This document discusses the possibility of more hawkish Federal Reserve leadership and policy in the near future ("New Fed Hawks"). It notes that two to three more interest rate hikes by the Fed could potentially invert the yield curve, which has preceded past recessions. The document also questions the rationale for raising rates given low inflation. Overall, it examines scenarios around more aggressive rate hikes by the Fed and the implications for economic growth and financial markets.

1. New Fed Hawks
25 April 2018
War Room

2. War Room
Idea Generation
Macro Coaching
Scenario Updates
HiddenLevers runs on SCENARIOS like Instagram runs on PHOTOS

3. The Skinny
Yield Curve + Business Cycles
Fed Fatigue
Scenario: New Fed Hawks
New Fed Hawks
UPDATE

4. HiddenLevers
THE SKINNY

5. New Fed Hawks – Why Ripe?
New Fed Leadership
Trump Tax Plan Priced In
Business Cycle
in
Extra Innings
10y at 3.00
2819

6. New Fed Hawks – Let’s take a Look
See it on HiddenLevers

7. Time Lag = 1y
Between
Yield Curve
Inversion +
Recession
New Fed Hawks – Take-aways
2-3 more hikes inverts yield curve
Stuck here on GDP Without
Population Growth
Why are We
Raising Rates
If No
Inflation?

8. HiddenLevers
YIELD CURVE + BUSINESS CYCLES

9. CYCLES: Rate Hikes v Business Cycle
sources: HiddenLevers, St. Louis Fed 1, St. Louis Fed 2, New York Federal Reserve
Fed Mandate
minimize unemployment – 4%
create stable inflation – 2%.
Rate hikes happen when inflation shows up
This time, rate hikes with no inflation in sight

10. CYCLES: Business Cycle Twilight Zone
sources: HiddenLevers, ValueWalk, StocksForBeginners, Washington Post
-Average recovery: 58 months
-Current recovery: 106 months
-Current GDP expansion slowest since
WWII
Stock sectors are
leading indicators
for different parts of
the business cycle

11. CYCLES: Yield Curve 101
sources: SF Federal Reserve, HiddenLevers
“Every U.S. recession in the past 60 years
was preceded by a negative term spread,
that is, an inverted yield curve.”
– SF Fed Researchers
Yield-Curve inversion preceded major
S&P 500 drops associated with past 3
recessions.
Treasury Term Spread and Recessions S&P 500 vs 2/10 Treasury Spread

12. CYCLES: Yield Curve Inversion History
sources: HiddenLevers, Bloomberg
Start of Inverted
Yield Curve
Start of Market
Correction
Lag Time
(Months)
S&P 500
Drawdown
Sept 1980 Nov 1980 3 -27%
Dec 1988 July 1990 20 -20%
Feb 2000 March 2000 2 -49%
June 2006 Oct 2007 17 -57%
Yield
Inversions
Market
Corrections
0%
Spread:
Inversion

13. HiddenLevers
FED FATIGUE

14. FED: Too Late in Cycle to Get to Old Normal
sources: HiddenLevers, Bloomberg
Bottom in unemployment
signals end of bull
Unemployment could be
signaling final phase of bull
market, very near early 2000’s
all-time low
Federal Reserve
Consensus fed funds
end 2018: 2.25%
10y must keep rising to
prevent inversion

15. FED: Each Recovery Weaker Than Last One
sources: HiddenLevers, Calculated Risk
Market gains from
2009-2014/15 due to
Fed juicing:
no economic benefit, but
huge market win
Post-2008 job recovery =
longest period of time to recover in last 100 years
But labor participation stabilized after 2015
Market gains without much labor recovery

16. FED: Economic Gains vs Market Gains
Sources: HiddenLevers, Yardeni Research, CNN Money
Do such weak
economic gains
support such
parabolic asset
price gains?
Nope
Recovery
Avg Annual
GDP Growth
Total
GDP Growth
Total
S&P Move
2009 - 2018 2% 27.5% +300%
2001 - 2007 2.7% 15.6% +85%
1991 - 2000 3.9% 45.9% +300%
1982 - 1990 4.8% 38.9% +117%
1990s Expansion
same S&P gain
2x the GDP gain

17. FED: Diminished Expectations on GDP
Sources: HiddenLevers, Multpl 1, Multpl 2, CNN Money, Population Pyramid
Average annual GDP growth higher
Population growth with big gains ahead
USA much larger population today
Now only averaging .7% population growth
Year
Avg Annual GDP
Growth
Avg Annual Pop
Growth
Per-Capita GDP
2009 - 2018 2% 0.73% 1.3%
2001 - 2007 2.7% 0.93% 1.8%
1991 - 2000 3.9% 1.22% 2.7%
1982 - 1990 4.8% 0.93% 3.9%

18. HiddenLevers
SCENARIO: NEW FED HAWKS
UPDATE

19. SCENARIO UPDATE: New Fed, Hawkish Tone
Sources: HiddenLevers, Brookings, Bizfluent, Washington Post
Old Normal reappearing since mid 2016:
High correlation between 10y treasuries + GDP growth
New Fed Hawks

20. BAD
GOOD
SCENARIO: New Fed Hawks
S&P 500
-%
US GDP
-.5%
S&P 500
+12
US GDP
3.1%
S&P 500
-20%
US GDP
2.5%
1987
Crash Repeat
UGLY
Inverted
2/10 Yields
10y RATE
3%
10y RATE
3.25%
10y RATE
3.5%
Old Normal
10y
GDP

21. New Fed Hawks – Let’s take a Look
See it on HiddenLevers

22. Time Lag = 1y
Between
Yield Curve
Inversion +
Recession
New Fed Hawks – Take-aways
2-3 more hikes inverts yield curve
Stuck here on GDP Without
Population Growth
Why are We
Raising Rates
If No
Inflation?