U.S. Wage Growth: Highest Since Dec-10 Jul-11. Jan-08 Jul-08. Jul-11 Jan-12. Jan-13. Jan-15. Jan-16. Jan-18. Jan-17. Jul-13. Jul-12.

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1 WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS Surprise! Inflation? March 6, 2018 Peter Donisanu Investment Strategy Analyst Key takeaways» Last month s sell-off in global equities was arguably triggered by concerns about the prospects of an inflationary surprise in the U.S. economy.» Inflation is gaining pace in the U.S. and in international developed markets, but little evidence suggests to us that a faster-than-expected price resurgence is brewing. What it may mean for investors» We believe that the evolution in global inflation and its implications for central-bank policies are likely to influence financial-market behavior this year. A surprise reading on U.S. wage growth last month arguably set the stage for a longawaited correction in global equity markets. For weeks, market participants have been waiting for some evidence of sharply rising prices to corroborate their thesis that 2018 would be the year that policymakers at the Federal Reserve (Fed), European Central Bank (ECB), and potentially even the Bank of Japan (BoJ) would solidly tighten their policy screws. While we expect central-bank policy to become generally less accommodative this year as prices rise, we believe that inflationary pressures are likely to build only gradually. In other words, we do not expect prices in the U.S., the eurozone, or Japan to accelerate at an unwieldy rate as some market expectations have suggested. Nevertheless, we are monitoring credit growth and household price expectations as two likely canaries in the inflation coal mine of surprise inflation. Thus far, these two measures suggest little reason for alarm. Chart 1. U.S. wage growth has risen, but it is not a good inflation predictor Y/Y change (%) U.S. Wage Growth: Highest Since 2009 Inflation Y/Y change (%) 0.5 Wages Tend To Lag Inflation r = Wages Y/Y change (%) Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 U.S.wage growth Source: Wells Fargo Investment Institute, Bloomberg; February 27, Jan-08 Aug-08 Mar-09 Oct-09 May-10 Dec-10 Jul-11 Feb-12 Sep-12 Apr-13 Nov-13 Jun-14 Jan-15 Aug-15 Mar-16 Oct-16 May-17 Dec-17 U.S. headline consumer price inflation U.S. wages (lagged 6 months) 2018 Wells Fargo Investment Institute. All rights reserved. Page 1 of 5

2 What about the wage data? The data report that market participants responded to with alarm last month was the Bureau of Labor Statistics hourly wage report. A reading of 2.9% YoY growth in January was indeed its highest level since Yet, as Chart 1 illustrates, this yearly rebound follows wide variations in wage growth at the end of We believe that there are two key points that investors should take away from this data print. First, one month of rising wage growth does not necessarily make a trend. This is of particular note for a data series that is known to experience wide variations, particularly when inclement weather affects hourly (versus salaried) workers ability to go to work. This view may change if this week s wage report is in line with economists 2.9% wagegrowth expectations for February. Yet, that brings us to our second point: hourly wages lag (don t lead) inflation. We conducted a statistical analysis on monthly wage and core (excluding food and energy prices) inflation data going back 10 years, and we found that wage growth trails inflation by about six months. This is an important point, because (while central bankers over the past year have cited rising wage inflation as a potential trigger for policy action) recent data shows that core inflation has leveled off. If the historical relationship between core inflation and wages holds, we believe that market participants pricing in higher wage growth could be setting themselves up for disappointment. Chart 2. Measures of global inflation suggest little evidence of acceleration Sources: Wells Fargo Investment Institute; Bloomberg; February 27, Note: A z-score reflects a standardized measure of change relative to a three year average for data sets that exhibit wide variability in absolute values. The wider the bands (higher/lower z-score), the greater the change is in a given measure of inflation over time (relative to the average). DM = developed markets. EM = emerging markets. Global inflationary pressures have been subdued Taking a step back, then, what should investors make of the current global inflationary environment? Our work shows that component indicators of inflation measured broadly across developed markets (including the U.S.) and emerging-market economies suggest that price conditions are generally balanced. In developed markets, price advances across various indicators reflect growth in line with trends over the past three years. Chart 2 illustrates this point. If inflationary pressures were indeed building at a faster clip, we would expect to see the plus signs 2018 Wells Fargo Investment Institute. All rights reserved. Page 2 of 5

3 in each of the DM boxes in Chart 2 being positioned all the way at the top end of each respective band. This does not appear to be the case, and the chart suggests that price growth across various indicators is either at (or slightly above) three-year averages. For emerging markets, the data reflect a trend of declining prices, which is consistent with our view that tighter monetary policy in emerging markets over the past few years has helped to curb rising rates of inflation there. What would we expect to see if inflation were to surprise to the upside? If inflation were to surprise to the upside in the U.S., the eurozone, or Japan, two measures that we would monitor include: 1) increasing utilization of consumer credit and 2) changing household expectations of price levels. So far, the evolution of trends in household credit growth (notably in the U.S., where the economic expansion has been the longest) is consistent with a late-cycle expansion. On the expectations side of the equation, a similar trend appears to be unfolding. For example, a measure of consumers inflation expectations is near 10-year highs, but it still is far from the levels set at the start of 2000 (around the end of the previous cycle). Taken together, these two measures have yet to suggest that headline inflation is likely to surprise anytime soon. Markets and the monetary policy conundrum We believe that the evolution in global inflation and its implications for central-bank policies are likely to have an outsized impact on global financial markets this year. For months, market participants have been primed for policy tightening from the Fed, ECB, and BoJ, yet their expectations have been dashed as monetary policy meeting minutes cited a weaker inflationary environment, particularly as it related to wage growth. Nevertheless, market participants remain prepared for policy rates to go higher, mainly because of robust improvement in the global economy. This presents a policy conundrum for financial markets, particularly as it relates to Fed policy. For example, there is potential for the U.S. economy to be tipped into a recession too soon if policymakers feel pressured by market expectations to raise rates while inflation remains low. Alternatively, a threat exists that waiting too long to get ahead of inflation could force the Fed, the ECB, or the BoJ to abruptly tighten policy, potentially tipping their respective economies into recession. We believe that this uncertainty has, in part, contributed to the latest bout of financial-market volatility. In the grand scheme of things, we believe that policymakers are likely to remain datasensitive and pay more attention to actual inflationary trends and less attention to market expectations for an important reason: forward guidance. Policymakers at these three key central banks have worked diligently over the past decade to build credibility with market participants. With that said, policymakers at the Fed, the ECB, and the BoJ continue to signal their reliance on relative data dependence. We would expect central bankers to commit to tighter monetary policy as inflationary pressures rise and remain above target rates for a prolonged period of time. Until then, credit growth and sentiment are likely to be of greater importance to financial markets as far as surprise inflation is concerned Wells Fargo Investment Institute. All rights reserved. Page 3 of 5

4 Economic Calendar Date Report Estimate Previous 3/6/2018 Factory Orders -0.50% 1.70% 3/6/2018 Factory Orders Ex Trans % 3/6/2018 Durable Goods Orders % 3/6/2018 Durables Ex Transportation % 3/6/2018 Cap Goods Orders Nondef Ex Air % 3/6/2018 Cap Goods Ship Nondef Ex Air % 3/7/2018 MBA Mortgage Applications % 3/7/2018 ADP Employment Change 193k 234k 3/7/2018 Nonfarm Productivity -0.10% -0.10% 3/7/2018 Unit Labor Costs 2.10% 0% 3/7/2018 Trade Balance -$52.6b -$53.1b 3/7/2018 U.S. Federal Reserve Releases Beige Book 3/7/2018 Consumer Credit $19.000b $18.447b 3/8/2018 Challenger Job Cuts YoY % 3/8/2018 Initial Jobless Claims k 3/8/2018 Continuing Claims k 3/8/2018 Bloomberg Consumer Comfort /8/2018 Household Change in Net Worth -- $1742b 3/9/2018 Change in Nonfarm Payrolls 200k 200k 3/9/2018 Two-Month Payroll Net Revision /9/2018 Change in Private Payrolls 195k 196k 3/9/2018 Change in Manufact. Payrolls 15k 15k 3/9/2018 Unemployment Rate 4.00% 4.10% 3/9/2018 Underemployment Rate % 3/9/2018 Average Hourly Earnings MoM 0.30% 0.30% 3/9/2018 Average Hourly Earnings YoY 2.90% 2.90% 3/9/2018 Average Weekly Hours All Employees /9/2018 Labor Force Participation Rate % 3/9/2018 Wholesale Trade Sales MoM % 3/9/2018 Wholesale Inventories MoM % 3/12/2018 Monthly Budget Statement -- $49.2b Source: Bloomberg, as of March 1, Wells Fargo Investment Institute. All rights reserved. Page 4 of 5

5 Risk Considerations All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities. General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR Wells Fargo Investment Institute. All rights reserved. Page 5 of 5