Economic Outlook: Transitioning to Expansion National Marine Bankers Association September 28, 2004 Gina Martin Wachovia Economics 704.383.6805 gina.martin@wachovia.com

2004/2005 Focus + _ Economic Growth Transition – Business Spending Employment Consumer Income _ Three “I”d Monster: Interest Rates Oil/Inflation Terror Politics

Spot vs Real Price of a Barrel of Oil Oil – How Bad Is It? Personal Consumption of Gasoline and Oil as a Percent of Disposable Income Spot vs Real Price of a Barrel of Oil

Personal Consumption of Gasoline and Oil as a Percent of Disposable Income Consumers complain about the $2 psychological level What is going on? Low margins strained capacity expansion – inefficient refineries closed down over the last 2 decades (321 in 1981 vs 149 today), though expansions have begun, supply is still tight. As a result, we’re importing more gasoline from abroad. Risk – these imports slow in response to tighter mandates for cleaner gasoline (raises cost of production),

“Crack” Spread – Oil and Gasoline

Inflation – Long Term Trends Remain CPI – Goods vs. Services Import prices popped in April, reflecting gasoline +4.6% Core cpi less core ppi still negative (2.9%) (both 5.1% in 1Q) Commodities? 2003: Steel 30%, iron 36%, lead 22%, but China mfd goods prices –5-10%, more expensive commodities favor resource rich nations Net – supply still exceeds demand, tech/pro business politics of last 20 years has helped industries b/c better at providing goods & services, transportation and communication more reliable and real time Core = Excluding Food and Energy Both Series are Year to Year Percent Changes

The Fed is On the Move At a “Measured Pace” of Course Neutral is 5% Greenspan watching – wage pressures as productivity slows Wage&Salaries 5.8% over last 3 months alone, 5.0 percent higher than last year Nom GDP up 6.7% in 1Q, maybe 7.5% in 2Q 2003 productivity nonfarm 4.4%, ULC –1.2 percent, real hourly compensation just 0.9%

What About Long Term Rates? 10-Year and Inflation 10-Year and Growth 3 forces on rates in 90s: globalization, technology, competition Low rates increased capacity faster than stimulated demand – recovery over last 3 years Late 1800s industrial revolution – 30 years if 4%+ gdp growth and mild deflation Other – fed holding nearly $1 trillion of treasuries for foreign central banks – was $600 billion in mid-2002 – this holding down treasury rates (big demand)

A Little Help? Net Purchases of U.S. Treasuries by the Rest of the World 1Q - $170 billion 4 Quarter Moving Average, Billions of Dollars

Home Sales and Interest Rates – Connection? Home price bubble? 7.6% 2002, 8.4% 2003, LT is closer to 5% Adjustable rate mortgages – 40% (not as high as prior periods, 94 @ 60%, 80s nearly 70%

Growth Transition – Recovery to Expansion Real GDP (Volume Growth) Bars = Seasonally Adjusted Compound Annual Rates

Yield Curve Signals

Business Spending is Back Components of Final Demand Recovery broadened to include all sectors Business spending playing catchup (2004 strongest since 1999) -5% in 2001, 3% in 2002, 5% in 2003 Businesses know that spending on equipment is key to competition, employment costs are 75-80% of cost structure

Both Series Are Year over Year % Change Businesses Have Cash To Burn Reality: profits rocking, even domestic mfg… domestic industries in 2003: mfg +23.3%, nonfin business 75.7%, all domestics +89.3% Financing gap: +350B to –100B, lots of cash to spend Both Series Are Year over Year % Change Corporate is Net Cash Flow with Inventory Valuation and Capital Consumption Adjustments, 12 quarter moving average

Employees are Pricey! Employment Cost Index

Steady Employment Gains This Year Nonfarm Employment Growth August @ 144,000 Thanks, Bonnie and Charlie!! 24 million jobs added in 1990s after last “jobless recovery” More than 1 million so far this year, even manufacturing industries show job growth of 91K since trough in jan Quality jobs are indeed growing. This issue is not in job creation, but is who is left behind… 10 industries over the avg of $15.64 per hour added 1,068,000 over last year (75% of all new jobs), 2.8% growth in last three months Below average industries (retail, leis&hospitality, nondur goods mfg, other services) Monthly Change, In Thousands, Seasonally Adjusted

Future Job Growth in the U.S. Percent Change in Employment 2002-2012 BLS Occupational Outlook Handbook Office of Occupational Statistics and Employment Projections 21.6 million jobs created by 2012 – 20.8 million in service-providing industries (96%)

Longer Term Troubles Remain Unemployment Rate by Education Level Unemployment Rate by Job Function Perception: job losses widespread Reality: “lost workers” Labor shortages in auto mechanics, nurses, mechanical techs, truckers, heating and air contractors

Manufacturing and the U.S. Economy

More Income Keeps Consumers Spending Personal Income and Spending Higher wages & more compensation caused surge in consumer spending in 1Q Est. $1BB loss in consumer expenditures for every 1cent increase in price of gas at pump Even if oil price unchanged, gas prices increase 4-5 cents in summer time Distinguish – average hourly earnings vs wages and salary growth. Both Series Are Year over Year % Change of 3 Month Moving Average

Consumers Indeed Better Off Household Net Worth, Billions of Dollars 2000 Peak: $43.6 Trillion Current: $45.9 Trillion

Consumer Debt Mix Change Q1 2003-Q2 2004 ($ Billions) Mortgage $7 Trillion, Credit $2 Trillion

Election Year Issues and Economics Federal Budget Deficit Health Care Reform Social Security Reform