1. This Recovery is for Real: Solid, Sustainable, but Sub Par October 2009 Chris Varvares President, Macroeconomic Advisers, LLC www.macroadvisers.com © Macroeconomic Advisers

2. 2 October 2009 The US Economic Outlook: Bottom Line The recession is over (growth returns) & downside risks dwindle Above-trend growth in 2 nd half of 2009: 3.5% a.r. Robust (but sub par) growth in 2010 (4.1%  ) & 2011 (4.2%  ) Unemployment rate peaks at 10% (or a bit higher) in 2009:q4 Unemployment rate declines to 9.1% in ’10:q4 and to 7.7%  in ’11:q4 Core inflation very low: =1.4% in 2009,  0.8 in 2010 &  0.8 in 2011 Revised higher versus recent forecasts --- but still below FOMC Fed: Still expecting a late exit; but will “end easing” long before Fiscal: Stimulus working for now; getting control of the deficit later

3. © Macroeconomic Advisers3 October 2009 Percent History Forecast Unemployment rate Real GDP growth Deep U.S. Recession Followed by a Sub Par Recovery Back from the Abyss and Gaining Momentum 09:2H20102011 GDP Growth:3.5% 4.1%4.2% Un. Rate (Q4):10.0%9.1%7.7%

4. © Macroeconomic Advisers4 October 2009 Slack Keeps Downward Pressure on Inflation Unit Labor Cost and Core PCE Inflation 4-quarter percent change Unit labor cost Core PCE inflation H F

5. © Macroeconomic Advisers5 October 2009 Long-Rates are on the Rise, but the Fed Stands Pat Percent H F Conventional mortgage rate Fed funds rate 10-year Treasury yield Below-Target Inflation & Lingering Slack Imply Late Exit

6. © Macroeconomic Advisers6 October 2009 Forecast Comparison 09Q209Q309Q410Q120092010 GDP Growth MacroAdvisers (Oct 7)-0.73.4 3.63.8-0.14.1 Blue Chip (Oct 10)-0.73.22.42.6-0.42.8 PCE Growth MacroAdvisers -0.92.71.24.60.93.5 Blue Chip -0.92.50.81.70.72.1 Unemployment Rate MacroAdvisers9.39.610.09.910.09.1 Blue Chip9.39.610.010.110.09.6 GDP Price Inflation MacroAdvisers0.00.70.20.80.7 0.6 Blue Chip0.01.51.21.51.1 1.5 Fed Funds Rate MacroAdvisers0.180.20 Blue Chip*0.180.20 0.250.201.00 10-yr Note Yield MacroAdvisers3.313.503.403.563.403.99 Blue Chip3.313.5 3.73.54.3 * Inferred from t-bill yield Q4/Q4 Q4 Average FOMC CT (Jul) −1.5-−1.0 2.1-3.3 FOMC CT (Jul) 9.8-10.1 9.5-9.8 Q4 Average

7. © Macroeconomic Advisers7 October 2009 Factors Contributing to Above-Trend GDP Growth Motor-vehicle production to rebound (with or without CARS) Inventory liquidation to slow sharply; X-auto: Q3=+$37b, Q4=+$56b Housing bounces off the bottom, will begin strong recovery Home prices are stabilizing, to remain flat (emergence of upside risk?) Broad financial conditions improving: –Especially equities –But spreads are narrowing too Implies improving balance sheets for households Helps stabilize & then boost consumer spending (pent-up demand!) ARRA actually is providing stimulus Global nature of the recovery Despite “Minsky Moment,” recession/recovery dynamics at work!

8. © Macroeconomic Advisers8 October 2009 Recession Dynamics Hint at Upside Risk 01234 Peak-to-trough decline in real GDP (%) 0 1 2 3 4 5 6 7 8 9 10 4-quarter percent change y = 2.1x + 1.5 R 2 = 0.7337 Strength of Early Recovery Depends on Depth of Recession 2001 1970 1990-91 1980 1960-61 1953-54 1981-82 1973-75 1957-58 MA forecast NABE Consensus * All other includes interest, dividend and transfer income. Forecast prepared on October 7, 2009.

9. © Macroeconomic Advisers9 October 2009 Significant Downside Risks Remain Securitization markets in key segments still “dependent” or broken CMBS market still facing a potential refi squeeze, with spillovers RMBS spreads may widen sharply as Fed unwinds balance sheet Bank lending to consumer remains stingy; More HH de-leveraging? Home price stabilization could prove temporary, drag housing lower Recovery in equities could falter; further erode HH balance sheets Energy price increases still are a drag on growth Foreign demand for $ assets could fall short, pressure $  and rates  Expiring Bush tax cuts could add drag Back side of ARRA stimulus implies drag; will recovery have legs? What about health care reform? Cap and Trade?

10. © Macroeconomic Advisers10 October 2009 Trillions of chained (2005) dollars MA’s Monthly GDP Index Q1 was not as Bad as it Appeared; Set up Q2 “Firming” Jan.2001Jan.2003Jan.2005Jan.2007Jan.2009 11.2 11.6 12.0 12.4 12.8 13.2 13.6 11.2 11.6 12.0 12.4 12.8 13.2 13.6

11. © Macroeconomic Advisers11 October 2009 Q3 Has the Makings of a Real Recovery

12. © Macroeconomic Advisers12 October 2009 Q4 Too!

13. © Macroeconomic Advisers13 October 2009 Q3: Even Without CARS MVO Was Set to Jump Motor Vehicle Output Swings to the Plus Column Millions of units, annual rate 200420052006200720082009 0.0 0.8 1.6 2.4 3.2 -0.8 -1.6 -2.4 -3.2 0 20 40 60 80 -20 -40 -60 -80 Contributions to GDP growth (left) Change (right)

14. © Macroeconomic Advisers14 October 2009 2nd Half and Beyond – Lift from Inventories Nonfarm Inventory Investment excl. Motor Vehicles & Parts Billions of chain-type (2005) dollars H F

15. © Macroeconomic Advisers15 October 2009 2nd Half and Beyond – Lift from Housing! New and Existing Home Sales Turn Up SAAR, thousands Existing (left) New (right) SAAR, thousands

16. © Macroeconomic Advisers16 October 2009 2nd Half and Beyond – Lift from Housing! Housing Starts and Residential Investment Turn Up SAAR, thous. units Residential investment (right) Private housing starts (left) 4-quarter percent change H F 09:2H20102011 Cont. to GDP Growth:0.5pp 0.8pp0.7pp

17. © Macroeconomic Advisers17 October 2009 Are House Prices About to Turn Up? …An Upward Revision to the Forecast of House Prices 2005:Q1 = 100 2006200820102012 75 80 85 90 95 100 105 75 80 85 90 95 100 105 Model predicted value Base 909 Base 907 A firming in home prices lowers the current user cost of housing and boosts demand for housing in a model that well understands the boom and bust…when fed the actual path of house prices! LoanPerformance House Price Index

18. © Macroeconomic Advisers18 October 2009 Single-Family Housing Starts 2nd Half and Beyond – Lift from Housing! SAAR, thous. units 2004200620082010 0 200 400 600 800 1000 1200 1400 1600 1800 2000 0 200 400 600 800 1000 1200 1400 1600 1800 2000 Current forecast Counterfactual assuming further 7½% decline in house prices

19. © Macroeconomic Advisers19 October 2009 Contributions to Real GDP Growth Percentage points Residential investment GDP excluding residential investment H F 2nd Half and Beyond – Lift from Housing!

20. © Macroeconomic Advisers20 October 2009 Financial Conditions: Healing Apace Credit Conditions Still Improving Percent H F Conventional mortgage rate – 10-yr treasury spread AAA – 10-yr treasury spread

21. © Macroeconomic Advisers21 October 2009 Senior Bank Loan Officer Survey Diffusion Indexes Index Net percentage “loosening” terms on C&I loans Net percentage “loosening” Terms on real estate loans Willingness to make consumer installment loans Financial Conditions: Healing Apace 197519791983198719911995199920032007 0 20 40 60 -20 -40 -60 -80 -100 0 20 40 60 -20 -40 -60 -80 -100

22. © Macroeconomic Advisers22 October 2009 Interest Rates & Equity Values Billions of dollars Percent Financial Conditions: Healing Apace Equity wealth (left) Conventional mortgage rate (right) 10-year Treasury yield (right) H F

23. © Macroeconomic Advisers23 October 2009 Household Net Worth Trillions H F Other Equities Total Household Net Worth: Stop the Pain! -$14 tril. (-1.2) -$5 tril. (-0.5) -$9 tril. -$11 tril.

24. © Macroeconomic Advisers24 October 2009 PCE Aided by Improving Financial Conditions PCE Growth & Contributions from Wealth 4-quarter percent change Percentage points 19911993199519971999200120032005200720092011 0 3 6 -3 0 3 6 H F

25. © Macroeconomic Advisers25 October 2009 Personal Saving Rate Percent H F PCE Reset Lower; Saving Rate Reset Higher

26. © Macroeconomic Advisers26 October 2009 Comparative Consumption/Income Ratios Percent Consumption Ratios Reset Lower 1985198919931997200120052009 84 86 88 90 92 94 96 98 6 8 10 12 14 16 18 20 EC$/YPD$ (left) CON$/YPD$ (left) ECD$/YPD$ (right) EC$ - Consumer expenditures ECD$ - Consumer expenditures durables CON$ - Service concept consumption YPD$ - Pers. Disposable Income H F

27. © Macroeconomic Advisers27 October 2009 Diminishing Drag as HH Balance Sheets Stabilize Contributions of Error-Correction Term to Growth of CON Percent change, annual rate 2005200620072008200920102011 0.0 0.5 1.0 1.5 -0.5 -1.5 -2.0 0.0 0.5 1.0 1.5 -0.5 -1.5 -2.0 H F

28. © Macroeconomic Advisers28 October 2009 Durables Bear Much of the Burden Light Vehicle Sales Millions of units, annual rate Monthly sales Quarterly sales and MA forecast

29. © Macroeconomic Advisers29 October 2009 Global Recovery, Dollar Decline “Help” Foreign Growth and the Dollar 4-quarter percent change Real trade-weighted exchange rate (right) H F Index Real foreign GDP (left)

30. © Macroeconomic Advisers30 October 2009 Sharply Rising Imports Depress Net Exports Exports, Imports, and Net Exports Billions of chain-type (2005) dollars 4-quarter percent change Exports (right) Imports (right) Net exports (left) H F

31. © Macroeconomic Advisers31 October 2009 Pent-up Demand Helps CapEx Tepid Recovery Growth of Nonresidential Fixed Investment 4-quarter percent change Computers and software “Other” equipment H F Structures

32. © Macroeconomic Advisers32 October 2009 Not Quite a Jobless Recovery! Employment, Labor Force, and Unemployment 4-quarter percent change Unemployment rate (right) Employment growth (left) H F Labor force growth (left) Percent

33. © Macroeconomic Advisers33 October 2009 Output per Hour in the Nonfarm Business Sector 4-quarter percent change Not Quite a Jobless Recovery! Overshoot on productivity in recession (cyclical anomaly) as firms shed workers quicker than typically (fearing deeper slump) argues for quicker re-hiring with recovery…somewhat slower productivity H F

34. © Macroeconomic Advisers34 October 2009 MA’s Unemployment Path versus Okun’s Law Simulation Results and MA Forecast Percent Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4 2008200920102011 4 5 6 7 8 9 10 11 12 4 5 6 7 8 9 10 11 12 Base 909 Predicted value +2 standard error -2 standard error H F

35. © Macroeconomic Advisers35 October 2009 Blue Chip Forecast Compared to Okun’s Law Predicted Values Percent Not Quite a Jobless Recovery! Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4 200820092010 4 5 6 7 8 9 10 11 12 4 5 6 7 8 9 10 11 12 Blue Chip forecast Predicted value from Okun’s Law model using Blue Chip GDP forecast H F

36. © Macroeconomic Advisers36 October 2009 Rising Energy Prices Marginally Boost Inflation Refiners’ Acquisition Cost of Imported Oil $/Barrel 2005 $ Current $ H F

37. © Macroeconomic Advisers37 October 2009 Inflation Revisions Reveal More Disinflation Pre-revised vs. Revised: 12-month Core PCE Inflation 12-month percent change Source: Bureau of Economic Analysis 200720082009 1.25 1.50 1.75 2.00 2.25 2.50 2.75 1.25 1.50 1.75 2.00 2.25 2.50 2.75 Revised Pre-revised 1.3% - lowest since September 2001

38. © Macroeconomic Advisers38 October 2009 Model Uncertainty and the Inflation Forecast Simulated Core PCE Inflation From Models Estimated over Alternative Samples 12-month percent change Source: Bureau of Economic Analysis; Macroeconomic Advisers, LLC 1986 - 2008 1996 - 2008 1981 - 2008 200720082009201020112012201320142015 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 -0.5 0 0.5 1 1.5 2 2.5 3 3.5 -0.5

39. © Macroeconomic Advisers39 October 2009 Unit Labor Cost and Core PCE Inflation 4-quarter percent change Unit labor cost Core PCE inflation H F Split the Difference…Lean Toward Intermediate Result

40. © Macroeconomic Advisers40 October 2009 Long-Rates are on the Rise, but the Fed Stands Pat Percent H F Conventional mortgage rate Fed funds rate 10-year Treasury yield Below-Target Inflation & Lingering Slack Imply Late Exit

41. © Macroeconomic Advisers41 October 2009 The US Economic Outlook: Bottom Line The recession is over (growth returns) & downside risks dwindle Above-trend growth in 2 nd half of 2009: 3.5% a.r. Robust (but sub par) growth in 2010 (4.1%  ) & 2011 (4.2%  ) Unemployment rate peaks at 10% (or a bit higher) in 2009:q4 Unemployment rate declines to 9.1% in ’10:q4 and to 7.7%  in ’11:q4 Core inflation very low: =1.4% in 2009,  0.8 in 2010 &  0.8 in 2011 Revised higher versus recent forecasts --- but still below FOMC Fed: Still expecting a late exit; but will “end easing” long before Fiscal: Stimulus working for now; getting control of the deficit later

42. Back-up Slides

43. © Macroeconomic Advisers43 October 2009 MA Forecast Details

44. © Macroeconomic Advisers44 October 2009 Real Fed Funds Rate and Real 10-year T-note Yield* Percent Below-Target Inflation & Lingering Slack Imply Late Exit H F Real 10-year T-note yield Real fed funds rate

45. © Macroeconomic Advisers45 October 2009 Contributions to Real Disposable Personal Income 4-quarter percent change Wage & Salary Income Poised to Turn Up 1982198519881991199419972000200320062009 0 2 4 6 8 10 -2 -4 -6 0 2 4 6 8 10 -2 -4 -6 Taxes Real disposable personal income Wage, salary & proprietors’ income H F