Global economic game changers for 2015 and beyond

© 2014 CME Group. All rights reserved.

Global Economic Game-Changers for 2015 and Beyond

Blu Putnam, Chief Economist

September 2014

1 © 2014 CME Group. All rights reserved.


Investment advice is neither given nor intended

The research views

expressed herein are

those of the author

and do not necessarily

represent the views of

CME Group or its

affiliates.

All examples in this

presentation are

hypothetical

interpretations of

situations and are

used for explanation

purposes only.

This report and the

information herein

should not be

considered

investment advice or

the results of actual

market experience.



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nor swaps trading are

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and each involves the risk

of loss. Swaps trading

should only be undertaken

by investors who are

Eligible Contract

Participants (ECPs) within

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1a(18) of the Commodity

Exchange Act.

Futures and swaps each

are leveraged investments

and, because only a

percentage of a contract’s

value is required to trade,

it is possible to lose more

than the amount of

money deposited for

either a futures or swaps

position.

Therefore, traders should

only use funds that they

can afford to lose without

affecting their lifestyles

and only a portion of

those funds should be

devoted to any one trade

because traders cannot

expect to profit on every

trade.



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Global Economic Game-Changers

for 2015 and Beyond

1. A Fed rate-rise decision on the horizon

2. Corporate earnings, M&A, and US equities

3. ECB bank stress tests and asset purchases

4. Gold: Fed, Inflation, China, India

5. U.S. natural gas production/consumption

6. El Niño, Droughts, and Agricultural Markets



Scenarios for Fed decision to raise rates

and possible bond market reactions

Scenario #1 – US labor

markets continue to improve

while core inflation only

creeps very slowly higher.

Fed pushes short-term rates

higher in 1H/2015. Since no

inflation pressure, the yield

curve flattens. (60%)

Scenario #2 – US labor

markets continue to improve

and core inflation rises above

2% year over year rate, and

inflation expectations rise for

the years ahead. Fed pushes

short-term rates higher

sooner rather than later.

With some inflation

pressure, the Fed is

perceived as being behind

the game, and the yield

curve rises in parallel across

the maturity spectrum.

(30%)

Scenario #3 – Global

economy hits a rough patch

and slows US growth. The

Fed stays on hold. US

Treasuries may rally and

yields move lower. (10%)



US unemployment rate projected to

decrease to 5.5% by Mid-2015

0%

3%

6%

9%

12%

Perc

enta

ge

Source: St. Louis Federal Reserve Bank FRED Database (UNRATE)

US Unemployment Rate

The last time the unemployment rate went above 10% (1982), it took 5 years to get back below 6%. -- the same time path the economy is currently following.



Inflation path is key to bond market

reaction to a Fed rate rise decision

0%

1%

2%

3%

4%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015Year

-ove

r-Ye

ar P

erce

nt C

hang

e

Source: Data from St. Louis Federal Reserve, Projections by CME Economics.

US Core Inflation Scenarios



Scenarios for US equity markets

Scenario #1 – US economy

continues to improve, but with

no inflation pressure, no

pricing power for corporation,

so earnings growth decelerates.

S&P500 suffers a 10%

correction but ends up on the

year. (60%)

Scenario #2 – M&A activity

and solid US economy propel

S&P500 Index to new highs,

up 15% or more on the year,

give or take. (30%)

Scenario #3 – US economy

hits a rough patch, (possibly

due to international causes) and

equities swoon, for a 20% bear

market downturn. (10%)



Earnings levels experienced a quick

recovery from the recession …

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

2003 2005 2007 2009 2011 2013 2015

US$

Bill

ions

, Ann

ual R

ate

Source: St. Louis Federal Reserve (CP).

US Corporate Profits (After Tax, GDP Basis)



… However, the growth rate of earnings is

decelerating


-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Perc

enta

ge ch

ange

, Tra

iling

12

mon

ths

com

pare

d to

one

yea

r ago

.

Source: St. Louis Federal Reserve (CP).

US Corporate Profits (After Tax, GDP Basis)


FX Markets, more than most, historically

embraced the “trend is my friend”

The lack of persistent and

strong trends in major FX

markets since September

2008 is directly related to

the zero rates from the US

Fed, ECB, Bank of

England, and Bank of

Japan. Until rate policies

diverge among the big

four central banks,

persistent trends in those

key currency pairs are

unlikely.

A consequence of the lack

of persistent price

momentum has been

reduced trading profits at

prop shops, FX funds, and

bank trading units

focusing on FX markets.

A number of formerly very

large FX desks and shops

have closed their doors.

The lack of meaningful

short-term interest rate

differentials among the

big four currencies has led

to an increase in political

or policy statement event

risk causing very

temporary price shocks.

Event risk environments

may favor options trading

over futures.



Scenarios for new dynamics in FX depend

heavily on central bank divergence

Scenario #1 – US and UK

economies perform well

enough to lead to

expectations of rate rises in

2015, while Euro-Zone and

Japan hit economic rough

patches. USD (and GBP

depending on Scottish vote)

outperform EUR and JPY.

(60%)

Scenario #2 – Creeping

inflation in the US and UK

versus deflation fears in

Europe and Japan magnify

country differences. (30%)

Scenario #3 – US, UK, Euro-

Zone, and Japan all

disappoint on economic

growth. Zero rates remain in

all countries. No trends, not

much volatility. (10%)



UK & US improving Growth, Japan and

Euro-Zone still struggling

-2%

0%

2%

4%

2011 2012 2013 2014

Annu

al A

vera

ge R

eal G

DP G

row

th R

ate

Source: Data from Bloomberg Professional,Projections from CME Economics.

Real GDP Scenarios

UK

US

Japan

Euro-Zone



US Fed ends quantitative easing in

Q4/2014, then comes the rate decision

$0

$1

$2

$3

$4

US$

Tril

lions

Source: Federal Reserve Bank of St. Louis FRED Database

Federal Reserve Assets

Other

MBS

UST 10+ Years

US Treasuries Less Than 10-Years



Bank of Japan remains committed to

massive government bond purchases

0

50,000

100,000

150,000

200,000

250,000

300,000

1997 1999 2001 2003 2005 2007 2009 2011 2013

Billi

ons o

f Jap

anes

e Ye

n

Source: Bank of Japan (www.boj.or.jp)

Bank of Japan Assets

Japanese Government Securities

LoansOther



Alone -- ECB balance sheet has shrunk …

but asset-backed purchases are coming


0

500

1,000

1,500

2,000

2,500

3,000

3,500

2000 2002 2004 2006 2008 2010 2012 2014

Euro

Bill

ions

Source: European Central Bank Monthly Bulletins

European Central Bank Assets


Yen fell 20% with Abe’s Election, then

hardly moved, but possibly falling again


75

85

95

105

115

125

Dec-

2007

Jun-

2008

Dec-

2008

Jun-

2009

Dec-

2009

Jun-

2010

Dec-

2010

Jun-

2011

Dec-

2011

Jun-

2012

Dec-

2012

Jun-

2013

Dec-

2013

Jun-

2014

Dec-

2014

JPY

per U

SD

Source: Bloomberg Professional (JPY)

Japanese Yen per US Dollar

Prime Minister Abe Wins Election and Promises Monetary Expansion Policy


Euro regained ground after the debt crisis

eased, but is now weakening.


1.10

1.20

1.30

1.40

US

Dolla

rs p

er E

uro

Source: Bloomberg Professional (EUR)

Euro

ECB vows to do whatever it takes to preserve the single currency.

Threat of deflation in EU, no growth, worry over bank stress tests, more ECB stimulus vs possibility of a US rate-rise in 2015.


Scenarios for oil and natural gas diverge

Scenario #1 – Natural gas

prices develop a long-term,

slow yet definitive upward trend

based on rising consumption

and deceleration of production

boom, while crude oil bounces

around in a narrow range.

(50%)

Scenario #2 – No definitive

trends in either natural gas or

crude oil develop. (35%)

Scenario #3 – More

unexpected negative surprises

from geo-politics or a total

shutdown of Iraqi oil sends

crude oil surging higher –

toward $125 per barrel. (15%)



US crude oil production is booming


0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

U.S.

Fie

ld P

rodu

ctio

n of

Cru

de O

il(T

hous

and

Barr

els p

er M

onth

)

Source: US Energy Information Administration,Sourcekey MCRFPUS1.

US Crude Oil Production


US refined petroleum consumption is

declining with transportation efficiencies


0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

1982 1986 1990 1994 1998 2002 2006 2010 2014U.S.

Pro

duct

Sup

plie

d of

Pet

role

um P

rodu

cts

(Tho

usan

d Ba

rrel

s per

Mon

th)

Source: US Energy Information Administration,Sourcekey = MTTUPUS1.

US Oil and Petroleum Product Consumption


More exports and less imports have

helped reconnect US oil to global markets

0

100,000,000

200,000,000

300,000,000

400,000,000

500,000,000

1981 1985 1989 1993 1997 2001 2005 2009 2013

Barr

els o

f Pet

role

um P

rodu

cts P

er M

onth

Source: US Energy Information Administration,Sourcekeys MTTIMUS1 (Imports) and MTTEXUS1 (Exports).

US Oil Petroleum Products:Imports and Exports

Imports

Exports



Rising consumption, decelerating production

= possible new natural gas price dynamics

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

1949 1957 1965 1973 1981 1989 1997 2005 2013

MM

cf

Source: US Energy Information Administration, Sourcekeys N9140US2 (Consumption) and N9010US2 (Withdrawals).

US Natural Gas Production & Consumption

Production

Consumption



Near-term production growth depends on

expansion in the Marcellus field


0

4,000,000

8,000,000

12,000,000

16,000,000

1998 2000 2002 2004 2006 2008 2010 2012

MM

cf a

t Ann

ual R

ate

Source: US Energy Information Administration,Natural Gas Gross Withdrawals by State.

Regions of Expanding Natural Gas Production

Texas, Oklahoma, Louisianna, Arkansas, New Mexico

Pennsylvania, Ohio, New York, West Virginia

Bakken


US natural gas production … the declining

regions are important, too


0

2,000,000

4,000,000

6,000,000

1998 2000 2002 2004 2006 2008 2010 2012

MM

cf a

t Ann

ual R

ate

Source: US Energy Information Administration,Natural Gas Gross Withdrawals by State.

Regions of Declining Natural Gas Production

Offshore Gulf of Mexico

Wyoming & Colorado

Alaska

Sum of Other Smaller Regions


Energy (BTU) price gap


0

100,000

200,000

300,000

400,000

500,000

600,000

2002 2004 2006 2008 2010 2012 2014

BTU

s of E

nerg

y pe

r 1 U

S Do

llar

Source: Bloomberg Professional for prices (USCRWTIC, NGUSHHUB), CME Economics Research for BTU conversion.

BTUs per US$1 by US Energy Source

WTI Oil

Natural Gas


Scenarios for metals depend on inflation

and global growth

Scenario #1 – No meaningful

inflation pressure in the major

countries and no financial

disasters. US economy

improves enough for Fed to

tighten. Gold has another price

break toward $900 - $1000 per

ounce. (60%)

Scenario #2 – Some US

inflation pressure develops.

Fed is seen as behind the

game. India grows faster and

lowers tariffs on gold. China

buying increases. Gold rises

to $1500+. (30%)

Scenario #3 – US and other

economies hit a rough patch

and fears of deflation return.

Gold has another price break

toward $600 - $900 per ounce.

(10%)



Gold has become range bound without

inflation fears or financial panic

1000

1200

1400

1600

1800

2000

US$

Spo

t Pric

e of

Gol

d

Source: Bloomberg Professional (GOLDS)

Gold



Scenarios for agriculture are weather

dependent and not based on economics

Scenario #1 – El Niño returns.

Too much rain in Brazil and

Argentina. Drought in India

and Australia. US impact

delayed. Milder winter and

good rain in the US corn belt.

Storms in California in latter

stages of El Niño. Benign US

hurricane season. Agriculture

prices may go higher based on

droughts outside the US.

(25%)

Scenario #2 – Drought in

California and

Texas/Oklahoma continues

through summer into fall and

winter, pushing livestock

prices higher, as well as US

food inflation. But abundant

harvests of corn and wheat

depress grain prices. (60%)

Scenario #3 – CA, TX, and

OK drought ends. Mild or no

El Niño. Corn belt gets good

rain. Abundant crops lead

agriculture prices lower (15%)



Summer warming trends in equatorial

Pacific (Possible El Niño) in June 2014 ….

Source: National Oceanic and Atmospheric Administration (NOAA).

http://polar.ncep.noaa.gov/sst/ophi/



Have weakened (as of September 2014),

decreasing chances of an El Niño event.

Source: National Oceanic and Atmospheric Administration (NOAA).

http://polar.ncep.noaa.gov/sst/ophi/



Some possible El Niño effects

Scenario #1 – By 2015,

warmer waters in the

Equatorial Pacific may drift

northward and bring severe

spring weather to California,

ending drought but not without

potentially high costs from

storm damage.

Scenario #2 – Australia and

India may experience higher

probability of drought. More

rain in Brazil and Argentina.

Scenario #3 – Milder winters

in southern Canada and US,

fewer hurricanes for the US,

among other things.



US drought in California, and Texas /

Oklahoma likely to raise retail food prices

Source: University of Nebraska, US Drought Monitor.



Global Economic Game-Changers

for 2015 and Beyond

1. A Fed rate-rise decision on the horizon

2. Corporate earnings, M&A, and US equities

3. ECB bank stress tests and asset purchases

4. Gold: Fed, Inflation, China, India

5. U.S. natural gas production/consumption

6. El Niño, Droughts, and Agricultural Markets



Thank you


Economy & Finance

Global economic game changers for 2015 and beyond