US economy: Q1 weakness will prove temporary

We reckon that adverse weather conditions have shaved at least one percentage point off real GDP growth in the first quarter. According to the latest Beige Book from the Federal Reserve, nine of the 12 Districts said that weather had impeded hiring, disrupted production and depressed retail and auto sales. Indeed, there were more than 100 references to weather in the Beige Book. That publication has been around since 1996 and the second highest reading is a little above 40. Activity should therefore bounce back; after a meagre estimated 1.7 per cent annualised real GDP growth rate in the first quarter, we have pencilled in a rebound in the second quarter to 3.5 per cent. But since fourth quarter real GDP growth was revised lower, we have also lowered our 2014 annual forecast to 3.1 per cent from 3.3 per cent. The underlying strength in Februarys employment report supports our view that economic weakness in Q1 is weather-related and temporary. While an inventory drawdown may be at play too, not least in the auto sector, the hurdle is high for the Fed to taper the taper. Quite to the contrary, if we get more numbers like the last jobs report, the market may well start pricing in rate hikes in the first half of 2015. While the risks are tilted towards earlier rate hikes, our forecast that rate normalisation will begin in the middle of 2015 is unchanged for now. What we find particularly interesting is that wage growth is showing signs of picking up, thus indicating that the labour market is indeed tightening. Moreover, it is our view that over the past few years the participation rate has fallen mostly due to demographic factors. As such, the unemployment rate is a good indicator of labour market health. The unemployment rate will continue to a decent 5.4 per cent at the end of 2015, which is well below most estimates of the non-accelerating inflation rate of unemployment (NAIRU). Our headline inflation forecast has been revised half a percentage point higher compared to the February edition of Nordic Outlook based on higher natural gas and food prices. Core inflation is not affected much by these changes but will nevertheless reach 2 per cent in 2015 as an annual average.

MONDAY MARCH 14, 2014 Mattias Brur SEB Economic Research +46 8 763 85 06

Key data

2012 2013 2014 2015 GDP, percentage change Unemployment, % Inflation, % YoY Core inflation, % YoY
Source: SEB

2.8 8.1 2.1 2.1

1.9 7.4 1.5 1.8

3.1 6.4 1.8 1.7

3.7 5.7 1.9 2.0

Economic Insights

SEVERAL FACTORS UNDERPINNING A REVIVAL IN CONSUMER SPENDING While consumer confidence indicators have not been affected so much by bad weather in recent months, retail sales and auto sales, for example, have been harder hit. As such, durable goods consumption has weakened considerably over the past few months. On the other hand, service spending is running stronger, driven by higher utilities and health care spending. Real consumer spending growth will thus be running at around a 2.5 per cent year-onyear rate in the first quarter, unchanged compared to the fourth quarter. Looking ahead, the case for stronger consumer spending is compelling. For example, household net worth expanded by USD 10 trillion last year and is at a record high, households are borrowing more and leveraging in the household sector is at its lowest level in 14 years. Moreover, the job market is improving and average hourly earnings are trending upward. As such, we forecast an uptick in consumer spending in the second quarter and subsequent quarters to 3 per cent or above. We also see stronger business investment ahead. Stronger capital spending usually follows in the wake of stronger consumption growth. Capacity utilisation rates are back at levels consistent with around 10 per real capital spending growth rates while core capital expenditure (CAPEX) goods shipments are tracking business spending growth of around 7 per cent in the first quarter. The average age of factories and machinery is 22 years, which is the highest such figure since the late 1950s. Moreover profit margins are high while credit availability is improving and business investment as a percentage of GDP is still low, which is suggesting a considerable upside. After weak CAPEX growth in 2013 we see business investment growth accelerating to 8.5 per cent in 2014 and 11 per cent in 2015.

Economic Insights

THE DELEVERAGING CYCLE HAS RUN ITS COURSE Net worth of US households increased almost USD 3 trillion in the fourth quarter of 2013, to USD 80.6 trillion. This is close to USD 12 trillion above the pre-crisis peak in 2007. As a percentage of disposable income, net worth rose to 639 per cent in the fourth quarter from 618 per cent in the third quarter. According to this metric, net worth is still below the pre-crisis high of 660 per cent, however. Household deleveraging appears to be yesterdays story; households have increasing their borrowings for three consecutive quarters. Looking at the details, consumer credit is the driving force behind the upswing while home mortgages are lagging behind. Despite adding more debt to the balance sheet, the household debt to income ratio is remaining relatively flat since the income side is improving too. Furthermore, household debt as a percentage of net worth which is an indicator of how leveraged households are is at 16.2 per cent,the lowest reading since 2000.

Economic Insights

STILL STRONG HOUSING FUNDAMENTALS After a long string of quarterly increases since 2010, residential investment fell by almost 9 per cent in Q4 last year. Housing starts, meanwhile, increased 55 per cent at an annualised rate in Q4 2013 thus suggesting that a rebound in residential construction spending lies around the corner when weather effects have faded away. According to the Beige Book, most areas attributed the slower pace of improvement to unusually severe winter weather. The housing market index plunged in February but that can be attributed to brutal winter weather too. Indeed fundamentals generally suggest that housing will rebound again, notwithstanding the downdraft in mortgage applications. Housing inventories are tight by historical standards and household formation is running well above the current level of housing starts. Looking at the 25-34 age group, which includes many first-time buyers, it is evident that the underlying demographic demand is large and growing rapidly. Our forecast is for housing starts to rise to 1.5 million in 2015 and real residential investment to grow by around 10 per cent annually in 2014-1015. Home prices increased 11.3 per cent year-on-year in the fourth quarter according to the Case-Shiller price index: the most since 2005. Despite these strong price gains, affordability remains high by historical standards. We still expect home price gains of 8 and 6 per cent in 2014-2015.

Economic Insights

THE LABOUR MARKET: WAGES ARE RISING The underlying strength in Februarys employment report convinces us that the economic weakness since the turn of the year is mostly weather-related, and thus temporary. More than 600,000 people were unable to work due to the weather in February, which is double the norm. Moreover, nearly 7 million worked part-time rather than full-time due to weather; only once before have we seen a higher number. Looking ahead, the March jobs report may well be strong, not least since initial jobless claims are down to a three-month low. The unemployment rate, at 6.7 per cent, is still above the Feds 6.5 per cent threshold but not by much, and will likely slide through that barrier soon. According to the Chicago Fed it only takes job growth of more than about 80,000 jobs per month to put downward pressure on the unemployment rate. That is significantly lower than the pre-crisis norm. The unemployment rate will reach 6 per cent as early as the end of 2014, according to our forecast. Moreover, in our assessment the unemployment rate is a good barometer of labour market health since at least 80 per cent of the drop in the participation rate over the past few years can be explained by people moving into retirement. While the discouraged worker effect was an important driver five years ago, that is not the case today. Basically what the unemployment rate is suggesting is that the labour market is tightening relatively rapidly which the wage data are finally beginning to respond to. Compared to a year earlier, average hourly earnings rose by 2.5 per cent in February, compared to 2.3 per cent in each of the prior four months. Wage growth is the canary in the coalmine when deciding how much spare capacity is left in the labour market. It is our view that spare capacity is lower than commonly acknowledged.

Economic Insights

FED POLICY: TIME TO REVAMP FORWARD GUIDANCE

Federal Reserve ChairJanet Yellen, in her testimony before Congress a few weeks ago, said that the recent choppy and sloppy economic data was explained by bad weather for the most part. If that assumption is correct, economic weakness is temporary and monetary policy will be unaffected. The Feds monthly asset purchase program will almost certainly be reduced by another USD 10 billion to USD 55 billion at the March 18-19 Federal Open Market Committee meeting. If the economy accelerates in Q2 and Q3, speculations of a quicker reduction in asset purchases may well increase too. While tapering is not necessarily on a pre-set course, the bar for altering the path is high. As such, the Fed will continue to taper its bond purchases by USD 10 billion at each policy meeting during 2014, according to our forecast. With the unemployment rate fast approaching 6.5 per cent the FOMC must revamp its forward guidance, probably as early as at the March 18-19 FOMC meeting. According to the most recent set of minutes, however, what form the new forward guidance might take was uncertain. Some favoured lowering the threshold while others preferred a qualitative approach that would provide additional information about the factors the FOMC finds important in the decision. Aside from a broader range of labour market indicators, several participants wanted risks to financial stability to appear more explicitly among the list of factors. Others wanted a greater emphasis on willingness to keep interest rates low if inflation were to persistently remain below the 2 per cent target. According to our forecast, headline inflation will reach 2.3 per cent late this year but will fall again somewhat in 2015. According to the latest FOMC forecasts from December last year, the central tendency for Personal Consumption Expenditure (PCE) inflation is 1.4 to 1.6 for 2016, which is looking a little bit low now. Inflation expectations, according to the 5-year, 5-year forward break-even, are trending somewhat lower compared to right after the Fed decision to begin scaling down asset purchases last December. When the tapering process is done in the fourth quarter of 2014, the stage is set for monetary policy normalisation to begin, at the earliest in the first half of 2015. The last key rate hike was in 2006 a long time ago and there is a risk that the Fed will stay accommodative for too long. Historical experience shows that the Fed has previously been caught unaware by rising inflation during similar stages of the business cycle. In 2003, too, the deflation risk was regarded as dominant, yet inflation took off and interest rates were raised sharply as early as the following year. In 1993 there were also few observers who thought that the rate hiking cycle would begin by the following year. If real GDP expands 3 per cent or more in 2014-2015, then the US economy may well begin to strain scarce supply-side resources, especially since the unemployment rate already is suggesting that the labour market is tightening rapidly. We fail to see how labour cost inflation stays low in this environment. As such, the first hike may come a little bit earlier than in our current forecast of mid-year 2015. In December 2015 the federal funds rate will stand at 1.25 per cent, according to our forecast, which is much more aggressive compared to current market pricing. While the unemployment rate is still above most estimates of NAIRU (the labour market gap is positive) some would argue that short-term unemployment is a better predictor of future wage inflation. In previous cycles the distinction has not been important, since the unemployment rate and the short-term unemployment rate have not diverged much, but that is hardly the case in the current cycle. While the short-term unemployment rate indicates little or no slack in the labour market, other metrics such as the employment rate have not improved at all since the recovery began.

Norway: Subtle signs of firmer momentum

Theres no mistaking the slower growth rate in the Norwegian economy since 2012, but momentum regained some lost speed last Q4 as sequential growth in mainland GDP i.e. excluding oil/gas and shipping was the best in more than a year. The just-released report from Norges Banks regional network suggests stable though continued below-trend growth in early 2014 and a slight acceleration ahead. The outlook continues to be marked by strong crosscurrents. First, investment growth in oil and gas extraction is downshifting markedly from 18% in 2013 to 4% in 2014 on our forecast, and will thus lend only modest demand impulses to the rest of the economy. While not deflating the effect, one shouldnt over-emphasise it either: according to calculations by Statistics Norway of the direct and indirect effects, approx. one tenth of aggregate growth in mainland GDP from 2002 to 2012 can be attributed to oil sector investment. On another negative note, we expect weaker residential investment this year and next. At the same time, non-petroleum exports should gain speed. Foreign orders have thus rebounded strongly according to the manufacturing Business Tendency Survey, spurred by accelerating activity at main exports markets and improved competitiveness due to the sharp NOK depreciation since early 2013. In addition, growth in private consumption should pick up somewhat in 2014 (though still trailing the pace in 2010-12). Meanwhile, declining existing home prices from last spring to late autumn fuelled fears of an imminent steep plunge, and was seen as a - if not the major downside risk to the economic outlook. However, demand shows surprising resilience, and sustained turnover has helped stabilising prices in recent months. Its too early to sound all clear, but our forecast for a 34% decline in prices on average in 2014 might prove too pessimistic.

THURSDAY 20 MARCH 2014

Stein Bruun SEB Norway +47 21 00 85 34 Erica Blomgren SEB Trading Strategy +47 22 82 72 77

The full-year forecast for growth in mainland GDP is nudged lower to 2.1% for 2014 due
to back-revisions leaving less of a carry-over effect from 2013 and slightly softer-thanexpected private consumption in Q1, and to 2.4% for 2015.

Recent developments suggest few forecast revisions in Norges Banks MPR due March 27, and the bank should repeat its intention to keep rates on hold in 2014. We expect the rate hike cycle to start in spring 2015, somewhat earlier than indicated by the banks rate path.
Markedly stronger orders should fuel non-oil exports
Year-on-year percentage change, index

15 12 9 6 3 0 -3 -6 -9 -12 05 06 07 08 09 10 11 12 13 Exports of non-oil goods, volume (LHS) Manufacturing survey actual export orders, 2Q earlier (RHS)

Key data Percentage change

64 58 52 46 40 34 28

2012 2013 2014 2015 GDP Mainland GDP Unemployment* Inflation Core inflation
* Per cent of labour force Source: Statistics Norway, SEB

2.9 3.4 3.2 0.8 1.2

0.6 2.0 3.5 2.1 1.6

2.0 2.1 3.7 1.9 2.1

1.9 2.4 3.7 2.0 2.1

Source: Statistics Norway

Economic Insights

DEMAND AND PRODUCTION Growth momentum has been rather soft over the past year, and the evidence from Norges Banks regional network, covering the supply-side of the equation, suggests more of the same in the near term although aggregate output expectations are slightly firmer. Suppliers to petroleum sector continue to see moderation in tandem with slower investment growth, while other manufacturers and service providers expect firmer activity in the near term. One exception is retail sales which only have managed to stabilise recently. Note, though, that growth in spending on services and abroad, which together makes up slightly more than half of overall consumption, is healthy enough. Consumer confidence has continued to slip, but the level is consistent with only slightly below-trend growth in spending and thus a pick-up. The outlook for households real disposable income suggests as much. The recent oil sector investment survey, based on projections from operators at the Norwegian continental shelf, was reassuring as the 2014-level is put at a new record high. Nonetheless, annual growth will slow sharply and is bound the affect production of investment goods which has been surging in recent years. However, manufacturers have on aggregate lifted their production expectations due to very solid gains in export orders during H2/13 which was the strongest in 6-7 years as measured by the manufacturing Business Tendency Survey.
Norges Bank network sees a slight acceleration
Year-on-year percentage change, index

Momentum in retail sales still soft in early 2014

Percentage change

8 6 4 2 0 -2 -4 05 11 12 06 07 08 09 10 Mainland GDP (LHS) Regional network output indicator (RHS) 13 14

4 3 2 1 0 -1 -2

12 8 4 0 -4 -8 05 06 07 08 09 10 11 12 Real retail sales excl. autos, year-on-year (LHS) 3 mth. average from 3 mth. earlier (RHS) 13

3 2 1 0 -1 -2

Source: Norges Bank, Statistics Norway

Source: Statistics Norway

Short-term trend in manufacturing likely to turn up

Percentage change

as suggested by firmer expectations

Year-on-year percentage change, index

20 16 12 8 4 0 -4 -8 -12 05 06 07 10 11 12 08 09 Manufacturing production, year-on-year (LHS) 3 mth. average from 3 mth. earlier (RHS) 13

5 4 3 2 1 0 -1 -2 -3

12 9 6 3 0 -3 -6 -9 -12 05 06 07 08 09 10 11 12 Manufacturing production, 3 mth. average (LHS) Production expectations, 2Q earlier (RHS) 13

66 62 58 54 50 46 42 38

Source: Statistics Norway

Source: Statistics Norway

Housing starts are heading lower

No in 1.000

Record high oil sector investment, more modest growth

NOK bn

37 34 31 28 25 22 19 16 04 05 06 07 08 09 10 11 12 13 Approved housing starts in 1.000, 12 mth. aggregate Housing completions, 12 mth aggregate

37 34 31 28 25 22 19 16

240 220 200 180 160 140 120 100 80 60 40

240 220 200 180 160 140 120 100 80 60 40 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Actual and planned investment oil/gas extraction and pipelines

Source: Statistics Norway

Source: Statistics Norway

Economic Insights

LABOUR MARKET AND INFLATION Unemployment started trending higher in late-2012 in tandem with softer momentum in the broader economy. At the same time and somewhat surprising, employment growth as measured by the Labour Force Survey has reaccelerated since mid-2013. The fact that LFS unemployment has ticked up recently is thus due to an outsized gain in the labour force which is volatile and occasionally erratic. Meanwhile, registered unemployment the measure favoured by Norges Bank has stabilised in recent months. We still expect unemployment to show a marginal increase in 2014 on either measure with the LFS unemployment rate inching up from 3.5% to 3.7%. Core CPI inflation has shifted markedly higher since last spring with the year-on-year rate on the ex.-taxes and energy measure at 2.4% in January and February, the highest in four years except for a spike last August. The uptrend has been broad-based with prices for domestically-produced goods accelerating fast and prices for imported goods turning from being a constant drag to rising as NOK depreciation during 2013 has filtered though. While the currency effect on imported inflation has yet to be exhausted, core domestic inflation has levelled out in recent months as rents (a fifth of the core CPI basket) seem to have peaked. As such, core inflation should moderate going forward although the full-year forecast for core inflation is nudged up to 2.1% due to the high starting point.
Employment growth is holding up
3-month average

while unemployment measures diverge somewhat

No in 1.000

5 4 3 2 1 0 -1 -2 05 09 10 11 12 06 07 08 Employment, % change year-on-year (LHS) LFS unemployment rate (LHS) 13

5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0

130 115 100 85 70 55 40 05 06 11 12 13 07 08 09 10 LFS unemployment, 3 mth. average Registered unemployed and employment schemes

130 115 100 85 70 55 40

Source: Statistics Norway

Source: Statistics Norway

Core inflation has shifted upwards

Year-on-year percentage change

on higher domestic and imported inflation

Year-on-year percentage change

7 6 5 4 3 2 1 0 -1 06 07 08 09 Consumer prices 10 11 12 13 CPI excl. taxes and energy

7 6 5 4 3 2 1 0 -1

6 5 4 3 2 1 0 -1 -2

6 5 4 3 2 1 0 -1 -2 06 07 08 09 10 11 12 13 Core CPI domestic goods and services Core CPI imported goods
Source: Statistics Norway, SEB

Source: Statistics Norway

Goods prices have turned sharply, rents peaking

Year-on-year percentage change

Existing home prices shows subtle signs of stabilising

Percentage change

7 6 5 4 3 2 1 0 -1 06 07 08 09 Core CPI domestic goods 10 11 Rents 12

7 6 5 4 3 2 1 0 -1 13 Core CPI services

24 18 12 6 0 -6 -12 05 06 07 08 09 10 Existing home prices, year-on-year (LHS) 11

6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 12 13 From 3 mth. earlier (RHS)
Source: Nef, Eiendomsverdi

Source: Statistics Norway, SEB

Economic Insights

MONETARY POLICY AND FINANCIAL CONDITIONS Economic developments so far this year have largely been consistent with Norges Banks expectations of stable and soft growth in mainland GDP for this year and indicators are in line with what the central bank sees in terms of momentum in H1 as well. If anything, the large uncertainty surrounding the banks forecasts at the time has been reduced. Hence, there is little suggesting any substantial forecast revisions in the upcoming March 27 MPR. The bank should thus stick to its message that the key rate will remain on hold until next summer. The December path implied one or two rate hikes in the course of 2015, and the new rate path should confirm this view. However, any possible revision beyond that is likely dovish as long-term interest rates abroad have declined since late 2013. We continue to expect the rate hike cycle to commence somewhat earlier than signalled by Norges Bank. Uncertainty regarding the housing market and growth will gradually recede in the course of the year and core inflation (although volatile) will remain close to the target. Consequently, the bank should attain a tightening bias in late 2014 followed by a rate hike early next year. Our forecast of a 2.00% and 2.75% key rate by end 2015/2016 remains above markets expectations.
Norges Bank has continued to lower its rate path
Per cent

A very elevated spread versus Bunds

Weekly average

7 6 5 4 3 2 1 0 06 07 08 09 10 11 Norges Bank deposit rate Optimal rate path, MPR 3/13 12

7 6 5 4 3 2 1 0 13 14 15 16 Optimal rate path, MPR 4/13

Source: Norges Bank

7 6 5 4 3 2 1 0 07 08 09 10 11 12 NOK 10-year government bond yield, % (LHS) Spread vs. Bunds, basis points (RHS) 13

150 125 100 75 50 25 0

Source: Reuters, SEB

Sharp depreciating trend has come to a halt

Weekly average

NOK index back at Norges Banks trajectory

Weekly average

10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 07 08 09 EUR/NOK (LHS) 10 11 12 USD/NOK (RHS) 13

8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5

Source: Reuters, SEB

106 102 98 94 90 86 82 07 08 09 10 11 NOK import-weighted NOK assumption MPR 3/13 12

106 102 98 94 90 86 82 14 15 13 NOK assumption MPR 4/13

Source: Norges Bank, SEB

Credit growth has slowed recently

Year-on-year percentage change
24 21 18 15 12 9 6 3 0 -3 05 06 07 08 09 10 11 12 13 Domestic credit growth Credit to non-financial companies Credit to households
Source: Statistics Norway

Banks eased credit standards to households last Q4

Change in credit standards, net balance
24 21 18 15 12 9 6 3 0 -3

40 30 20 10 0 -10 -20 -30 -40 -50 -60 2008 2009 2010 2011 2012 2013 Households Non-financial businesses

40 30 20 10 0 -10 -20 -30 -40 -50 -60

Source: Norges Bank