The document discusses the current state of inflation and economic growth in the U.S., indicating that inflation is well below the Federal Reserve's target and the labor market exhibits signs of duality, with stable unemployment but low participation rates. Wage growth remains subdued due to globalization and technological changes, while overall economic growth is modest compared to pre-crisis levels. The Fed is preparing for potential interest rate increases but must navigate emerging market vulnerabilities and the risks of exacerbating disinflationary trends.

1. Rupert Seggins, Marcus Wright
RBS Economics
December 2015

3. Inflation isn’t the phantom menace…it’s just a phantom
3
0%
1%
2%
3%
4%
5%
Jan-05 Jan-08 Jan-11 Jan-14
Inflation expectations for 5-10 years' time
Households Financial markets & finance professionals
Source: Macrobond, Cleveland Fed
• Inflation is well below
the Fed’s 2% target.
Headline inflation has
been affected by
gyrations in energy
prices & dollar
strength, but core has
remained remarkably
stable.
• Expectations are well
anchored. The Fed is
not even close to a
credibility problem.
-2%
0%
2%
4%
6%
2005 2006 2008 2009 2011 2012 2014
PCE inflation
(the Fed's favoured measure)
Source: Macrobond
Headline
Core

4. The labour market is pointing in 2 directions at once
4
• Employment has grown
for an uninterrupted 5
years. Unemployment is
at a level that the Fed
thinks may spark future
inflation.
• But the share of people
either in employment or
looking for work is at its
lowest since the late
1970s.
• This cannot just be
explained by shifting
demographics & the
financial crisis.
50
55
60
65
70
Jan-48 Jan-58 Jan-68 Jan-78 Jan-88 Jan-98 Jan-08
Participation rate - 16 & over (%)
Source: Macrobond
-600,000
-300,000
0
300,000
600,000
Feb-46 Feb-66 Feb-86 Feb-06
US non-farm payroll gains (12 monthaverage)
Source: BLS, NBER
*Shaded bars = periods of recession

5. Wage growth….very far from alarming
• Unit labour costs are
rising, but growth in
wages and salaries
remains low. As in other
developed economies,
globalisation and
technological change are
holding back wage growth.
• Demand-pull inflation
doesn’t look like
appearing anytime soon.
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
Average Hourly Earnings by Industry
(% Y/Y Change, Differenceto 8-year Avg)
Source: Macrobond
-
1.0
2.0
3.0
4.0
5.0
-3
-1
1
3
5
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Unit Labour Costs and Wages
(% Y/Y Change)
UnitLabour Costs
Wages& Salaries,RHS Source: Macrobond

6. And growth isn’t shooting the lights out
• Growth has been
ticking along nicely
compared to recent
years. But it’s modest
compared to the pre-
crisis period.
• Personal consumption
growth is robust, but it’s
cooled a little in recent
months.
0.0
1.0
2.0
3.0
4.0
1995-2007 2003-2007 2012-2015 2015
USGDP Growth
(Annualised Rate, Y/Y Change)
GDP
Personal Spending
Source: Macrobond
-4%
-2%
0%
2%
4%
6%
2005 2007 2009 2011 2013 2015
US - PersonalConsumption
(% Y/Y Change, 3mma)
Personal Consumption
(Exc.Food & Energy)
Source: Macrobond

7. Investment is….meh!
• Fixed investment is a
similar story to spending –
solid but not spectacular.
• Investment in
intellectual property
(around 25% of private
fixed investment) has
remained robust while
commodity related
investment has fallen.
• Durable goods orders – a
leading indicator of
investment – are falling.
• And so has manufacturing
capacity utilisation.
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1995-2007 2003-2007 2012-2014 2015
US Private Fixed Investment
(% Y/Y Growth)
Mining& OilfieldMachinery
Intellectual Property
Total Private FixedInv
Source: Macrobond
65
70
75
80
85
-40
-30
-20
-10
0
10
20
30
2005 2007 2009 2011 2013 2015
Durable Goods Orders and Capacity
Utilisation
Durable Goods Orders,
Y/Y Change, LHS
Capacity Utilisation (%),
RHSSource: Macrobond

8. The global backdrop is hardly great
• The last time the Fed
raised rates, China and the
Eurozone were growing
twice as fast as they are
now. And exports were
consequently booming.
• But now, global growth
is stuck in the slow lane
and exports are falling in
volume terms.
-2%
0%
2%
4%
6%
8%
10%
Past 20 years 2004-2007 2012-2015 Past Six Months
US Exports and World Trade
(Volume, % Y/Y Change)
US Export Volume
World Trade
Source: CPB
-5
0
5
10
15
US Export
Growth
(Volume)
China Growth EZ Growth Global Growth
%Y/YChange
US Rate Rise - The Global Backdrop
Q2 2006 (Last FedRate Rise)
2015
Source: IMF, Macrobond, Bloomberg

9. China slowing and other EM concerns
• China is slowing more
than the headline figures
suggest.
• Its problems are
structural not cyclical so
the slowdown likely has a
lot further left to run.
• Emerging market firms
have been increasing their
leverage. A significant
proportion of that is dollar-
denominated. Higher US
interest rates potentially
spells further trouble.
0
5
10
15
20
1998 2000 2002 2004 2006 2008 2010 2012 2014
EstimatingChina's 'True' Growth
ReportedGDP
GDP'Estimate'
Source: Bloomberg,Macrobond, RBSEconomics
1.0
1.5
2.0
2.5
3.0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Leverage Ratio of Corporations
(Annualised Ratio)
Emerging Economies
Advanced Economies
Source: BIS

10. Easy does it
10
•At the very least the Fed's tightening cycle is going to be
extremely gentle when compared to the past. And it won't take
much at all for tightening to become easing once again.
0%
1%
2%
3%
4%
5%
0 10 20 30 40
Cumulativepercentagepointincrease
Months following 1st rate rise decision
Mar-83
Jan-87
Mar-88
Feb-94
Jun-99
Jun-04
OIS forward curve implied
Source: Macrobond

11. Trying to create some wriggle room
11
•The Fed may be looking to create room to respond to future
slowdowns in growth. Especially given that it feels the
unemployment rate is sufficiently low that higher inflation could be
around the corner.
0%
5%
10%
15%
20%
25%
Feb-71 Feb-81 Feb-91 Feb-01 Feb-11
Recessions Federal Funds Target Rate
-5.00%
-5.50%
-5.25%
Source: Macrobond

12. -10
-5
0
5
10
Debt Service Ratios
- Change since 2008, Private Non-Fin Sector
Source: BIS
Watch out Emerging Markets!
•The Fed has spent much of the year preparing the ground for a rate
rise, aiming not to repeat 2013's taper tantrum. But, it will have to
continue communicating its intent to gradually raise interest rates.
• Otherwise an abrupt tightening of global financial conditions could
occur, an unwanted outcome given concerns over the debt loads in
emerging markets.
Mainly Developed
Economies
Mainly Emerging
Economies

13. Final thoughts
• The US is better placed than other major developed
economies for a rate hike. But it’s not clear that one is needed.
•The risk is that the Fed treads the well-worn path of other
central banks in places such as the Euro Area, Sweden &
Switzerland. Rates rise, disinflationary forces intensify and
rates have to be brought down further than before.
•There is an argument in favour of higher rates to cool asset
price growth and risk-taking. But interest rates are a blunt tool
for this purpose.

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14
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15. 15
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