for the Pocket Flag Project; and Shirley and Bruce Krenzke for volunteering with many organizations in and around Cedarburg.
Among the stories told was one about the Cedarburg Lions Club’s very successful nine year and running Cedarburg Community Blood Drive and Craig Dousharm and Todd Lemke’s 20 year story behind the $50 million Mercury Marine Cedar Creek clean-up project. Long hours, donut bribes, and the joy that comes when a job is well done and others succeed is the common thread that hold these extraordinary stories and people together.
We all rise by lifting others. Truly the people honored as extraordinary citizens think of themselves as ordinary. But for a few hours, they were coaxed out from the shadows to be applauded at Partnership Bank’s annual event. To read all of the stories click here.