2 “Bottom line” on UBS U.S. economic forecasts Real GDP growth at a 2.0% pace in H2(06) and at 2.4% in 2007 (Q4/Q4) mainly due to consumer slowdown. H2(07) growth above H1(07) growth in response to lower rates and dollar. (2.2% for calendar average 2007 GDP growth.) 5¼% Fed funds peak followed by 2007 easing to 4¼% 4½% to 5% 10-yr Treasury yield range for most of 2006; 4 to 4½% for most of 2007. Core PCE price index inflation rises from 2.1% in 2005 to 2.4% in 2006 before slowing to 2.0% in 2007.
3 “Soft landing” growth forecast fundamentals Terminated real estate boom had added 1% per year to growth, but... Some 2007 assistance from eventual interest rate relief. Capex supported by high capacity utilization. Export assist from expected resumed dollar decline.
4 Major growth risks Housing-related uncertainty following unprecedented boom. Crude oil prices much above our $68/barrel 2007 forecast. Upside growth risk is hard-to-forecast household formation
6 Inflation forecast crosscurrents Temporarily accelerating Owners’ Equivalent Rent (OER) Productivity slowing to trend Projected lower dollar Only moderate wage acceleration Slower output and demand growth
7 Inflation Other than a pickup in rents, which is arguably a byproduct of weakening in homebuying rather than “overheating,” core PCE inflation has been stable. * Weights based on Q4(05) nominal personal consumption expenditures. Source: Bureau of Economic Analysis and UBS calculations
8 Interest rate forecast drivers 5 1/4% Fed funds rate peak “data dependent” on sustained slowing in growth. Fed and investors start to expect that OER-led core inflation acceleration in 2006 is unsustainable as growth slows Foreign savings help keep bond yields somewhat below normal, although such “help” now less than in 2005.
9 US forecasts GDP Source: Bureau of Economic Analysis and UBS estimates
10 US forecasts Key business indicators, income, and productivity Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board, and UBS estimates
11 US forecasts Inflation and interest rates Note: Quarterly interest rate forecasts are for end of period yields Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board, and UBS estimates
15 When the new homes sales months’ supply is over 6 months, real new home prices tend to decline. Source: U.S. Census Department
16 The reported 6.6 months’ supply in August understates the inventory overhang, because reported sales exclude surging cancellations. Source: UBS
17 Housing’s indirect effects… …have been larger than usual in the current cycle, due to a surge in wealth as home prices have risen. Wealth has been tapped through home equity extraction (HEE). At least some of that extraction has likely been used to finance extra household spending. * Single-family only are available prior to 1999; ** UBS estimate of home equity extraction calculated as increase in residential mortgage debt minus all new residential investment other than home improvements *** Quarterly except latest. Source: Federal Reserve, Bureau of Economic Analysis, National Association of Realtors, OFHEO, and UBS