1. John E. Silvia, Chief Economist November 14, 2016
Economics and Finance in a Two-Percent Economy Young Presidents’ Organization
John E. Silvia, Chief Economist
November 14, 2016

2. Five benchmarks for good decision making
Where Are We Now?
Five benchmarks for good decision making
Interest Rates
Inflation
Growth
Profits
The Dollar
Source:

3. Wells Fargo vs. Consensus
How do we differ from consensus?
Expectations for the Future
Sustained trend growth, no recession in 2016
Employment—cyclical and structural change
Consumer solid
Housing improving—single-family picking up
Unsustainable long-run fiscal policy
Europe downside risk post-Brexit
China growth slower for 2016, 2017

4. Sustained Growth in 2016—Great Divide Between Domestic and Trade
Trend growth at percent in the year ahead. Consumer and housing lead, but exports will remain a drag.
Source: U.S. Department of Commerce and Wells Fargo Securities

5. Domestic Strength/Export Weakness
Domestic growth has held up relatively well. We expect trade to be a drag moving forward.
Source: U.S. Department of Commerce and Wells Fargo Securities

6. Recession in 2016?
The probability of recession in the next six months is very low, according to our model
Source: Wells Fargo Securities

7. Potential Growth—Little Help From Productivity
Productivity growth has downshifted over the past cycle
Source: U.S. Department of Labor and Wells Fargo Securities

8. Potential Growth—Little Help from Labor
Labor supply growth is slowing, particularly for prime-age workers. The share of marginally attached workers remains elevated.
Working Age Population
Labor Force Participation
Source: U.S. Department of Labor and Wells Fargo Securities 8

9. Manufacturing & Services: A Divide
Indices on business activity suggest continued growth for Services have been a bulwark, while manufacturing has been impacted by the dollar and collapse in commodities.
Source: Institute for Supply Management and Wells Fargo Securities

10. Wages & Salaries
Total income from wages & salaries is best associated with consumer spending—not average hourly earnings alone
Source: U.S. Department of Labor, U.S. Department of Commerce and Wells Fargo Securities

11. Wage Fundamentals
Low productivity growth will limit the pace of wage growth even as the labor market tightens
Source: U.S. Department of Commerce and Wells Fargo Securities

12. Personal Income
Income growth has finally begun to turn around but still lags prior recoveries
Source: U.S. Department of Labor and Wells Fargo Securities

13. Household Debt Delinquencies: Student Loans the Exception
Tighter credit standards and a strengthening economy have helped to improve the credit position of households over the past few years—with the exception of student debt
Source: FRBNY and Wells Fargo Securities

14. Auto Lending: Slippery Slope
The subprime share of auto sales is still below prerecession levels
Source: FRBNY and Wells Fargo Securities

15. Housing: Pickup in Single-Family
Apartment demand remains exceptionally strong but supply is catching up with demand.
Single-family housing starts are beginning to ramp back up. Gains will be more modest than in past building cycles.
Source: U.S. Department of Commerce and Wells Fargo Securities

16. CRE
Apartment and industrial markets have seen the largest drops in vacancy rates.
Source: Reis, Inc., CoStar Realty Information, Inc. and Wells Fargo Securities

17. High valuations have caught the Fed’s attention
Property Prices
High valuations have caught the Fed’s attention
Source: RCA and Wells Fargo Securities

18. Mixed signals from the factory sector
Factory Orders
Mixed signals from the factory sector
Standard inst
Source: U.S. Department of Commerce and Wells Fargo Securities

19. Composition of Federal Spending Federal Debt Continues to Rise
Federal Fiscal Policy
The composition of federal spending has shifted dramatically.
The CBO projects that the debt-to-GDP ratio will surpass 85 percent by 2026.
Composition of Federal Spending
Federal Debt Continues to Rise
Source: Congressional Budget Office and Wells Fargo Securities 19

20. Inflation & Interest Rates
Core
Inflation
Interest
Rates
Inflation
Growth
Key
Drivers
Yield
Curve
The Dollar
Profits
Wage-Price
Spiral
Market
Expectations

21. Inflation: Rising—But Less Than Market/FOMC Expect
Inflation remains historically low, but we expect to see a pickup in coming quarters – average less than 2% since 1991
Source: U.S. Department of Commerce and Wells Fargo Securities 21

22. Inflation: A Divide in Goods vs. Services
Inflation for services has been much firmer than for commodities
Source: U.S. Department of Labor and Wells Fargo Securities

23. We expect a moderate rebound in energy prices over time
Brent Oil
We expect a moderate rebound in energy prices over time
Source: IHS Global Insight and Wells Fargo Securities

24. Inflation Expectations
Long-term inflation expectations have fallen alongside oil, keeping some FOMC members worried about the future path of inflation
Source: Federal Reserve Board, Bloomberg LP and Wells Fargo Securities

25. The FOMC’s expectations for inflation in 2016 held steady in September
FOMC Projections
The FOMC’s expectations for inflation in 2016 held steady in September
Source: Federal Reserve Board and Wells Fargo Securities

26. Pace of Policy Firming: We Say a December Hike
Normalization is underway, but there remains wide variation between the market and Fed officials themselves about the appropriate path of the fed funds rate
Source: Federal Reserve Board, Bloomberg LP and Wells Fargo Securities

27. The yield curve has flattened since the Taper Tantrum in 2013
Source: Federal Reserve Board and Wells Fargo Securities

28. Government bond yields have declined across the globe
Sovereign Yields
Government bond yields have declined across the globe
Source: Federal Reserve Board, IHS Global Insight and Wells Fargo Securities

29. Foreign Purchases of U.S. Securities: Still Solid
Capital flows and asset allocation by global investors play a strong role in rate determinations
Standard inst
Source: U.S. Department of the Treasury and Wells Fargo Securities

30. S&P Revenues Earned Abroad
IT and Materials earn the highest share of their revenues abroad, making those industries the most at risk to the stronger dollar—Invoicing in dollars?
Source: Bloomberg LP and Wells Fargo Securities

31. S&P 500 P/E Ratio
The S&P 500 P/E ratio has risen above its long-run average. Deviations from the average can be persistent
Source: Bloomberg LP and Wells Fargo Securities

32. Corporate Profit Growth
Corporate profit growth has slowed recently—typical mid- to late-cycle slowdown
Source: U.S. Department of Commerce and Wells Fargo Securities

33. Corporate Profits
Corporate profits as a share of gross value added remains historically high but is now past its peak
Source: U.S. Department of Commerce and Wells Fargo Securities

34. Dollar appreciation should be more modest moving forward
Source: Federal Reserve Board and Wells Fargo Securities

35. Dollar Appreciation
The dollar has appreciated versus most of our largest trading partners over the past year. That said, dollar appreciation has varied significantly by country.
Source: Federal Reserve Board and Wells Fargo Securities

36. Global trade has clearly downshifted
Global Exports
Global trade has clearly downshifted
Standard inst
Source: IHS Global Insight and Wells Fargo Securities

37. Five Takeaways
Growth
Continued moderate growth led by domestic consumer and housing
Inflation
Rising, but is the pace slow enough to delay Fed move?
Interest Rates
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

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

39. Appendix

40. Wells Fargo Economics Group Publications
To join any of our research distribution lists please visit our website: economics
Recent Special Commentary

41. Wells Fargo Securities Economics Group
Diane Schumaker-Krieg …………………
Global Head of Research & Economics
Global Head of Research and Economics
Eric J. Viloria, Currency Strategist
Sarah House, Economist
Michael A. Brown, Economist
Jamie Feik, Economist
Economists
Chief Economist
John E. Silvia
Mark Vitner, Senior Economist
Jay H. Bryson, Global Economist
Sam Bullard, Senior Economist
Nick Bennenbroek, Currency Strategist
Anika R. Khan, Senior Economist
Eugenio J. Alemán, Senior Economist
Azhar Iqbal, Econometrician
Tim Quinlan, Senior Economist
Economic Analysts
Senior Economists
Erik Nelson, Currency Analyst
Misa Batcheller, Economic Analyst
Michael Pugliese, Economic Analyst
Julianne Causey, Economic Analyst
E. Harry Pershing, Economic Analyst
Administrative Assistants
Donna LaFleur, Executive Assistant
Dawne Howes, Administrative Assistant
Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. ("WFS") is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. ("WFBNA") is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. WFS and WFBNA are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC’s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company © 2016 Wells Fargo Securities, LLC.
SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE
Important Information for Non-U.S. Recipients
For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority’s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. 41 41 41