1. Anika R. Khan, Senior Economist October 20, 2015
2015 Economic Outlook
Anika R. Khan, Senior Economist
October 20, 2015

2. Five Key Themes U.S. Economic Growth Slow Global Growth
Overall economic growth is improving at a steady pace. The household sector is seeing strong gains and the housing market is advancing. However, capital investment has been lackluster and net exports will continue to be drag on real GDP growth
Slow
Global Growth
Global real GDP growth is gradually increasing, but remains below its long-run average. Although economic growth in the U.S. is strengthening, activity in other advanced economies are lagging in the recovery
Risks to U.S. Outlook
The U.S. dollar has strengthened significantly since last summer due to the divergence in the outlook for monetary policy. As a result, the U.S. manufacturing sector is showing weakness. The renewed drop in the price of oil has also been a headwind and unresolved fiscal issues will continue to add uncertainty
Data-Dependent
Federal Reserve
The Fed is looking at an array of data and will need to continue to see strengthening labor market conditions, inflation moving toward its target and improvement in emerging economies
China
China’s economic growth continues to slow bringing much of the commodity export-dependent world down with it. The manufacturing sector is weak and construction is also showing marked declines. Foreign excess reserves have likely peaked

3. Real Private Final Sales
Economic Growth
We are now six years into the recovery and economic growth is increasing at a steady pace. Despite a slow start to the year, activity is expected to improve in the coming quarters
Real GDP Forecast
Real Private Final Sales
Source: U.S. Department of Commerce and Wells Fargo Securities, LLC 3 3

4. Business Fixed Investment
GDP Components
Businesses still have a considerable amount of cash on the sidelines. We expect some of this money to be redirected into capital spending, but there are downside risks due to the recent drop in oil prices
Business Fixed Investment
Cash on Sidelines
Source: U.S. Department of Commerce and Wells Fargo Securities, LLC 4 4

5. Residential Investment Spending
Residential investment spending has made only a marginal contribution to real GDP growth. However, growth in the household sector is gradually improving
Residential Investment Spending
Household Formations
Source: U.S. Department of Commerce and Wells Fargo Securities, LLC 5 5

6. Consumer spending is driving overall economic growth
Real Consumer Spending
Retail Sales
Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

7. Household Finances
Although consumer leverage remains elevated relative to historical norms, it is well off its prerecession high and debt service has returned to more sustainable levels
Debt to Income
Debt Service
Source: Federal Reserve Board and Wells Fargo Securities, LLC

8. Revolving credit is beginning to come back
Consumer Credit
Revolving credit is beginning to come back
Source: Federal Reserve Board and Wells Fargo Securities, LLC

9. Percent change in real GDP by state 2013-2014AR AZ CA CO FL GA IA ID IL IN KS KY LA ME MI MN MO MS MT NC ND NE NH NM NV NY OH OK OR PA SC SD TN TX UT VA VT WA WI WV WY
0.7
0.8
1.4
2.8
4.7 CT
0.6 DC
1.6 DE
1.2
2.7
2.3
0.4
1.8
1.0
1.9 MA MD
0.2
0.9
-1.2
6.3 NJ
2.5
2.1
3.6 RI
2.2
1.7
5.2
3.1
0.02
3.0
5.1 HI
0.8
U.S. = 2.2%
2.7% - 6.3%
(-1.3)% - 0.7%
1.8% - 2.7%
1.2% - 1.8%
0.7% - 1.2% AK
-1.3

10. Economic Policy Uncertainty
The Index of Economic Policy Uncertainty reached its highest level on record during the debt ceiling debate, but remains well above its long-run trend
Source: Economic Policy Uncertainty and Wells Fargo Securities, LLC

11. 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, LLC

12. Treasury Fundamentals
Net Treasury issuance and international capital flows remain the key drivers of price dynamics in the market
Source: IHS Global Insight and Wells Fargo Securities, LLC

13. The composition of federal spending has shifted dramatically.
Federal Fiscal Policy
The composition of federal spending has shifted dramatically.
The CBO projects that the debt-to-GDP ratio will reach nearly 80 percent by 2025.
Composition of Federal Spending
Federal Debt Continues to Rise
Source: Congressional Budget Office and Wells Fargo Securities, LLC 13 13

14. What to watch for in the 114th Congress
Fiscal Policy Outlook
What to watch for in the 114th Congress
Key Issues
Oct. 29th - Funding for Highway Trust Fund expires
How will the gap be filled?
November 5th - Re-establishment of debt ceiling
How will Congress increase the borrowing limit?
December 11th - FY 2016 budget debate
Current funding runs out
Corporate tax reform
Both sides agree action is needed, but what will be done?
International trade agreements (TPP, TTIP)
Don’t expect immediate action, but progress is being made

15. Fed Balance Sheet Operations
Five Key Themes
Lift-Off
We continue to believe the Fed is on course to begin to raise short-term interest rates later this year. Lift-off in December is still on the table, but the risks have shifted
Yield Curve &
Term Premium
Decomposing the yield curve into the risk-neutral yield and the term premium, we find longer-dated U.S. Treasuries have been lower, principally due to a lower term premium
Fed Balance Sheet Operations
Fed balance sheet operations have had substantial effects on longer-term Treasury Yields, by reducing the term premiums on longer-dated Treasury securities
Data Dependent
The Fed is looking at an array of data and will need to continue to see strengthening in global and labor market conditions.
Safe-Haven Flows
& Policy Divergence
The divergence between monetary policies of large economies will continue to put upward pressure on the dollar with continued flows into U.S. assets and longer-term U.S. Treasuries

16. Past Tightening Cycles
There have been five tightening cycles in the past 25 years
In the 2004 cycle, the Fed stayed on hold for 12 months and hiked rates 425 bps from 1.00%
Source: Federal Reserve Board and Wells Fargo Securities, LLC

17. Lift-Off: Pace of Policy Firming
The FOMC Committee downshifted its expectations for the Federal Funds rate path in its recent meeting
The FOMC has steadily reduced its projections and the market is currently discounting the possibility of a rate hike this year
Source: Federal Reserve Board and Wells Fargo Securities, LLC

18. Fed Balance Sheet
Although the Fed is largely expected to begin increasing its target short-term interest rate this year, the Fed will remain accommodative due to its balance sheet holdings
Source: Federal Reserve Board and Wells Fargo Securities, LLC

19. Employment Situation
Slack in the labor market is steadily diminishing and wage growth is beginning to show some signs of picking up
Unemployment Rate
Unemployment Rate
Source: U.S. Department of Labor and Wells Fargo Securities, LLC 19 19

20. Inflation
Members of the FOMC expect inflation to rise over the course of the year and approach its long-run target this year as the economy gradually strengthens and inflation expectations remain stable
Source: U.S. Department of Commerce, Federal Reserve Board and Wells Fargo Securities, LLC

21. Inflation Expectations
Survey-based inflation expectations remain stable, while market-based measures have fallen
Market-Based Inflation Expectations
Survey-Based Inflation Expectations
Source: Bloomberg, LP, University of Michigan and Wells Fargo Securities, LLC 21 21

22. A Divergence in Central Bank Policy
Over the next year, central bank policies will continue to diverge
Source: Bloomberg LP and Wells Fargo Securities, LLC

23. Global Outlook

24. Global Real GDP Growth
Global real GDP growth has grown slightly below its long-run average in recent years. Although we look for global GDP to increase somewhat next year, we do not expect to see the robust pace of growth seen in the previous expansion
Source: IHS Global Insight and Wells Fargo Securities, LLC

25. Eurozone GDP Forecast
The Eurozone has emerged from its double-dip recession, but the recovery will lag the U.S.
Source: IHS Global Insight and Wells Fargo Securities, LLC

26. The Euro
We expect the dollar to strengthen against the euro on stronger US growth and higher interest rates
Source: IHS Global Insight and Wells Fargo Securities, LLC

27. China

28. Chinese GDP Forecast
Growth in China is not expected to return to the double-digit rate seen earlier in the decade
Source: IHS Global Insight and Wells Fargo Securities, LLC

29. China Manufacturing & Reserves
Manufacturing activity in China continues to weaken and is also starting to weigh on the markets. China has begun whittling down its war chest of foreign exchange reserves
Manufacturing Activity vs. S&P 500
Foreign Exchange Reserves
Source: Bloomberg LP and Wells Fargo Securities, LLC

30. Chinese GDP vs Industrial Metals
A weakening Chinese economy has weighed heavily on prices, specifically industrial metals
Source: IHS Global Insight, Bloomberg LP and Wells Fargo Securities, LLC

31. China Household Assets
Equities play a limited role in the allocation of Chinese financial wealth
Source: CEIC and Wells Fargo Securities, LLC

32. American banks are not overly exposed to China
Bank Exposure
American banks are not overly exposed to China
Source: Bank for International Settlements and Wells Fargo Securities, LLC

33. Chinese Trade
Although Chinese trade has clearly weakened over the past few years, part of the recent decline can be attributed to price effects.
Moreover, the direct effects to the U.S. appear to be minimal. China accounts for just 7 percent of U.S. exports and less than 1 percent of real GDP
Source: IHS Global Insight and Wells Fargo Securities, LLC

34. Construction Started in China
Residential and nonresidential construction have slowed markedly
Source: CEIC and Wells Fargo Securities, LLC

35. U.S. Forecast 35

36. Appendix

37. Wells Fargo Economics Group Publications
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38. Wells Fargo Securities, LLC Economics Group
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