Economic Outlook

1. Economic Outlook Winter 2013 US Economy Prevails .. Maybe Gregory Miller Chief Economist

2. Economic Outlook • The US economy is on a tentative path toward sustainable expansion • Cap Spending stalled for Presidential Campaign – Always Does! • Consumer holding on, but resources stretched thin • Labor market: Housing is back but skills rule • Inflation is below 2%; gasoline prices no help • But, the economy confronts an overload of uncertainty • Government still has extensive agenda of unfinished and barely-started business • Failure to date • Fiscal Cliff Half Done • Debt Ceiling • Global recession is a real issue but export impact is minor • Inflation: On hold; risk of deflation • Energy: Shale boosts US/Canada above OPEC capacity • Monetary Policy: Bernanke, ZIRP, Guidance, QE. • Fed is Bailing Out “Do Nothing Right” Congress

3. Economic Performance: Back Story • Since Great Recession, THREE sectors account for “all the BAD”: • Housing • Worst housing recession in history • Bank lending • Regulatory uncertainty is not the way to repair capital markets • Government/ Politics • The risk of committing ECONOMIC issues to POLITICAL solutions • Politics can stall; Markets never do

4. Housing is Back • Still has plenty of warts, i.e. foreclosure backlog • Production is back • Prices are low but rising, and mortgage rates are historically low • Biggest problem is getting borrowers through underwriting

5. Bank lending is half back • Credit is the “grease.” All economies need access to capital • Not a LIQUIDITY problem! TRANSMISSION problem! • Government regulatory uncertainty in aftermath of financial meltdown leaves bank liquidity sequestered • And there’s plenty of liquidity in “reserve”: IOER from 3% to 93%

6. Not everything wrong with the economy is the government’s fault. • BUT MOST OF IT IS: • Policy throwing good money after bad • Government still recession 3.5 years after recession ended • Fiscal Cliff/ Debt/ Taxes • Bad policy for the times • Higher taxes and spending cuts are correct policy, but stretched over 5 or 10 years. • Brinksmanship yields uncertainty

7. Not everything wrong with the economy is the government’s fault. • BUT MOST OF IT IS: Debt Ceiling • Brinksmanship yields uncertainty – probably the worst thing for business and households • The irony of the debt ceiling is, the level is not the problem -- Downgrade is. • US debt remains the global “safe haven” • Who owns it, anyway?

8. There is a recession out there somewhere • The prospect of near-term recession should not be a surprise • The US economy suffers cyclical recession on average about every five years • The current recovery is now over three years old • Year-to-date GDP = 1.7% • When the economy slows to 2.0%, it does not remain there long • Beneath 2.0%, we quickly resolve to either re-acceleration or recession • The probability is about 50/50

9. What Bernanke Knows • Bernanke will hold the funds rate at ZIRP (Zero Interest Rate Policy). • Effective zero, until 2015 unless something remarkable occurs – like rationality out of politics. • Bernanke sees his short-term goal as protecting economy from Fiscal Cliff/sequestration. • Part of Bernanke’s decision to deploy an open ended QE3 was a direct jab at Congress failure • Further, No support for rumors of Bernanke retirement • He can always go back to being a college professor

10. Deterioration of Household Resources • The single biggest market-based risk to the economy: • deterioration of household resources. • No real wage increases for the past five years. Households are falling behind. And taxes have gone up. • Past 20 years = 2.8 • Past 5 years = -0.6

11. Labor Market: Composition is the key • Unemployment peaked at 10.2% but slowly recovered to 7.8%. Expect that is will accelerate downward from here. But there are constraints on improvement. • During the Great Recession, 30% of all jobs lost were in construction and mortgage finance.. • With only a year of housing market recovery, housing accounts for 10% of job gains • Fed Chair Bernanke expects 6.5% unemployment in mid-2015 • You should expect 6.5% in mid-2014 • The underlying labor market weakness is skill complement. • Unemployment for college grads is 3.9%; for less-than-high school it is 9.9% -- 2.5 times higher

12. Summary and looking ahead • The US economy weathered the Great Recession • Recovery and expansion is a tribute to the resilience of the Private Sector driven by US business and confirmed by relentless US consumers • Expansion continues through the next two years but risk is high • Consumer resources are stretched thin while taxes rise • Business investment should rebound in the short-run and corporate profits should continue