Economic Outlook for 2016 and Beyond Michael A. Brown, Economist September 30, 2016

Labor Market Global Growth Business Investment 2016 Overview Labor Market Inflation & Interest Rates Global Growth Business Investment 2016

Where Are We Now? Economic growth should continue at a modest pace over the coming quarters Source: U.S. Department of Commerce and Wells Fargo Securities

Growth in domestic spending is expected to average around 2 percent Real Final Sales Growth in domestic spending is expected to average around 2 percent Source: U.S. Department of Commerce and Wells Fargo Securities

Manufacturing & Services Indices on business activity suggest a moderating near-term outlook for services while manufacturing continues to show signs of softness Source: Institute for Supply Management and Wells Fargo Securities

Growth in equipment spending will remain modest Capital Spending Growth in equipment spending will remain modest Source: U.S. Department of Commerce and Wells Fargo Securities

Nonresidential Construction The drag from oil and gas on, commercial construction is beginning to diminish Source: U.S. Department of Commerce and Wells Fargo Securities

Commercial Real Estate Apartment and industrial have seen the largest drops in vacancy rates Source: Reis, Inc., CoStar Realty Information, Inc. and Wells Fargo Securities

Small business optimism has finally turned around Small Businesses Small business optimism has finally turned around Source: National Federation of Independent Businesses, Gallup, Wells Fargo Bank and Wells Fargo Securities

Recovery in home equity values has supported small business activity Small Businesses Recovery in home equity values has supported small business activity Source: Federal Reserve Board, Wells Fargo Bank, Gallup and Wells Fargo Securities

Negative Equity Mortgages The rise in home prices has helped bring down the share of owners who owe more on their home than their home is worth Source: CoreLogic and Wells Fargo Securities

The homeownership rate is now at its lowest level since the 1960s. U.S. Housing Market Despite some recent setbacks, we continue to look for a gradual recovery in homebuilding. The homeownership rate is now at its lowest level since the 1960s. Homeownership Owners vs. Renters Source: NAR, CoreLogic, U.S. Department of Commerce and Wells Fargo Securities 12 12

U.S. Housing Market Household formations are rising, albeit slowly, however a larger share of new households are becoming renters rather than traditional homeowners Household Formation Housing Starts Source: U.S. Department of Commerce and Wells Fargo Securities 13 13

Demographic Breakdown Millennials are now the country’s largest and most diverse generation Source: U.S. Department of Commerce and Wells Fargo Securities

A Shifting Demographic Profile Higher student debt burdens are hindering young adults’ ability to form new households. Student Loans Household Formation Source: Federal Reserve Board, U.S. Department of Commerce and Wells Fargo Securities 15 15

Demographic Fundamentals A greater share of millennials are participating in the labor market. Fewer millennials getting married implies slower or delayed growth in household formations. Employment-Population Growth by Age Marriage Rates by Generation Sources: U.S. Department of Labor and Wells Fargo Securities Pew Research Center . (March 2014). “Millennials in Adulthood: Detached from Institutions, Networked with Friends.”

The Consumer Food away from home, entertainment, and apparel spending have improved over the past year as the economy has picked up Source: U.S. Department of Labor and Wells Fargo Securities

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 3 years Source: Federal Reserve Bank of New York and Wells Fargo Securities

Consumer Confidence and Equity Markets “The Only Thing We Have to Fear Is Fear Itself” – Franklin D. Roosevelt Source: The Conference Board, IHS Global Insight and Wells Fargo Securities 19 19

Consumer spending growth will continue to average around 2.5 percent The Consumer Consumer spending growth will continue to average around 2.5 percent Source: U.S. Department of Commerce and Wells Fargo Securities

Unemployment Rates Alternative measures of unemployment show a high level of underemployment Source: U.S. Department of Labor and Wells Fargo Securities

Employment Rate Slower growth in the workforce population combined with lower labor force participation will limit potential GDP growth Source: U.S. Department of Labor and Wells Fargo Securities

The Employment Situation The employment picture is mixed across different levels of education Source: U.S. Department of Labor and Wells Fargo Securities

Employment: Structural A large proportion of the jobs created over the past four years have been part-time, which has weighed on wage & salary growth Source: U.S. Department of Labor and Wells Fargo Securities

Initial Claims Initial jobless claims remain near historic lows but have shown recent signs of bottoming Source: U.S. Department of Labor and Wells Fargo Securities

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

U.S. Budget Gap The federal government faces some significant fiscal challenges—the current path is not sustainable Source: Congressional Budget Office and Wells Fargo Securities

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 28 28

Political Outlook Baseline D.C. Update Political Outlook Baseline Key Issues FY 2017 budget debate We expect a continuing resolution for FY 2017 that maintains funding levels until after the first of the year. Control of the Senate 24 Republican seats up for re-election vs. 10 Democratic seats Control of the House Democrats would need to pick up 30 seats to regain control Cook Political Report currently shows only 25 Toss Up Seats Presidential Elections and the Economy Our baseline is for a divided Congress regardless of who is in the White House, thus we do not expect to modify our outlook based on the outcome of the election.

Oil prices have continued to slump Source: IHS Global Insight and Wells Fargo Securities

Oil Supply & Demand Factors The implied supply & demand imbalance is expected to come down in the third quarter Source: Energy Information Administration and Wells Fargo Securities

Inflation remains in check Source: U.S. Department of Commerce and Wells Fargo Securities

FOMC Dot Plot The tightening cycle has finally commenced, but the pace of tightening has been repeatedly revised down. Source: Federal Reserve Board, Bloomberg LP and Wells Fargo Securities

Yield Curve: Short-Term Rates Headed Higher The yield curve is expected to flatten further as the Fed raises short-term interest rates Source: IHS Global Insight and Wells Fargo Securities

Global Economies: A Strong Dollar Policy? The dollar has strengthened relative to the currencies of our major trading partners Standard inst Source: Bloomberg LP and Wells Fargo Securities

International Trade The stronger U.S. dollar, slower global growth and stronger domestic demand will result in trade weighing on growth Standard inst Source: U.S. Department of Commerce and Wells Fargo Securities

Contributions to Chinese Growth Chinese authorities hope to rebalance growth toward the service sector Source: CEIC and Wells Fargo Securities

The Perception of Chinese Growth Chinese growth appears slower to U.S. market participants due, in part, to the strength of the U.S. dollar relative to the renminbi Source: Bloomberg LP and Wells Fargo Securities

Chinese Financial Markets Bank lending is the primary means of financing for Chinese companies—not equities Source: International Monetary Fund and Wells Fargo Securities 39

Trade With China China accounts for 7 percent of American exports and less than 1 percent of GDP Source: U.S. Department of Commerce and Wells Fargo Securities

China Outlook Growth in China will likely continue to downshift to a more sustainable pace Source: Bloomberg LP and Wells Fargo Securities 41

The U.K. will remain a member of the EU until the exit is negotiated Brexit Brexit…what’s next? Key Points The U.K. needs to formally notify Brussels that they are leaving the European Union by triggering Article 50 of the Lisbon Treaty The mechanics of the Brexit need to be negotiated with the EU, which could take as long as 2 years The U.K. will remain a member of the EU until the exit is negotiated The two biggest issues for the U.K. to address: Renegotiate trade agreements with the EU Determine immigration rules, including the status of EU-27 citizens currently residing in the U.K. We now expect a mild recession in the U.K. beginning in later this year and into 2017

U.K. GDP Growth In our view, the uncertainty created by Brexit will lead to a modest U.K. recession in the near term Source: IHS Global Insight and Wells Fargo Securities, August 2016 43

The Eurozone will see some improvement in the year ahead Eurozone Outlook The Eurozone will see some improvement in the year ahead Source: IHS Global Insight and Wells Fargo Securities

Growth in the global economy remains below its long-run average Global Forecast Growth in the global economy remains below its long-run average Source: International Monetary Fund and Wells Fargo Securities 45

Global Industrial Production It would take a sharp downturn in the rest of the world to have a meaningful effect on U.S. economic growth Source: IHS Global Insight and Wells Fargo Securities

The Health Care Industry

Health Care Spending by Type Real health care spending continues to increase Source: U.S. Department of Commerce and Wells Fargo Securities

Consumer Price Growth Health care cost growth has increased in recent months as overall consumer price inflation has shown signs of stabilizing Source: U.S. Department of Labor and Wells Fargo Securities

Medical Care Inflation Components After a sharp decline, inflation for pharmaceutical products has rebounded significantly Source: U.S. Department of Commerce and Wells Fargo Securities

Health Care Employment Hiring in ambulatory care and hospitals are showing signs of slowing but remain high Source: U.S. Department of Labor and Wells Fargo Securities

Changing Demographics The population aged 65 and older is growing much more rapidly than the under 65 age demographic Source: U.S. Department of Labor and Wells Fargo Securities

Medicare and Medicaid Transfer Payments Transfer payments for Medicare and Medicaid have shown steady growth over the past decade. Medicare Medicaid Source: U.S. Department of Commerce and Wells Fargo Securities 53 53

Medicare and Medicaid Expenditures Projections The CBO projects that expenditures on federal government outlays for healthcare programs will continue to grow Source: The Congressional Budget Office and Wells Fargo Securities

The Mix of Growth Is Shifting Toward Consumption Five Key Takeaways Economic Outlook Headwinds from overseas will weigh on growth, but the U.S. economy should weather the storm. Look for real GDP to rise 1.5 percent in 2016. The Mix of Growth Is Shifting Toward Consumption Weak global growth and the strong dollar are keeping sectors tied closely to global markets, such as manufacturing, energy and agriculture, under pressure. The Housing Recovery Will Gain Momentum Demand for single-family homes remains sluggish as the home ownership rate continues to fall. Apartment construction is close to peaking. Interest Rates and the Federal Reserve The Fed has begun the process of raising short-term rates from record lows, but uncertainty remains surrounding the path of future rate hikes. Global Growth Will Be Below Average In 2016 China’s growth will downshift but we do not expect a hard landing. Eurozone growth should begin to firm later this year.

Outlook Summary Source: IHS Global Insight and Wells Fargo Securities

International Outlook Source: International Monetary Fund and Wells Fargo Securities

FX Outlook Source: Wells Fargo Securities

Appendix

Wells Fargo Economics Group Publications A Sampling of Our Recent Special, Regional & Industry Commentary To view any of our past research please visit: http://www.wellsfargo.com/ economics To join any of our research distribution lists please visit: http://www.wellsfargo.com/ economicsemail Recent Special Commentary

Wells Fargo Securities Economics Group Diane Schumaker-Krieg ………………… ……….diane.schumaker@wellsfargo.com Global Head of Research & Economics Global Head of Research and Economics Eric J. Viloria, Currency Strategist eric.viloria@wellsfargo.com Sarah House, Economist …………… ………… sarah.house@wellsfargo.com Michael A. Brown, Economist ……………… … michael.a.brown@wellsfargo.com Jamie Feik, Economist jamie.feik@wellsfargo.com Economists Chief Economist John E. Silvia … ....................... … john.silvia@wellsfargo.com Mark Vitner, Senior Economist……………....………. . mark.vitner@wellsfargo.com Jay H. Bryson, Global Economist …………………....…… ….jay.bryson@wellsfargo.com Sam Bullard, Senior Economist sam.bullard@wellsfargo.com Nick Bennenbroek, Currency Strategist ……nicholas.bennenbroek@wellsfargo.com Anika R. Khan, Senior Economist … . anika.khan@wellsfargo.com Eugenio J. Alemán, Senior Economist… …………eugenio.j.aleman@wellsfargo.com Azhar Iqbal, Econometrician………………… …………… azhar.iqbal@wellsfargo.com Tim Quinlan, Senior Economist …………… ……………. .tim.quinlan@wellsfargo.com Senior Economists Economic Analysts Misa Batcheller, Economic Analyst misa.n.batcheller@wellsfargo.com Michael Pugliese, Economic Analyst michael.d.pugliese@wellsfargo.com Julianne Causey, Economic Analyst julianne.causey@wellsfargo.com E. Harry Pershing, Economic Analyst edward.h.pershing@wellsfargo.com May Tysinger, Economic Analyst may.tysinger@wellsfargo.com Administrative Assistants Donna LaFleur, Executive Assistant. donna.lafleur@wellsfargo.com Dawne Howes, Administrative Assistant dawne.howes@wellsfargo.com Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, 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, 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. ("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 does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities’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 does not guarantee their accuracy or completeness, nor does Wells Fargo Securities 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 is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company © 2016 Wells Fargo Securities. 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 2007. 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. 61 61 61