Economics Group MONTHLY OUTLOOK. May 13, Eurozone Real GDP Bars = Compound Annual Rate Line = Yr/Yr % Change

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Erik Newman
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1 May 13, 2015 Economics Group MONTHLY OUTLOOK Groundhog Day U.S. Overview This recovery has been reminiscent of the movie Groundhog Day. Economic growth seems destined to replay the story from prior years, with a weak Q1 followed by a rebound in the spring and summer. Recall in 2014 real GDP declined at a 2.1 percent annual rate in Q1 before rebounding at a 4.6 percent pace in Q2 and finishing the year up percent. The economy seems to be sticking to the script in Firstquarter real GDP growth came in at a 0.2 percent annual rate, and recent data suggest that revisions will bring that number even lower. A mix of temporary shocks the harsh winter weather in the Northeast and the West Coast ports stoppage combined with a couple of more lasting shifts the slide in oil prices and abrupt strengthening in the dollar weighed on growth. These four factors took a big bite out of Q1 growth by holding back construction, consumer spending and manufacturing activity. In addition, we endured some unusually large swings in international trade. The reasons behind the Q1 slowdown are less temporary than last year. Oil prices are lower than they were a year ago and the dollar is stronger. Both factors will remain a drag on growth in Q2. In addition, inventories added 0.7 percentage points to Q1 growth. Those additions will need to be drawn down in coming quarters. By contrast, inventories subtracted 1.2 percentage points from Q GDP growth and the subsequent rebound in inventory building added some oomph to the following quarter. The swing in inventory building is a big reason we are looking for real GDP to rise at just a percent annual rate in the current quarter and now look for just percent growth for the year as a whole. International Overview A Below-Average Year for Global GDP Growth in 2015 We forecast that global GDP will grow roughly 3 percent in 2015 before returning next year to its long-run average growth rate of 3.5 percent. On one hand, economic data in the Eurozone have generally been stronger than most analysts had expected just a few months ago. Lower energy prices, euro depreciation and accommodative monetary policy are all exerting some tailwinds on Eurozone economic growth at present. In our view, the cyclical upswing in the Eurozone will continue and should strengthen somewhat in coming quarters On the other hand, however, the Chinese economy continues to decelerate as the government attempts to rebalance the economy toward more consumer spending before a debtfueled investment collapse leads to a deep economic downturn. In our view, the Chinese government will tweak economic policy at the margin in an effort to smooth the adjustment of the economy. Although we forecast that the rate of Chinese GDP growth will continue to moderate, we believe that Chinese authorities will be able to more or less pull off a soft landing. The Chinese slowdown appears to be exerting some restraint on economies with significant trading ties with the mainland. For example, weaker demand for commodities in China is helping to depress investment in the mining sector in Australia. Some of Brazil s current economic wounds are selfinflicted but slower real GDP growth in China certainly does not help the Brazilian economy, which sends about 20 percent of its exports to mainland China. 1 U.S. Real GDP Bars = CAGR Line = Yr/Yr Percent Change GDP - CAGR: 0. GDP - Yr/Yr Percent Change: 3. 1 Eurozone Real GDP Bars = Compound Annual Rate Line = Yr/Yr % Change Compound Annual Growth: 1.3% Year-over-Year Percent Change: 0.9% Source: U.S. Department of Commerce, IHS Global Insight and Wells Fargo Securities, LLC -1 This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

2 Economics Group U.S. Outlook Wells Fargo Securities, LLC Time for the Recovery to Get Rolling We expect real GDP to expand at a modest percent annualized pace during Q2. Growth will be driven by a rebound in consumer spending and residential construction. International trade should be a modest drag in Q2 despite shaving a full 1.4 percentage points off growth in Q1. The continued slide in energy production and slower growth in the factory sector will continue to weigh on growth. The current environment is somewhat reminiscent of the 1980s, when the economy endured a series of rolling recessions throughout parts of the economy but continued to post solid overall gains. The setbacks facing the economy today seem a little less formidable than they did back then, but growth is also a little less robust. The important point to note is that beneath the quarterly gyrations in real GDP growth are some pretty meaningful shifts in the composition of growth. It is also helpful to note that there is enormous stimulus in the pipeline that could lead to a resurgence in growth in some areas. Consumer spending should post stronger gains in coming months. So far, the slide in gas prices has had only a limited effect on outlays. Real personal consumption grew at just a 1.9 percent pace in Q1. The growth in consumer spending is disappointing given the plunge in gas prices. Consumers tend to respond less to temporary windfalls in purchasing power than they do permanent shifts. So, while lower gasoline prices are clearly welcome, spending would likely perk up more if income growth were to accelerate in a lasting and meaningful way. Most of the lift from lower gas prices, however, has been for smaller discretionary purchases such as dining out and movies. We expect spending growth to gain momentum in Q2, as bigticket purchases bounce back following more modest gains this winter. We are looking for personal consumption outlays to rise at a 2.8 percent pace in Q2 and percent for After dipping in Q1, residential outlays appear poised for stronger gains. First-quarter activity was affected by the weather, with construction activity held back in the Northeast and parts of the South. Demand for housing seems to be improving. While the winter months are notoriously volatile, sales of new and existing homes have shown encouraging trends recently, with new home sales and pending home sales rising in recent months. Builder sentiment has also improved. The one big fly in the ointment is the lack of available inventory, which has led to firming home prices more recently. Builders are also running into quite a few roadblocks in developing new residential communities, which means that new supplies may take longer to come online and may be pricier than we have seen in recent years. Commercial construction is also showing some encouraging signs. Development of industrial space has picked up around major seaports and key distribution hubs. Office and retail development has been slower to get back on track, but both are improving and will add to growth once the drag from reduced oil exploration plays out. Oil prices have rebounded slightly faster than we had projected, even though production and consumption patterns have been close to expectations. Prices have benefitted from the unrest in the Middle East. If these conflicts subside, prices could retrace much of their recent gains. If prices hold up, however, the drag from energy exploration and production could prove to be more moderate. Even with the slower growth at the start of this year and less of a rebound in the spring, we continue to believe the Fed remains on course to begin to raise short-term interest rates later this year. We are looking for no more than two hikes in the federal funds rate this year, however. Long-term rates have already backed up following better economic news out of Europe. September remains the most likely timing for lift-off, or the start of efforts to normalize interest rates. The September date is thought to be optimal for the Fed to begin to raise interest rates because it will be holding a press conference following that meeting. The Fed has been trying to get away from being datespecific, however, and has tested a web-conferencing system if it decides to raise rates at a FOMC meeting that does not have a scheduled press conference. Real Personal Consumption Expenditures Bars = CAGR Line = Yr/Yr Percent Change 1,800 1,600 Baker-Hughes Rig Count vs. Oil Prices Oil Rotary Rigs; USD per Barrel Oil Rig Count: 668 (Left Axis) WTI: $59.8 (Right Axis) $180 $160 1,400 $140 1,200 1,000 $120 $ $ $ $40 - PCE - CAGR: 1.9% PCE - Yr/Yr Percent Change: $20 $0 Source: U.S. Department of Commerce, IHS Global Insight and Wells Fargo Securities, LLC 2

3 Economics Group U.S. Economic Wells Fargo Securities, LLC Wells Fargo U.S. Economic Actual Actual Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q Real Gross Domestic Product (a) Personal Consumption Business Fixed Investment Equipment Intellectual Property Products Structures Residential Construction Government Purchases Net Exports Pct. Point Contribution to GDP Inventory Change Pct. Point Contribution to GDP Nominal GDP (a) Real Final Sales Retail Sales (b) Inflation Indicators (b) PCE Deflator Consumer Price Index "Core" Consumer Price Index Producer Price Index (Final Demand) Employment Cost Index Real Disposable Income (a) Nominal Personal Income (b) Industrial Production (a) Capacity Utilization Corporate Profits Before Taxes (b) Corporate Profits After Taxes Federal Budget Balance (c) Current Account Balance (d) Trade Weighted Dollar Index (e) Nonfarm Payroll Change (f) Unemployment Rate Housing Starts (g) Light Vehicle Sales (h) Crude Oil - Brent - Front Contract (i) Quarter-End Interest Rates (j) Federal Funds Target Rate Month LIBOR Prime Rate Conventional Mortgage Rate Month Bill Month Bill Year Bill Year Note Year Note Year Note Year Bond as of: May 13, 2015 Notes: (a) Compound Annual Growth Rate Quarter-over-Quarter (b) Year-over-Year Percentage Change (c) Quarterly Sum - Billions USD; Annual Data Represents Fiscal Yr. (d) Quarterly Sum - Billions USD (e) Federal Reserve Major Currency Index, 1973=100 - Quarter End (f) Average Monthly Change (g) Millions of Units - Annual Data - Not Seasonally Adjusted (h) Quarterly Data - Average Monthly SAAR; Annual Data - Actual Total Vehicles Sold (i) Quarterly Average of Daily Close (j) Annual Numbers Represent Averages Source: U.S. Department of Commerce, U.S. Department of Labor, Federal Reserve Board, IHS Global Insight and Wells Fargo Securities, LLC 3

4 Economics Group International Outlook Wells Fargo Securities, LLC A Below-Average Year for Global GDP Growth in 2015 The relative economic fortunes of some of America s major trading partners have been mixed recently. The good news is that economic data in the Eurozone have generally been stronger than most analysts had expected just a few months ago. Not only are the manufacturing and service sector PMIs above the demarcation line separating expansion from contraction, but both indices have trended higher so far this year, suggesting that economic activity in the overall euro area may be gaining a bit of badly needed momentum. The Eurozone economy has some tailwinds at its back at present. The decline in energy prices helps support real income growth, and the depreciation of the euro since last summer has delivered a boost to the price competitiveness of Eurozone exports. The ECB s targeted long-term refinancing operations (TLTRO) program appears to be stimulating bank lending again. In our view, the cyclical upswing in the Eurozone will continue and should strengthen somewhat in coming quarters (see graph on front page). On the other hand, however, the Chinese economy continues to decelerate (bottom left chart). Some of this slowdown is not unwelcome by Chinese authorities. Investment spending currently accounts for more than 40 percent of real GDP in China (comparable ratios in most advanced economies are less than 20 percent). The government wants to rebalance the economy toward more consumer spending before a debt-fueled investment collapse leads to a deep economic downturn. In our view, the government will tweak economic policy at the margin in an effort to smooth the adjustment of the economy. The central bank has cut its benchmark lending rate 90 bps since December, and further rate cuts seem to be in the offing in the future. Some infrastructure projects could be accelerated to shore up overall economic growth. Although we forecast that the rate of Chinese GDP growth will continue to moderate, we believe that Chinese authorities will be able to more or less pull off a soft landing. The Chinese slowdown appears to be exerting some restraint on economies with significant trading ties with the mainland. For example, Australia sends one-third of its exports to mainland China, and the overall rate of GDP growth in Australia has downshifted over the past year or so due, at least in part, to weakness in investment spending in the mining sector. Commodities account for two-thirds of Australia s exports, and weaker demand for commodities in China is helping depress investment in the mining sector down under. Brazil, which sends about 20 percent of its exports to mainland China, is also feeling some of the side effects of slower Chinese economic growth. The Brazilian economy slipped into a mild recession in 2014, and we forecast that real GDP growth in Brazil will remain sluggish into next year (bottom right chart). Some of Brazil s economic wounds are self-inflicted (e.g., weak infrastructure spending has led to production bottlenecks), but slower growth in China certainly does not help the Brazilian economy. Real GDP in Japan continues to grow, but the expansion lacks vigor. If, as we project, real GDP in Japan grows only 1 percent or so this year, it is unlikely that the CPI inflation rate this year will get anywhere close to the Bank of Japan s (BoJ) two percent target. In other words, the BoJ will likely continue to maintain an accommodative monetary policy stance for the foreseeable future. As shown in the table on the following page, we forecast that global GDP will grow roughly 3 percent in 2015, which is slower than the 3.4 percent rate that the IMF estimates the global economy grew last year. We estimate that global GDP growth will return to its long-run average of 3.5 percent next year. 15% Chinese Real GDP Year-over-Year Percent Change 15% 1 Brazilian Real GDP Year-over-Year Percent Change % 1 13% % 11% 1 1 9% 9% 7% 7% - 5% 5% Year-over-Year Percent Change: 7. Real GDP: -0.3% - Source: Bloomberg LP, IHS Global Insight and Wells Fargo Securities, LLC - - 4

5 Economics Group International Economic Wells Fargo Securities, LLC (Year-over-Year Percent Change) Wells Fargo International Economic GDP CPI Global (PPP weights) % 3.5% 3.3% 3.5% Global (Market Exchange Rates) % 3.1% n/a n/a n/a Advanced Economies % % United States 2. % 2.9% % % Eurozone 0.9% % 1.3% United Kingdom % 1.5% 0.5% 1.5% Japan -0.1% % 2.7% Korea 3.3% 3.1% 3.7% 1.3% 0. % Canada 2.5% 1.9% % Developing Economies % % 5.9% 5.3% China % % 1.7% India 2 6.9% n/a 5.3% 5.3% Mexico 2.1% % % Brazil 0.1% % 6.3% 8.9% 8.1% Russia 0.7% -3.5% % 5.7% as of: May 13, Aggregated Using PPP Weights 2 s Refer to Fiscal Year (End of Quarter Rates) 3-Month LIBOR 10-Year Bond Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q2 Q3 Q4 Q1 Q2 Q3 Q4 U.S % % 1.95% 5% 2.19% 5% 1% 2.53% 2.77% 2.89% Japan % 0.37% % % 0.65% Euroland 1-3% -5% -5% -5% - 5% 0.45% % U.K. 0.55% 0.55% 0.65% 0.95% 1.15% % % Canada % 1.25% % 5% as of: May 13, year German Government Bond Yield 2 3-Month Canada Bankers' Acceptances Wells Fargo International Interest Rate Source: IHS Global Insight, IMF and Wells Fargo Securities, LLC 5

6 Wells Fargo Securities, LLC Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) (212) John E. Silvia, Ph.D. Chief Economist (704) Mark Vitner Senior Economist (704) Jay H. Bryson, Ph.D. Global Economist (704) Sam Bullard Senior Economist (704) Nick Bennenbroek Currency Strategist (212) Eugenio J. Alemán, Ph.D. Senior Economist (704) Anika R. Khan Senior Economist (704) Azhar Iqbal Econometrician (704) Tim Quinlan Economist (704) Eric Viloria, CFA Currency Strategist (212) Sarah House Economist (704) Michael A. Brown Economist (704) Michael T. Wolf Economist (704) Mackenzie Miller Economic Analyst (704) Erik Nelson Economic Analyst (704) Alex Moehring Economic Analyst (704) Donna LaFleur Executive Assistant (704) Cyndi Burris Senior Admin. Assistant (704) Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, 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, LLC, 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, LLC. ("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, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC 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, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC 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, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2015 Wells Fargo Securities, LLC. 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 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. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE

Economics Group MONTHLY OUTLOOK. January 14, Eurozone Real GDP Bars = Compound Annual Rate Line = Yr/Yr % Change

January 14, 2015 Economics Group MONTHLY OUTLOOK U.S. Overview Better First Half of 2015, Fed Call Key Our forecast remains for U.S. real GDP to grow roughly 2.5-3 percent in each of the next two years,