Outlook for the Texas Economy. Luis Bernardo Torres Ruiz, Ph.D. August 26, 2016

Outlook for the Texas Economy Luis Bernardo Torres Ruiz, Ph.D. August 26, 2016 Research Economist Texas Society of Architects

Contents 1. U.S. Economic Outlook 2. Texas Economic Outlook 3. Challenges and Issues

During the last two years, economic conditions have deteriorated U.S. and advanced nations are stuck in slow growth mode, emerging economies are decelerating, and global trade is stagnant The medium-term outlook is for low commodity prices Doubts and concerns on monetary policy and divergences among developed countries are present Worries over China persist, while uncertainty is rising on geopolitical issues Heightened risk aversion is causing volatility in financial markets and discouraging business investment

Slow growth caused by slow productivity growth Real GDP and Nonfarm Productivity Growth (Year-over-Year Percent Change) Real GDP Real Output per Hour I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II 6 5 4 3 2 1 0-1 -2-3 -4-5 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 16 Note: Shaded area refers to recession Source: Bureau of Economic Analysis and Bureau of Labor Statistics

20 16 Caused by declining capital investment Real Private Fixed Investment (% of GDP) Total Private Nonresidential Residential (right-y-axis) 8 6 12 8 4 4 I III I III I III I III I III I III I III I III I III I III I III I III I III I III I III I III I 2 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 16 Note: Shaded area refers to recession Source: Bureau of Labor Statistics

Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 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 and increasing labor, creating a wedge between robust job growth amidst soft GDP growth Total Nonfarm Employment and Job Openings (Thousands) 6,000 5,500 Job Openings Employment 147,000 145,000 5,000 143,000 4,500 4,000 3,500 141,000 139,000 137,000 135,000 3,000 133,000 2,500 131,000 2,000 129,000 Note: Seasonally adjusted. Shaded area refers to recession Source: Bureau of Labor Statistics

Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 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 Even with job openings above pre crisis levels, some people cannot find jobs Unemployment Rate by Educational Attainment (Percent) Total, 25 years and older Less than high school High school graduates, no college Some collee or associate degree Bachelor's degree and higher 18 16 14 12 10 8 6 4 2 0 Note: Seasonally adjusted. Shaded area refers to recession Source: Bureau of Labor Statistics

Jan-00 Aug-00 Mar-01 Oct-01 May-02 Dec-02 Jul-03 Feb-04 Sep-04 Apr-05 Nov-05 Jun-06 Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12 Nov-12 Jun-13 Jan-14 Aug-14 Mar-15 Oct-15 May-16 while wage growth does not reflect the strong labor market Wage Growth (Year-over-Year Percent) Overall Services College degree 7 6 5 4 3 2 1 0 Note: Shaded area refers to recession Source: Federal Reserve Bank of Atlanta

and have maintained employment costs relatively stable Employment Costs (Year-over-Year Percent) Wages and Salaries Total Benefits Health Benefits I III I III I III I III I III I III I III I III I III I III I III I III I III I III I III I III I 11 10 9 8 7 6 5 4 3 2 1 0-1 -2-3 -4 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 16 Note: Shaded area refers to recession Source: Federal Reserve Bank of Atlanta

Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 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 Moderate output and wage growth, low commodity prices, and an appreciated dollar has created a low-inflation environment Inflation (Year-over-Year Percent) Overall PCE PCE excluding food and energy 5 4 3 2 1 0-1 -2 Note: Seasonally adjusted. Shaded area refers to recession Source: Bureau of Economic Analysis

Low inflation and low interest rates have made debt more attractive even with flat income growth Household and Nonfinancial Business Debt (% of GDP) 75 65 Mortgage Debt Corporate Business Debt Consumer Credit (right-y-axis) 20 19 55 18 17 45 16 35 I III I III I III I III I III I III I III I III I III I III I III I III I III I III I III I III I 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 16 15 Note: Seasonally adjusted. Inflation adjusted PCE 2009=100. Shaded area refers to recession Source: Fededal Reserve Board and Bureau of Economic Analysis

Contents 1. U.S. Economic Outlook 2. Texas Economic Outlook 3. Challenges and Issues

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 In this difficult environment, Texas has maintained moderate growth Texas Business Cycle Index and Leading Index (Index Jan 2007 = 100) 140 Business Cycle Index Leading Index (Right Axis) 120 135 115 130 110 125 105 120 100 115 95 110 90 105 85 100 80 95 75 Note: Composite Index of 3 Coincident Indicators (1987=100). Composite Index of 8 Leading Indicators (1987=100). Shaded area refers to recession Source: Federal Reserve Bank of Dallas

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Texas major MSAs are showing signs of slowing, especially Houston Major Metros Business Cycle Index (Year-over-Year Percent Change) Austin-Round Rock Dallas-Plano-Irving Fort Worth-Arlington Houston-Sugar Land-Baytown San Antonio 14 12 10 8 6 4 2 0-2 -4-6 -8-10 Note: Seasonally adjusted. Composite Index of 3 Coincident Indicators (1987=100). Shaded area refers to recession. Source: Federal Reserve Bank of Dallas

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Recent Texas growth has been driven by the service sector Good-Producing and Service-Providing Employment (Year-over-Year Percent Change) 8 Goods-Producing Service-Providing 6 4 2 0-2 -4-6 -8-10 -12-14 Note: Seasonally adjusted. Shaded area refers to recession. Source: Bureau of Labor Statistics

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Mining and manufacturing job losses continue and have spread to construction and transportation and warehousing Employment Growth Rate (Year-over-Year Percent Change) 20 Mining & Logging Manufacturing Construction Trade, Transportation & Utilities 15 10 5 0-5 -10-15 -20-25 Note: Seasonally adjusted. Shaded area refers to recession. Source: Bureau of Labor Statistics

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Texas manufacturing will continue to falter in the short run Manufacturing Outlook Survey (Index) Expansion 30 20 10 0 Contraction -10-20 United States Texas -30-40 Note: Seasonally adjusted. Shaded area refers to recession. Source: Federal Reserve Bank of Dallas and Institute for Supply Management. United States index is adjusted -50 to be on scale with Texas Index

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 while Texas services are expected to grow Services Sector Outlook Survey (Index) United States Texas 50 Expansion 40 30 20 10 0 Contraction -10-20 Note: Seasonally adjusted. Shaded area refers to recession. Source: Federal Reserve Bank of Dallas and Institute for Supply Management. United States index is adjusted -50 to be on scale with Texas Index

Slowdown in employment growth is broad based across sectors from May to July Employment by Sector (Year-over-Year percentage change May-July 2016 ) Jul-16 Jun-16 May-16 Leisure & Hospitality 4.5 Educational & Health Services 3.9 Financial Activities 2.4 Government 2.3 Trade, Transp & Utilities 1.8 Professional & Business Svc 1.3 Construction Other Services Information Manufacturing Mining & Logging -15.3-3.7-0.7 1.0 0.4 Source: Bureau of Labor Statistics -20.0-15.0-10.0-5.0 0.0 5.0 10.0

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Texas job growth to lag U.S. Employment Growth Rate (Year-over-Year Percent Change) United States Texas 5 4 3 2 1 0-1 -2-3 -4-5 -6 Notes: Seasonally adjusted Source: Bureau of Labor Statistics

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 and Houston s job growth to lag the state s Major Metros Employment Growth Rate (Year-over-Year Percent Change) 6 5 4 3 2 1 0 Austin-Round Rock Dallas-Plano-Irving Fort Worth-Arlington Houston-Baytown-Sugar Land San Antonio -1-2 -3-4 -5-6 Notes: Seasonally adjusted Source: Bureau of Labor Statistics

Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Slow growth in labor market causes wages to decrease Average Hourly Earnings, All Employees: Total Private (Year-over-Year Percent Change) United States Texas Average Hourly Earnings July-16 U.S. $25.5 Texas $24.3 5 4 3 2 1 0-1 -2-3 -4-5 Note: Seasonally adjusted. Deflated with Consumer Price Index for all urban consumers: All items. Shaded area refers to recession. Source: Bureau of Labor Statistics

Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Wages are falling in DFW and Houston MSAs, which have more mining and manufacturing jobs Major Metros Total Private Employee Hourly Earnings (Year-over-Year Percent Change) Austin-Round Rock-San Marcos Dallas-Plano-Irving Fort Worth-Arlington Houston-Sugar Land-Baytown San Antonio-New Braunfels 8 6 4 2 0 Average Hourly Earnings Jul-16 Austin $27.2 Dallas $26.4 Fort Worth $24.6 Houston $26.8 San Antonio $22.1-2 -4-6 Note: Seasonally adjusted. Deflated with Consumer Price Index for all urban consumers: All items. Shaded area refers to recession. Source: Bureau of Labor Statistics

Contents 1. U.S. Economic Outlook 2. Texas Economic Outlook 3. Challenges and Issues

❶Weak energy sector Challenges and Issues Price of oil has flattened close to $50 per barrel? Rig counts appeared to have reached a trough Oil production continues to fall and expected to decline more forcefully going forward ❷ Strong dollar and lackluster global growth (uncertainty) Texas is the number one exporting state in the nation and one of the top regions in the world Texas exports will be expensive facing weak global demand

Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 Mar-16 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 Mar-16 Challenges and Issues Exports (All Commodities) (Year-over-Year Percent Change) Real Trade Weighted Value of U.S. Dollar (Index January 2007 = 100) United States Texas 35 30 25 20 15 United States Texas Appreciation 115 110 105 10 5 100 0 95-5 -10 90-15 -20 Depreciation 85-25 80 Note: Adjusted for inflation with Bureau of Labor Statistics export indices. Source: International Trade Administration, Foreign Trade Division and U.S. Census Bureau Source: Federal Reserve Bank of Dallas and Federal Reserve Bank of St. Louis

Challenges and Issues ❸ Monetary unwinding best way to normalize monetary policy Goal of monetary policy is to manage exit from low interest rates so economy converges to full employment with stable prices while avoiding financial instability With current economic conditions and global volatility, can it be done?

Challenges and Issues ❹U.S. mid- and long-term economic growth prospects Medium-term potential growth forecast to average just above 2 percent for the next several years, significantly below historic average growth rate of 3 percent Downgrade reflects effects of labor force participation declining and modest prospects for productivity growth Distribution of income and wealth (increasing poverty levels) Boost long-term growth through: investment in infrastructure, raising educational outcomes, improving tax structure (e.g. corporate tax), and developing and expanding a skilled labor force (immigration reform and job training).

U.S. economy will continue to grow in 2016 while forecast for Texas suggests moderate expansion The U.S. economy is expected to grow around 2.2% in 2016. Household disposable income is growing Housing markets appear solid Household and corporate balance sheets are in relatively good shape (aided by historically low interest rates) Wages appear to be rising possible sign of reaching full employment Headwinds are weak energy and non-energy investment, drag from net exports, and slowing consumer demand.

Moderate 2016 outlook for Texas economy Employment growth will slow Dallas Federal Reserve: Initial forecast, Texas 2.5-2.0% most recent 0.5-1.5%, currently standing at 0.8% Houston employment expected to fall by less than 1%

U.S. economy has been characterized by slow growth and uncertainty, and now Texas economy faces the same issues Some uncertainty continues to pose downside risk to Texas economic outlook: Duration of low oil prices Strength of the U.S. economy Federal Reserve s exit strategy U.S. shale role of swing producer (cyclical behavior) Growth in world economy

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