John silvia brexit

Economics and Finance in a Two-Percent Economy John E. Silvia, Chief Economist July 2016

Where Are We Now?

Interest Rates

Inflation

Growth

Five benchmarks for good decision making

Profits

Source:

Wells Fargo Economic Outlook

2

The Dollar

Sustained Growth in 2016—Great Divide Between Domestic and Trade

U.S. Real GDP Bars = CAGR

Line = Yr/Yr Percent Change

10%

10% GDP - CAGR: Q1 @ 1.1%

8%

GDP - Yr/Yr Percent Change: Q1 @ 2.1%

6%

6% Forecast

4%

Trend growth at 1.5-2 percent in the year ahead. Consumer and housing lead, but exports will remain a drag.

4%

2%

2%

0%

0%

-2%

-2%

-4%

-4%

-6%

-6%

-8%

-8%

-10% 2000

-10% 2002

2004

2006

2008

2010

Source: U.S. Department of Commerce and Wells Fargo Securities

Wells Fargo Economic Outlook

8%

3

2012

2014

2016

Recession in 2016?

Recession Probability Based on Probit Model Model with LEI

120%

120% Two-Quarter Ahead Recession Probability: Q2 @ 10.4%

Threshold: Two-Consecutive Quarters > 50% 100%

The probability of recession in the next six months is very low, according to our model

100%

80%

80%

60%

60%

40%

40%

20%

20%

0%

0% 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

Source: Wells Fargo Securities

Wells Fargo Economic Outlook

4

Inflation: Rising—But Less Than Market/FOMC Expect

PCE Deflator vs. Core PCE Deflator Year-over-Year Percent Change

5%

Inflation remains historically low, but we expect to see a pickup in coming quarters – average less than 2% since 1991

5%

4%

4%

3%

3%

2%

2%

1%

1%

0%

0%

-1%

-1%

PCE Deflator: May @ 0.9% "Core" PCE Deflator: May @ 1.6% FOMC's 2.0% Inflation Target

-2%

-2% 92

94

96

98

00

02

04

06

Source: U.S. Department of Commerce and Wells Fargo Securities

Wells Fargo Economic Outlook

5

08

10

12

14

16

Inflation: A Divide in Goods vs. Services

Core Goods vs. Core Services CPI Year-over-Year Percent Change

7%

7% Core Services CPI: May @ 3.2%

6%

Inflation for services has been much firmer than for commodities

6%

Core Goods CPI: May @ -0.5%

5%

5%

4%

4%

3%

3%

2%

2%

1%

1%

0%

0%

-1%

-1%

-2%

-2%

-3%

-3% 88

90

92

94

96

98

00

02

Source: U.S. Department of Labor and Wells Fargo Securities

Wells Fargo Economic Outlook

6

04

06

08

10

12

14

16

Inflation Expectations

Med. Inflation Expectations 5 to 10-Years Ahead U. of Mich. Consumer Sentiment, Breakeven Rate of Inflation, 3-MMA

3.8%

3.8% Median Inflation Expect. For 5-10 Yrs: Jun @ 2.4% Fed 5-Year Five Years Forward: Jun @ 1.6%

Long-term inflation expectations have fallen alongside oil, keeping some FOMC members worried about the future path of inflation

3.4%

3.4%

3.0%

3.0%

2.6%

2.6%

2.2%

2.2%

1.8%

1.8%

1.4%

1.4% 99

01

03

05

07

09

Source: Federal Reserve Board, Bloomberg LP and Wells Fargo Securities

Wells Fargo Economic Outlook

7

11

13

15

Pace of Policy Firming: Two Increases in 2016

Appropriate Pace of Policy Firming Target Federal Funds Rate at Year-End

5.0% 4.5% 4.0%

Normalization is underway, but there remains wide variation between the market and Fed officials themselves about the appropriate path of the fed funds rate

5.0%

June 2016 Median Response March 2016 Median Response December 2015 Median Response December 2014 Median Response Futures Market: July 6

4.5% 4.0%

3.5%

3.5%

3.0%

3.0%

2.5%

2.5%

2.0%

2.0%

1.5%

1.5%

1.0%

1.0%

0.5%

0.5%

0.0%

2016

2017

2018

Source: Federal Reserve Board, Bloomberg LP and Wells Fargo Securities

Wells Fargo Economic Outlook

8

Longer Run

0.0%

Brexit

U.K. Real Investment Spending Bars = Compound Annual Rate

30%

Line = Yr/Yr % Change

30%

Forecast

Uncertainty related to the ultimate relationship between the UK and the EU will likely depress investment spending in the UK

20%

20%

10%

10%

0%

0%

-10%

-10%

-20%

-20%

-30%

-30%

Gross Fixed Capital Formation: Q1 @ -0.2% Gross Fixed Capital Formation: Q1 @ 0.7%

-40%

-40% 00

02

04

06

08

Source: IHS Global Insight and Wells Fargo Securities

Wells Fargo Economic Outlook

9

10

12

14

16

Brexit

U.K. Real GDP Bars = Compound Annual Rate

6%

Line = Yr/Yr % Change

6%

Forecast

In our view, further contraction in investment will lead to a modest U.K. recession later this year and into early 2017

3%

3%

0%

0%

-3%

-3%

-6%

-6%

-9%

-9% Compound Annual Growth: Q1 @ 1.8% Year-over-Year Percent Change: Q1 @ 2.0%

-12%

-12% 00

02

04

06

08

Source: IHS Global Insight and Wells Fargo Securities

Wells Fargo Economic Outlook

10

10

12

14

16

Brexit

Bank of England Policy Rate 7.00%

7.00% Bank of England: Jul-1 @ 0.50%

If, as we expect, the British economy is headed for a modest recession, then the BoE will likely cut further

6.00%

6.00%

5.00%

5.00%

4.00%

4.00%

3.00%

3.00%

2.00%

2.00%

1.00%

1.00%

0.00%

0.00% 00

02

04

06

Source: Bloomberg LP and Wells Fargo Securities

Wells Fargo Economic Outlook

11

08

10

12

14

16

Brexit

U.K. and Euro Exchange Rates

The pound has depreciated since the Brexit vote

1.50

1.16

1.45

1.14

1.40

1.12

1.35

1.10

1.30

1.08

USD per GBP: Jul-08 @ 1.29 (Left Axis) USD per EUR: Jul-08 @ 1.10 (Right Axis) 1.25 Jun-1

Jun-8

Jun-15

Source: Bloomberg LP and Wells Fargo Securities

Wells Fargo Economic Outlook

12

Jun-22

Jun-29

Jul-6

1.06 Jul-13

Brexit

Exports to the United Kingdom As a Percent of Total Exports, 2014

The UK accounted for less than 4 percent of American exports of goods in 2015, which is equivalent to only 0.4 percent of U.S. GDP

20%

20%

15%

15%

10%

10%

5%

5%

0%

0% IRE

NLD

BEL

DNK

SWE

Source: IHS Global Insight and Wells Fargo Securities

Wells Fargo Economic Outlook

13

FRA

SPA

GER

EU Avg.

U.S.

Brexit

Americans own $1.3 trillion worth of British securities, most of which are equities. That said, total household balance sheets in the U.S. have $70 trillion worth of financial assets.

U.S. Holdings

U.K. Holdings

U.S. Holdings of U.K. Portfolio Assets

U.K. Holdings of U.S. Portfolio Assets In Billions of Dollars

In Billions of Dollars $1,400

$1,700

$1,400 Short-Term Debt Securities Long-Term Debt Securities

$1,200

$1,500

Equities

$1,200

$1,000

$1,000

$800

$1,700 Short-Term Debt Securities Long-Term Debt Securities Equities

$1,500

$1,300

$1,300

$1,100

$1,100

$900

$900

$700

$700

$500

$500

$800

$600

$600

$400

$400 2010

2011

2012

2013

$300

2014

Note: This includes private and public institutions Source: IHS Global Insight and Wells Fargo Securities

Wells Fargo Economic Outlook

$300 2010

14

2011

2012

2013

2014

2015

Brexit

Anglo-Saxon Trade

 Singapore

 United States

 South Korea “Breakaways”

 Bangladesh

 India

 Canada

Wells Fargo Economic Outlook

15

Five Takeaways

Growth

Inflation

Interest Rates

 Continued moderate growth led by domestic consumer and housing

 Rising, but is the pace slow enough to delay Fed move?

 Rising short rates, but flat long rates as capital flows favor the U.S.

Dollar

 Stronger dollar as rates and growth favor U.S.

Profits

 A late cycle slowdown

Wells Fargo Economic Outlook

16

U.S. Forecast

Wells Fargo U.S. Economic Forecast q 2 2 01 6

Actual 2015

2 01 6

Forecast 2016

2017

2013

Actual 2014

2015

Forecast 2016 2017

1Q

2Q

3Q

4Q

1Q

2Q

3Q

4Q

1Q

2Q

3Q

4Q

0.6

3.9

2.0

1.4

1.1

2.3

2.1

1.9

1.8

2.4

2.5

1.4

1.5

2.4

2.4

1.8

2.1

1.8

3.6

3.0

2.4

1.5

4.3

2.7

2.0

2.3

3.2

3.1

1.9

1.7

2.7

3.1

2.7

2.7

1.6

4.1

2.6

-2.1

-4.5

1.1

0.6

3.4

3.1

2.9

2.8

2.5

3.0

6.2

2.8

-0.5

2.6

Equipment

2.3

0.3

9.9

-2.1

-8.7

1.6

-1.0

3.5

3.0

2.7

2.2

1.7

3.2

5.8

3.1

-1.1

2.2

Intellectual Property Products

7.4

8.3

-0.8

-0.1

4.4

4.2

4.8

5.3

4.9

4.8

4.8

4.7

3.8

5.2

5.7

3.2

4.9

Structures

-7.4

6.2

-7.2

-5.1

-7.9

-5.0

-2.5

0.0

0.5

0.5

1.0

1.0

1.6

8.1

-1.5

-4.8

-0.2

Residential Construction

10.1

9.4

8.2

10.1

15.6

0.0

9.0

8.5

8.5

8.5

8.0

8.0

9.5

1.8

8.9

8.9

7.9

Government Purchases

-0.1

2.6

1.8

0.1

1.3

-0.3

1.8

1.7

1.2

1.0

1.0

0.9

-2.9

-0.6

0.7

1.0

1.2

-1.9

0.2

-0.3

-0.1

0.1

0.1

-0.7

-0.6

-0.6

-0.6

-0.6

-0.5

0.2

-0.2

-0.6

-0.1

-0.6

0.9

0.0

-0.7

-0.2

-0.2

-0.4

0.2

0.1

0.0

-0.1

0.0

-0.1

0.0

0.0

0.2

-0.2

0.0

190

251

192

282

196

147

175

170

165

160

155

150

193

251

229

172

158

5.6

5.4

5.2

5.0

4.9

4.9

4.8

4.7

4.7

4.6

4.6

4.5

7.4

6.2

5.3

4.8

4.6

-0.1

0.0

0.1

0.4

1.1

1.1

1.3

1.7

2.4

2.3

2.3

2.3

1.5

1.6

0.1

1.3

2.3

Real Gross Domestic Product Personal Consumption

1

Business Fixed Investment

Net Exports Inventories

2 2

Nonfarm Payroll Change

3

Unemployment Rate Consumer Price Index

4 5

Quarter-End Interest Rates Federal Funds Target Rate

0.25

0.25

0.25

0.50

0.50

0.50

0.50

0.75

0.75

1.00

1.00

1.25

0.25

0.25

0.27

0.56

1.00

Conventional Mortgage Rate

3.77

3.98

3.89

3.96

3.69

3.57

3.46

3.53

3.57

3.60

3.64

3.67

3.98

4.17

3.85

3.56

3.62

2 Year Note

0.56

0.64

0.64

1.06

0.73

0.58

0.66

0.83

0.92

1.13

1.22

1.35

0.31

0.46

0.69

0.70

1.16

10 Year Note

1.94

2.35

2.06

2.27

1.78

1.49

1.41

1.50

1.55

1.60

1.66

1.71

2.35

2.54

2.14

1.55

1.63

Forecast as of: July 13, 2016 1

C ompound Annual Growth Rate Quarter-over-Quarter

2

Percentage Point C ontribution to GDP

4

Year-over-Year Percentage C hange

5

Annual Numbers Represent Averages

3

Average Monthly C hange

Source: U.S. Department of Commerce, U.S. Department of Labor, Federal Reserve Board, Freddie Mac and Wells Fargo Securities

Wells Fargo Economic Outlook

17

Appendix

Wells Fargo Economics Group Publications

Recent Special Commentary Date

Title

Authors

U.S. Macro

To join any of our research distribution lists please visit our website: http://www.wellsfargo.com/ economics

Wells Fargo Economic Outlook

June-30

Job Quality and the Missing Middle

House & Batcheller

June-30

Brexit and the U.S. Economy

Vitner

June-24

Brexit—Now What?

Bryson

June-23

Can labor force participation ever recover?

House

June-08

Where's the Rebound in Inflation Expectations?

House

June-23 June-22 June-22 June-17 June-17

U.S. Regional California mid-year economic update: June 2016 State GDP Q4: Output continues to grow as headwinds come and go Healthcare, technology and construction drive incomes in Q1 Florida Employment Conditions: May 2016 North Carolina Employment Conditions: May 2016

Vitner & Batcheller Vitner & Feik Vitner Vitner, Feik & Batcheller Vitner, Feik & Batcheller

June-28

Korea and Global Trade Dynamics

Quinlan

June-21

Chilean economy struggles in early 2016

Alemán

June-09

Global Chartbook: June 2016

Alemán, House & Nelson

June-01

Disappointing Swiss GDP Growth in Q1-2016

Bryson

June-01

Indian GDP Growth Bests Expectations in Q1-2016

Bryson

July-06 July-06 July-01 June-28 June-22

Interest Rates/Credit Market Argentina Sets the GDP Record Straight Go Your Own Way: Policy with Imperfect Information U.K. Recession Post-Brexit Referendum?

The Referendum & the Reckoning: Rates Implicaions of Brexit Profits, Corporate Financing and Capital Investment

Alemán Silvia Bryson Silvia Silvia & Moehring

July-06

Real Estate International Home Buying: 2016

Vitner, Khan & Batcheller

June-28

Brexit Vote Could Pump More Dollars into U.S. CRE

Khan

June-01

Housing Chartbook: June 2016

Vitner, Khan & Batcheller

May-20

Commercial Real Estate Chartbook: Q1

Khan & Causey

April-29

Is the Housing Market Finally Becoming Unstuck?

Vitner, Khan & Batcheller

Global Econom y

19

Wells Fargo Securities Economics Group Global Head of Research and Economics

Economists

Diane Schumaker-Krieg ………………… ….diane.schumaker@wellsfargo.com Global Head of Research & Economics

Eric J. Viloria, Currency Strategist

……

Sarah House, Economist

…………… …………

Michael A. Brown, Economist ……………… …

Chief Economist

eric.viloria@wellsfargo.com sarah.house@wellsfargo.com michael.a.brown@wellsfargo.com

Jamie Feik, Economist John E. Silvia …

...................... …

jamie.feik@wellsfargo.com

john.silvia@wellsfargo.com

.

Economic Analysts Senior Economists Mark Vitner, Senior Economist……………....………. .

Erik Nelson, Currency Analyst mark.vitner@wellsfargo.com

Misa Batcheller, Economic Analyst

erik.f.nelson@wellsfargo.com misa.n.batcheller@wellsfargo.com

Jay H. Bryson, Global Economist …………………....…… ….jay.bryson@wellsfargo.com

Michael Pugliese, Economic Analyst

michael.d.pugliese@wellsfargo.com

Sam Bullard, Senior Economist

Julianne Causey, Economic Analyst

julianne.causey@wellsfargo.com

sam.bullard@wellsfargo.com

Nick Bennenbroek, Currency Strategist ……nicholas.bennenbroek@wellsfargo.com Anika R. Khan, Senior Economist …

. anika.khan@wellsfargo.com Administrative Assistants

Eugenio J. Alemán, Senior Economist… …………eugenio.j.aleman@wellsfargo.com Azhar Iqbal, Econometrician………………… …………… azhar.iqbal@wellsfargo.com

Donna LaFleur, Executive Assistant.

donna.lafleur@wellsfargo.com

Tim Quinlan, Senior Economist …………… ……………. .tim.quinlan@wellsfargo.com

Dawne Howes, Administrative Assistant

dawne.howes@wellsfargo.com

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Wells Fargo Economic Outlook

20