The Economic Outlook. Consumers still expected to drive strong growth in May Outlook Review

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1 The Economic Outlook May 2015 Consumers still expected to drive strong growth in 2015 Outlook Review The first quarter got the year off to a weak start as weather, challenges in the energy sector and a surge in the U.S. dollar slowed economic growth at the start of the year. The lingering effects of a West Coast port slowdown in 2014 added additional logistical challenges at the start of the year. Despite a slow start and new challenges, the US economy is expected to accelerate in the second quarter and remain on track for solid consumer led real GDP growth for the rest of 2015 and into Consumers were confronted with an unseasonably harsh winter for the second year in a row, reducing their consumption spending during the first quarter again. Inflation adjusted consumer spending rose 1.9%, slowing down from stellar 4.4% annualized rate in the fourth quarter. The slowdown in spending will likely be temporary as the fundamental conditions for consumers have improved steadily throughout the recovery and are generally sound. Despite a relatively soft period for GDP growth, 775,000 net new jobs were created year to date through April and the unemployment rate declined to 5.4% its lowest point since May Wage growth has remained tepid and underemployment has remained above long term trends, but improvements in these areas are forecasted with the expected continuation of labor market recovery this year. The historic drop in energy prices since last summer has been a boon to most consumers, flattening overall inflation measures, and potentially raising real disposable incomes in The low interest rate environment of recent years has helped consumers improve their finances to the point where the aggregate Financial Obligations Ratio reached its lowest point since it began being measured in (Please see the chart below.) Wealth has been rising in not only in financial markets, but also in housing markets where the S&P Case Shiller 20 metro area composite home price index has risen nearly 30% in the last 3 years. With interest rates still historically low overall, consumer spending growth on both durable goods and residential investment are expected to be the strongest of the recovery to date in Consumers Reduce Ratio of Financial Obligations to Disposable Income to Lowest Point in Over 3 Decades Household Financial Obligation Ratio Latest data plotted: 2014 Q4.Household Debit Service Ratio (ratio of debt service payments to disposable personal income), plus auto lease payments, rent on tenant occupied property, homeowners insurance and property tax Prepared by: George Mokzran, Ph.D. Director of Economics, Huntington National Bank 1

2 Strong Jobs Growth and Low Interest Rates Support Vehicle Sales and Production at High Levels Total Vehicle Sales Fully Recovered Millions of Units, Seasonally Adjusted Annual Rate Month Latest month plotted: April Real Incomes Get Boost from Job Growth and Lower Energy Prices since 2013 * Real After-Tax Personal Income Percent Change Since Inflation adjusted Disposable Personal Income Latest month plotted: March Per Capita *Spikes in chart denote temporary tax cuts or rebates that tend to be large as a percent of income but short in duration

3 New Challenges Arise Oil Prices Begin To Rebound from Dramatic Declines Although consumers benefitted from a sharp drop in energy prices in the latest year, historically low crude oil prices also created the most challenging environment for many energy producers since the recession. The negative impact has been especially evident in sharp cutbacks in oil rigs of around 60% according to the International Energy Agency (IEA). Total Mining employment declined by 48,700 workers between December and April, largely due to reduced demand for mining support activities to the energy sector. Jobs were also lost in the manufacturing sector due to reductions in demand for oil & gas infrastructure investment. The price of West Texas Intermediate crude oil has appeared to bottom at an average $48.54 per barrel in the first quarter. Spot prices have already approached $60 per barrel and are expected to continue a gradual rise as demand grows from a generally expanding U.S. and world economy. Oil rig closures will likely reduce supplies to the market in the coming months, thereby further putting upward pressure on oil prices. However, the oil & gas industry, a major source of economic growth in the United States during the economic recovery, will likely be generally cautious in its capital investment and employment decisions in It could also incur long term reductions to domestic energy supply if end markets for high sweet crude oil the major liquid product of fracking technology are not opened abroad or in refinery destinations in the United States. Domestic refinery capacity for sweet crude oil is insufficient to meet new supply generated by the fracking technologies, and domestic oil producers are currently prohibited from exporting non processed crude oils internationally. If these conditions continue, more cutbacks in the energy sector are likely. Exports declined every month from October to February as a stronger dollar reduced the price competitiveness of many U.S. goods and services in international markets. Exports rose in March for the first time since October, but the increase may have been due in part to the end of the West Coast ports labor slowdowns. Nonetheless, a recent stabilization of the dollar, should it hold, and a general firming of the world economy are expected to slow the downward forces on exports as the year advances. Like energy, export development has been an important driver of the current U.S. economic recovery and expansion. A slowdown in exports will likely impact industries and regions with especially strong international connections in 2015, but these impacts are expected to ease once the dollar stabilizes and the world economy improves. Export Growth Expected to be Slow Compared to Recent Years 3

4 Inflation The energy component of the consumer price index (CPI U) declined 18.0% between June 2014 and March As a result, the overall consumer price index in March was virtually unchanged from March of last year. However, the CPI U began to rise at a relatively normal month to month pace of 0.2% in February and March as energy prices reversed direction. The CPI U excluding food and energy, also referred to as a core inflation measure, rose a steady 0.2% during each month in the first quarter for 1.7% annualized growth for the entire first quarter. Hence, inflation has begun to move in line with what has been viewed as typical in recent years. Demand for energy and other goods and services were suppressed by inclement weather in the first quarter, but a general strengthening of consumer demand is expected in the second and third quarters that will likely put firmer upward pressure on prices than was experienced in early Due to a sharp recent percent rise in energy prices from low levels, the overall annualized growth in the CPI U is expected to bounce upwards in the second quarter, and subsequently return to a relatively normal long term inflation rate for the U.S. economy in the 2.0 to 2.5% range. Areas where inflation is expected to be above average include rents and consumer services, but price gains will likely be generally widespread. For example, the prices of vehicles and apparel rose during March as stronger consumer demand offset downward cost pressures created by the stronger dollar. In sum, broadbased inflation in line with the historical norm of the last decade is forecasted to return during the second half of the year. Monetary Policy Will Be Data Driven Unusually slow overall GDP growth in the first quarter coupled with the likelihood of slower economic growth in the industrial part of the U.S. economy for at least the first half of the year will likely result in a somewhat slower recovery in labor markets during 2015 than was originally projected. Hence, the first Fed Funds rate target increase will likely be delayed until sometime in the second half of 2015 at the earliest. The timing of interest rate increases is expected to align with the general conditions of labor markets during interest rate lift offs in previous cycles, and most notably in the most recent experience. On June 30, 2004, the Fed Funds rate target was increased for the first time in a succession of policy interest rate increases. In July 2004, the official unemployment rate was at 5.5%, marginally above the April 2015 unemployment rate of 5.4%. However, the U 6 unemployment rate, the unemployment rate that also includes marginally attached workers and part time workers that would like to be working full time, was at 9.5% in July 2004, well below the U 6 unemployment rate of 10.8% in April. Monetary policy makers have consistently expressed concerns that the official unemployment rate, though relatively low by historical standards, does not reflect the true state of labor markets because measures such as this underemployment rate have remained high. However, as evident in the chart below, the U 6 unemployment rate has been descending rapidly. It is forecasted to continue to decline steadily until it is projected to reach 9.5% sometime in late 2015 or early As this measure of unemployment and indeed underemployment declines, wage growth will likely pick up in a general reflection of a strengthening labor market. At this projected future point, the conditions in labor markets for policy rate increases will likely be met. The Broad U 6 Unemployment Rate will likely be an Important Indicator of when Policy Interest Rates Begin to Rise 4

5 Monetary Policy (continued) Other factors will likely be important in the ultimate timing decision of policy rate takeoff. The Federal Reserve has been publicly preparing markets for the eventual lifting of policy interest rates. Therefore, waiting excessively long could reduce credibility. While moving too early in raising policy interest rates has its risks to economic growth, there are sound policy and operational reasons to raise policy interest rates sooner in a small first step that would not necessarily be immediately followed up by other interest rate increases or other tightening measures. Such an increase would allow the Federal Reserve and financial markets to better gage changes in financial flows that will likely occur as interest rates rise. Additionally, a small interest rate increase implemented sooner rather than later would reduce excessive seeking of returns by investors resulting from the unusually low interest rate environment, thereby reducing the risks of financial bubbles forming. Finally, the Federal Reserve would probably prefer a period when there are few unusual events occurring in financial markets and the international economy. They would also probably avoid seasonally volatile periods such as the weeks around year end. Taking all of these factors into account, the end of the third quarter is the forecasted date for the first increase in policy interest rates, in which the Fed Funds rate target is forecasted to rise from its current 0 to 0.25% range to a new range of 0.25% to 0.50%. Subsequently, the Fed Funds rate target is forecasted to be held for an unusually lengthy period spanning into late January at the earliest before the next increase in the Fed Funds rate target is implemented. This forecast is contingent on a strong consumer led acceleration in the economy in the second and third quarters of 2015 that brings the U 6 unemployment rate down close to 9.5%. The Federal Reserve is forecasted to continue gradual measured Fed Funds rate target increases throughout 2016, and end the year at 1.50%. Although the forecasted timing of the first Fed Funds rate target is pushed back by only one quarter from the previous forecast, the gradually rising path of interest rates in the forecast is maintained to reflect weaker average real GDP growth in the U.S. than has been the norm during past economic cycles. Maintained somewhat higher than the Fed Funds rate target, the interest rate paid on excess reserves (IOER) will likely rise along with the Fed Funds rate target, and is expected to support the Federal Reserve s monetary policy in a normalizing rate environment. The new Overnight Reverse Repurchase agreement (ON RRP) is potentially another policy interest rate tool in a rising rate environment, as it could be set precisely by the Federal Reserve, and it could put a firm floor under money market interest rates. Given the extraordinary levels of liquidity in financial markets, the actual Fed Funds rate will likely deviate more from the Federal Reserve s target during the early stages of policy rate increases than it has done during past periods when the Fed Funds rate target was raised. The new monetary policy tools IOER and ON RRP should aid the Federal Reserve in reducing this potential volatility. The Federal Reserve ended its outright purchases of securities after its October 28 29, 2014 FOMC meeting, although it plans to continue its reinvestment of principal payments on its portfolio into agency mortgage backed securities (MBS) and to roll over maturing Treasury bonds upon their maturity. According to Chairwoman Yellen in the September FOMC news conference, the Federal Reserve s intention is to gradually reduce the size of its assets to a level consistent with no more than it needs to effectively perform monetary policy. This downsizing will likely take a significant period of time. Chairwoman Yellen estimates that the desired size of the Federal Reserve s balance sheet won t be achieved until the end of this decade. Hence, the Federal Reserve plans to maintain its large balance sheet and the monetary stimulus it provides for the next several years, even as it raises its policy interest rates. The European Central Bank (ECB) is expected to continue its large quantitative easing program comprising asset purchases of 60 billion euros per month that began in March and is scheduled to end in September The ECB will buy government bonds proportional to the size of the respective member economies, securities issued by European institutions and private sector bonds. The purchases will massively expand high powered reserves in the Eurozone banks by over 1 trillion euros when completed. As has been the case with the activist monetary policies in the U.S. and Japan, the purchases will probably exert downward pressures on long term interest rates worldwide. However, the Europeans have added a caveat to their monetary policy that has not occurred in the other major central banks it charges the banks in its system 0.2% to hold the reserves that the banks receive as a result of the asset purchases. (Source: WSJ) Hence, European banks have an added incentive to lend out their reserves. The historically stimulative monetary policy of the ECB virtually assures inflation will reaccelerate in the Eurozone, as already evidenced by 3 consecutive month to month increases in the Eurozone consumer price index. Low interest rates and a cheaper euro also add economic stimulus to Europe overall, but the success of implementing structural reforms in the stressed European economies will ultimately determine the success of the euro experiment in the long term, in all likelihood. 5

6 Monetary Policy (Continued) The direction of monetary policies outside the US will likely begin to diverge. The Bank of Japan (BOJ) has committed to continue its extraordinary monetary policy into 2015, which is the highest relative to GDP in the world. In contrast to the ECB and BOJ, the Bank of England is beginning to signal a potential tightening of monetary policy and lifting of policy interest rates to counter rising inflationary pressures in the United Kingdom. Countries with large natural resource sectors such as Canada and Australia may continue to reduce their policy interest rates to offset pressures on economic growth created by lower commodity prices. Other countries may find reducing policy rates keep their respective currencies from appreciating to the point where exports slow overall economic growth. This will likely be the case for many of the major trading partners with the Eurozone in Hence, the European actions, like those of other major economies in the world, will likely set the monetary policy tone for the other economies worldwide in Pro growth policies imply massive injections of liquidity worldwide and potentially in any country challenged by economic growth. Treasury Yield Curve The short end of the Treasury yield curve will likely remain low and in line with the Fed Funds rate target and gradually lead the Fed Funds rate target in Long term Treasury interest rates were suppressed by weak worldwide economic growth, central bank monetary policies in the U.S. and globally including recent European Central Band actions, excess savings worldwide and general uncertainties in the financial landscape. Despite the end of additional Federal Reserve bond purchases, high demand for Treasury bonds for liquidity, regulatory, or asset diversification purposes has probably put further downward pressure on long term interest rates. These combined downward forces, including the recent sharp declines in government bond interest rates in Europe, have resulted in the 10 year Treasury interest rate declining below 2.0% in early However, the onslaught of downward forces has now largely been priced into bonds and is not likely to intensify further as the 10 year Treasury yield has been rising in recent weeks. Continued solidifying of the U.S. economy and labor markets are expected to reassert upward pressure on long term interest rates in 2015, with 10 year yields advancing gradually upwards through This interest rate forecast hinges on a gradual expected improvement in the world economy overall in the next 2 years. Long term risks: The Congressional Budget Office (CBO) projects federal debt held by the public to increase from 74.1% of GDP in 2014 to 78.7% in Federal Debt to GDP would likely be even higher should a recession occur in the next decade. A recession is not forecastable at this time, but history foretells it is likely to occur sometime within that time period. Furthermore, based on current CBO projections, federal debt relative to GDP begins to escalate substantially after 2025 based on demographic and government policy projections. Hence, long term interest rate risks and the risks they might pose to the economy are probably high later this decade. Most U.S. Treasury Issuance since 2007 has been in Securities with Maturities of 0 to 5 years. Interest Costs on this Debt Will Likely Rise as the Federal Reserve Raises the Fed Funds Rate Target. 6

7 Dollar The U.S. dollar appreciated an impressive 19.6% against other major currencies between March of 2014 and March of 2015 (average daily rate for the month). Against all trade weighted currencies, the dollar appreciated 13.0% during the 12 month period as nonmajor currencies held their value somewhat better against the dollar than their developed economy counterparts. As impressive as these currency exchange rate moves were, the appreciation of the dollar reversed somewhat in the second quarter to date, keeping the dollar s rise well short of the highs made by the dollar in early Hence, while competitiveness was made more challenging for U.S. exporters as well as for import competitors, the dollar appreciation was not necessarily out of line with historic volatility in exchange rates. In response to the stronger dollar, U.S. exporters reduced their prices charged by 6.7% between March 2014 and March Profit margins will likely be hurt as a result, but the price declines should help support volumes and market share until the international economy begin to strengthen. 140 The Dollar s Strengthening Paused Short of Millennial Highs Foreign Exchange Value of U.S. Dollar Nominal Trade-Weighted Indexes (3/73=100) 140 Profits Aggregate corporate profits should experience moderate growth overall with significant dispersion in 2015, but a pick up in U.S. companies with large foreign earnings exposure will likely experience downward forces on earnings in the near term as a result of the foreign exchange impacts of the rise in the dollar. Profits for U.S. domestic oriented companies will likely perform the best overall in the near term and in The energy sector in aggregate will likely encounter a sharp decline in profitability in the near term that should gradually reverse with an expected normalization of energy prices over the next 2 years. Positive Long term Factors Improving consumer balance sheets; strong corporate balance sheets; improving housing markets; improving average state and local government finances although pension liabilities will rise in some states; strong potential export growth in the long term despite recent currency headwinds; natural gas and resource richness in the longterm but with risks in the near term; strong technological innovation. The International Energy Agency projects the U.S. is probably becoming the top oil producer and could become energy independent by 2035 through its success in exploiting shale deposits, but long term supply risks are emerging Negative Long term Factors vs. Major Currencies Most Recent Data: May 11, vs. All Currencies High long term government debt and deficits; rising taxes; slowing productivity growth; long term risks to inflation, interest rates and exchange rates; geo political risks; rising regulatory costs; weak real disposable personal income growth; underperforming average educational and skills attainment; aging infrastructure; demographic shifts towards aging population; cyber risks. The recent run up of the dollar against other major currencies experienced a mild reversal that began in the second quarter as U.S. economic data have been weaker than market expectations while data from the Eurozone have surprised on the upside. With the expected reacceleration of the U.S. economy in the forecast, the dollar should pick up some relative strength again, but no further dramatic moves against other major currencies are in the forecast for the remainder of The currencies of emerging market countries that have minimal domestic inflation risks and have continued to exhibit solid economic growth in the last year should continue to perform well in the next year overall. 7

8 Economic Risks The risk of recession is relatively low in the next year as momentum in labor markets builds and expansionary monetary policy remains supportive of economic growth even if policy rates gradually begin to rise as forecasted. If oil prices remain at extraordinarily low levels for an extended period of time, then increased stresses could result in the energy sector. However, OPEC may weaken its own member states as well as the competition by continuing to produce at maximum levels. Hence, OPEC s production levels will likely slow at some point for the political and economic interests of its members. Furthermore, world demand for oil has been restrained by unusually weak economic growth in the world overall and especially in Europe, Japan and China. With monetary stimulus rising abroad in 2015, economic growth and the concurrent demand for energy that it creates will likely begin to rise as the year progresses, pushing up the price of petroleum. Although forecast risks are high, a gradually rising price of crude oil is presumed in the forecast. The price of West Texas Intermediate oil has already risen off a possible floor of $47.52 per barrel in January to above $60 per barrel in May. Policy uncertainty has been reduced at the macroeconomic level with passage of the 2014 federal budget and the lifting of the debt ceiling, but policy and international uncertainties are not likely to disappear in At the federal level, corporate taxation, regulatory policies and immigration policy will likely attain the highest degree of debate. Disagreements regarding federal expenditure priorities may also result in renewed fiscal policy uncertainties later in the year. Global debt in excess of $100 trillion in conjunction with slowing demographic trends in the United States and other developed economies probably poses the greatest known risk to sustained economic growth in the long term future. High debt can ultimately deplete private sector expansion through its eventual impact on interest rates, taxation and the reduction of essential government spending. High debt also raises long term inflation risks as high debt relative to GDP may require extraordinarily high levels of monetary stimulus to counter, as recently exemplified in Japan and most recently in the Eurozone. In the worst case scenarios, the Ukraine/Russia conflict and Middle East crises pose risks to the recovery, worldwide stability of energy markets and international commerce, especially to the regional economies directly impacted by the crises. The ongoing crisis in Greece also raises questions concerning the viability of the Eurozone, but it is not in either the interests of Greece or the EU members economic and political interests to leave the Eurozone and/or have a default on Greece s debt. Hence, a trudging working solution that combines structural reform with manageable debt relief is the most likely scenario. 8

9 Table 1 Real GDP Forecast as of May 14, III 14-IV 15-I 15-II 15-III 15-IV 16-I 16-II Annualized Real Growth Rates (bln Chained 2009 Dollars) GROSS DOMESTIC PRODUCT (bln $) % change IMPLICIT PRICE DEFLATOR % change REAL GROSS DOMESTIC PRODUCT Real GDP Annualized Growth Rate quarter % change CONSUMPTION % change DURABLE GOODS % change NON-DURABLE GOODS % change SERVICES % change GROSS PRIV. DOM. INVESTMENT % change FIXED INVESTMENT % change NON-RESIDENTIAL* % change NON-RESIDENTIAL STRUCTURES % change EQUIPMENT % change RESIDENTIAL % change CHANGE IN INVENTORIES NET EXPORTS EXPORTS % change IMPORTS % change GOVERNMENT PURCHASES % change FEDERAL % change STATE & LOCAL % change

10 Table 2 Economic Indicators Forecast as of May 14, 2015 KEY ECONOMIC INDICATORS 14-III 14-IV 15-I 15-II 15-III 15-IV 16-I 16-II Gross Domestic Product (bln $) * Implicit GDP Price Deflator * Consumer Price Index -- CPI-U * Producer Price Index * FEDERAL FUNDS RATE -- average YEAR T-NOTE -- average U.S. DOLLAR (FRB Index) AVERAGE MONTHLY CHANGE (Thou UNEMPLOYMENT RATE (%) Existing Home Sales (Thous SAAR) Housing Starts (Millions) Motor Vehicle Sales (Millions SAAR) Industrial Production Growth (SA) * Consumer Credit * C & I * CORPORATE PROFITS (Bil. of $) % change * (Profits generated through U.S. GDP) * Annualized Growth Rates Red -- First Period Forecasted Brown -- Annual Averages Data Source: Haver Analytics Forecasts: Huntington This publication contains general information: the views and strategies described may not be suitable for all investors, and individuals should consult with their investment advisor regarding their particular circumstances. Any forecasts presented are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. Content herein has been compiled or derived in part from sources believed reliable and contain information and opinions that are accurate and complete. However, Huntington is not responsible for those sources and makes no representation or warranty, express or implied, in respect thereof, and takes no responsibility for any errors and omissions. The opinions, estimates and projections contained herein are as of the date of this publication and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Investing in securities involves risk, including possible loss of principal amount invested. Past performance is no guarantee of future results. and Huntington are federally registered service marks of Huntington Bancshares Incorporated Huntington Bancshares Incorporated. 10