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Economic Outlook

Moving Over the Hump

Jan Hatzius
Chief Economist Jan.Hatzius@gs.com 212-902-0394

February 2013

Goldman Sachs Global Economics, Commodities and Strategy Research

A Gradual Acceleration in Global Growth


Real GDP Growth % yoy USA Japan Euro Area Germany France Italy Spain UK China India Brazil Russia Developed Markets Emerging Markets World 2011 1.8 -0.6 1.5 3.1 1.7 0.6 0.4 0.9 9.3 7.5 2.7 4.3 1.7 6.9 3.8 2012 2.2 2.0 -0.4 0.9 0.1 -2.0 -1.3 0.0 7.8 5.4 1.0 3.4 1.3 5.5 3.0 2013 1.8 0.9 -0.2 0.7 0.0 -0.8 -1.7 1.4 8.2 6.5 3.5 3.8 1.3 6.1 3.3 2014 2.9 1.3 0.9 1.9 0.6 0.6 -0.2 2.0 8.4 7.2 4.3 4.8 2.2 6.6 4.1 2015 3.2 0.7 1.3 2.1 1.2 0.9 1.0 2.3 8.3 7.2 4.0 4.3 2.3 6.5 4.2 2016 3.0 1.2 1.5 2.2 1.5 1.2 1.8 2.6 8.2 7.5 4.0 3.1 2.5 6.4 4.3

Source: GS Global ECS Research.


GS Global ECS Research 1

Spare Capacity in DM But Not EM

Percent of GDP 4 Forecast 2

Percent of GDP 4

-2 Output Gaps: -4 EM

-2

-4

DM
World -6 04 05 06 07 08 09 10 11 12 13 14 15 16
Source: GS Global ECS Research.

-6

GS Global ECS Research

Key US Economic Indicators: GS vs. Consensus


Ann. % chg. 5

Growth (Real GDP)


Forecast

Ann. % chg. 5

Inflation (Core PCE)


Percent change, year ago 3.0 2.5

Percent change, year ago 3.0


2.5

4
3 2 1 0 -1 2011

4
3

2.0
2

2.0
1.5 Range* GS Consensus 1.0 Forecast 0.5

Range* GS Consensus

1 0 -1

1.5 1.0 0.5 2011

2012

2013

2014

2012

2013

2014

* Top 10 avg - bottom 10 avg.

* Top 10 avg-bottom 10 avg.

Percent 2.0 GS 1.5

Fed Funds Rate

Percent 2.0

Fed Securities Holdings


Trillions of dollars 5 GS Consensus 4 3 Trillions of dollars 5 4 3

Consensus

1.5

1.0

1.0

2
1

0.5

0.5
1

0.0
2H 2012 1H 2H 1H 2H 1H 2H 1H 2016 2013 2014 2015

0.0

0
1H 2013 2H 1H 2014 2H 1H 2015 2H 1H 2016 2H

Actual Data

Growth consensus from Blue Chip Consensus Forecasts (February 2013) Inflation consensus from Bloomberg Fed consensus from Survey of Primary Dealers (December 2012)
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Source: Dept. of Commerce. Bloomberg. FRB New York. GS Global ECS Research.
GS Global ECS Research

Temperature Check Current Activity Indicator Slows in January


Percent change, annual rate 5 Current Activity Indicator (CAI) 4 3 2 1 0 -1 Jul 2011 Oct Jan 2012 Apr Jul Oct Jan 2013 Housing Employment Consumer Industry 4 3 2 1 0 -1 Percent change, annual rate 5

* First principal component of 25 key weekly and monthly US economic indicators. Source: GS Global ECS Research.

GS Global ECS Research

Temperature Check Upside Data Surprises Have Stopped


Standard deviation 3 2 1 Standard deviation 3 2 1

0
-1 -2 -3 -4 Jan Mar 2011 May Jul Sep Nov Jan 2012 Mar May Jul Sep Nov Jan Mar 2013

0
-1 -2 -3 -4

US-MAP Surprise Index*

* Weighted index of US economic data surprises, linearly weighted 3-month average. Source: GS Global ECS Research.

GS Global ECS Research

US Growth Outlook Private Boost, Public Drag


Percent of GDP 12 9 6 3 0 -3 -6 -9 -12 1960 Private Sector Financial Balance General Government Budget Balance -12 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 1960-2011 Avg = 1.9% Percent of GDP 12 9 6 3 0 -3 -6 -9

Source: Department of Commerce. GS Global ECS Research.

GS Global ECS Research

US Growth Outlook Fiscal Drag Peaks in Mid-2013


Percentage points 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 Q1 2012 Q2 Q3 Q4 Q1 2013 Q2 Q3 Q4 Q1 2014 Q2 Q3 Q4 Impact of Federal Fiscal Policy on Real GDP Growth: Tax Spending (Ex Sequester) Sequester Percentage points 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0

Source: GS Global ECS Research.

GS Global ECS Research

US Growth Outlook Capital Spending Looks Very Profitable

Percent 8 Profit Margin, Domestic Industries (left) Growth Rate of Real Private Capital Stock (right) 7

Percent 6

2 1950

1960

1970

1980

1990

2000

2010

Source: Department of Commerce.

GS Global ECS Research

US Growth Outlook Homebuilding Has a Long Way to Rise


Thousands 2800 2400 2000 1600 1200 800 400 0 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
* Assumed demolition rate of 300,000 per year. Source: Department of Commerce. GS Global ECS Research.

Thousands 2800 Housing Starts Household Formation Demolitions* Housing Starts Household Formation Forecast 2400 2000 1600 1200 800 400 0

GS Global ECS Research

US Growth Outlook Excess Housing Supply Has Fallen Sharply


Percent 3.0 Homeowner Vacancy Rate* Percent 3.0

10

2.5

2.5

2.0

2.0

1.5 1980-2005 Average = 1.6% 1.0 1980

1.5

1.0 1985 1990 1995 2000 2005 2010

* Vacant homes for sale in percent of housing stock for owner occupation. Source: Department of Commerce.

GS Global ECS Research

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Labor Market Slack and Its Implications Employment Still Far Below Potential
Percent of labor force 3 2 1 0 -1 -2 Percent of labor force 3 2 1 0 -1 -2

11

-3
-4 -5 -6 1994

-3 Unemployment Gap
Participation Gap -4 -5 -6 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: Department of Labor. GS Global ECS Research.

GS Global ECS Research

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Labor Market Slack and Its Implications Wages and Unit Labor Costs Still Weak
Percent change, year ago 15 Average Hourly Earnings Employment Cost Index* 10 Unit Labor Costs** 10 Percent change, year ago 15

12

-5 1975

-5 1980 1985 1990 1995 2000 2005 2010

* Private industry workers. ** Nonfarm business sector. Source: Department of Labor.

GS Global ECS Research

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Labor Market Slack and Its Implications Implication #1: Profit Margins Expand
Percent 11 10 9 8 7 6 5 4 3 70 75 80 85 90 95 00 05 10 15
** After-tax adjusted profits as percent of GDP. Source: Department of Commerce. GS Global ECS Research.

13

Percent 11

Corporate Profit Margins*:


Actual Forecast

10 9 8 7 6 5 4 3

GS Global ECS Research

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Labor Market Slack and Its Implications Implication #2: Low Core Inflation
Percent change, year ago 5 Core PCE Inflation: Actual 4 Fed Forecast 4 Percent change, year ago 5

14

GS Forecast
3 3

1 Fed Inflation Target = 2.0% 0 90 92 94 96 98 00 02 04 06 08 10 12 14


Source: Department of Commerce. Federal Reserve Board.

GS Global ECS Research

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Fed Policy Stays Easy Visualizing the Shifts in Fed Policy


Liftoff from Funds Rate = 0 Inflation (%) 4.0 3.5 3.0 2.5
Optimal Control Approach

15

Inflation (%) 4.0 3.5 3.0 2.5


Pre-CrisisTaylor Rule

2.0 1.5 1.0

2.0 1.5 1.0

December 2012

0.5
0.0 0 2

Current Threshold Guidance

0.5
0.0

Source: GS Global ECS Research.

6 Unemployment (%)

10

12

GS Global ECS Research

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A Gradual Increase in Bond Yields The Bond Term Premium


Percentage points 6 5 4 3 2 1 0 -1 2000 10-year Term Premium (left)* 10-year Yield (right) 6 5 4 3 2 1 2002 2004 2006 2008 2010 2012 Percentage points 8 7

16

*As estimated by the Kim-Wright Term Structure Model. Source: Federal Reserve Board. GS Global ECS Research.

GS Global ECS Research

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A Gradual Increase in Bond Yields Is Unlikely to Rise Quickly as QE Persists


Basis points 0 -20 -40 -60 -80 -100 -120 -140 -160 Total Portfolio Balance Effect on 10yr Yield Term Premium: QE3+Mid-2015 Twist 2 2014 Fwd Guidance Twist 2013 Fwd Guidance QE2 Reinvest MBS QE1 Basis points 0 -20 -40 -60 -80 -100 -120 -140 -160

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Mar 2009

Sep

Mar 2010

Sep

Mar 2011

Sep

Mar 2012

Sep

Note: Assumes no change in expectations between announcements. Source: GS Global ECS Research.

GS Global ECS Research

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The Truth about the Deficit Deficit Should Decline in Coming Years

18

Percent of GDP 0

Percent of GDP 0

-2

-2

-4 US Federal Budget Deficit: Actual GS Forecast Forecast -8

-4

-6

-6

-8

-10

-10

-12 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: CBO. GS Global ECS Research.

-12

GS Global ECS Research

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The Truth about the Deficit Healthcare Holds the Key


Percent of GDP 35 Actual 30 25 20 15 Healthcare 10 5 Social Security 0 1970 0 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 10 5 Total Primary Spending CBO's Long-Term Alternative Fiscal Scenario Projected 30 25 Other Noninterest Spending 20 15 Percent of GDP 35

19

Revenues

Source: Congressional Budget Office.

GS Global ECS Research

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Where Shale Matters Energy Supply Gets More Elastic

20

GS Global ECS Research

20

0
Saudi Arabia ('69 - '74)

GS Global ECS Research

Saudi Arabia ('87 - '92)


US ('11 - '16)

Russia ('99 - '04) Iran ('68 - '73)


Saudi Arabia ('75 - '80)

Millions of barrels per day 6

Source: GS Global ECS Research.

US ('65 - '70)
Libya('65 - '70)

Iraq ('94 - '99) Kuwait ('91 - '96) Mexico ('77 - '82) Nigeria ('68 - '73)
Saudi Arabia ('99 - '04)

Iraq ('83 - '88)


UK ('75 - '80)

5 year Increase in Oil Production

Iraq ('74 - '79) Iran ('86 - '91)


Norway('91 - '96)

Where Shale Matters A Big Supply Boost in Absolute Terms

UAE ('86 - '91)


UAE ('69 - '74)

Angola ('03 - '08)


0 1 2 3 4 5

Millions of barrels per day 6

21

21

GS Global ECS Research

Kuwait ('91 - '96)


Angola ('03 - '08)

Percent of GDP 25 131 84 78

Saudi Arabia ('69 - '74) Saudi Arabia ('87 - '92) Saudi Arabia ('75 - '80) UAE ('86 - '91)
Russia ('99 - '04)

35

Source: GS Global ECS Research.

27

Iran ('86 - '91)


Norway('91 - '96)

Saudi Arabia ('99 - '04) Mexico ('77 - '82) UAE ('69 - '74) UK ('75 - '80)
US ('11 - '16)

Where Shale Matters But a Much Smaller One Relative to US GDP

5-year Increase in Oil Production

Percent of GDP 25

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22

The European Crisis ECB Addresses Part of the Vicious Cycle

23

Bank Solvency & Liquidity Concerns LTRO

Fiscal Crisis
Lower Tax Receipts Expected Bailout Costs ESM & OMT Loan Losses

Fiscal Austerity

Banking Crisis
Reduced Loan Supply

Economic Crisis

GS Global ECS Research

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The European Crisis ECB Has Reduced Spillover Risk


Index 100.6 100.4 100.2 100.0 99.8 99.6 99.4 99.2 99.0 Jan Apr 2010 Jul Oct Jan Apr 2011 Jul Oct Jan Apr 2012 Jul Oct Jan Apr 2013 GSFCI* (left) Euro Risk** (right, inverted) 0.95 0.90 0.85 Worse Index 0.75

24

0.80

1.00

* Wt avg of riskless int rates, spreads, equities, FX and house prices, based on ef f ects on1-yr f wd US GDP growth. ** First principal component of European bank stocks, bank CDS, svrgn CDS, and EUR/USD cross-currency basis spread. Source: GS Global ECS Research.

GS Global ECS Research

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The European Crisis Periphery FCIs Only a Bit Easier


Index (2007=100) 108 106 104 102 100 98 96 94 05 06 07 08 09 10 11 12 13
Source: GS Global ECS Research.

25

Index (2007=100) 108 Tighter 106 104 102 100

Financial Conditions Index:


Germany France Italy Spain

98 96 94

GS Global ECS Research

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The European Crisis Fiscal Drag Intensifies in Spain and France


Percentage points 0.2 0.0 -0.2 -0.4 Percentage points 0.2 0.0 -0.2 -0.4

26

-0.6
-0.8 -1.0 -1.2 -1.4 -1.6 -1.8 Germany
Source: GS Global ECS Research.

-0.6
-0.8 -1.0 Fiscal Drag on Real GDP Growth: 2012 2013 2014 France Italy Spain -1.6 -1.8 -1.2 -1.4

GS Global ECS Research

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The European Crisis ULCs Have Only Adjusted Partially


Index (2000Q1=100) 150 Unit Labor Costs: 140 Germany France Ireland Italy Spain Greece Portugal 140 Index (2000Q1=100) 150

27

130

130

120

120

110

110

100

100

90 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: National Statistics. Haver Analytics. GS Global ECS Research.

90

GS Global ECS Research

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Key Numbers in the US Economic Outlook


2011 OUTPUT AND SPENDING Real GDP Consumer Expenditure Residential Fixed Investment Business Fixed Investment Structures Equipment & Software Federal Government State and Local Government Net Exports ($bn, '05) Inventory Investment ($bn, '05) Industrial Production, Mfg INFLATION (% ch, yr/yr) Consumer Price Index (CPI) Core CPI Core PCE* Unit Labor Costs LABOR MARKET Unemployment Rate (%) 2012 (f)
2.2 1.9 11.9 7.7 9.6 6.9 -2.2 -1.3 -406 45 4.1 2.1 2.1 1.7 0.6 8.1

2013 (f)
1.8 1.7 13.7 5.7 2.5 6.9 -5.3 0.1 -393 42 0.9 1.7 1.7 1.3 1.2 7.7

2014 (f)
2.9 2.5 14.8 9.0 7.0 9.8 -5.9 1.2 -411 49 2.8 1.8 1.8 1.5 1.5 7.3

2015 (f)
3.2 2.7 13.4 7.5 5.9 8.1 -2.5 1.8 -433 57 3.7 2.0 1.9 1.6 1.7 6.7

2016 (f)
3.0 2.5 12.5 5.8 5.0 6.1 -1.2 2.0 -445 57 3.1 2.1 2.1 1.8 2.1 6.3

Q1
2.0 2.4 20.6 7.5 12.8 5.4 -4.2 -2.2 -416 57 9.8 2.8 2.2 1.9 0.2 8.2

2012 Q2 Q3
1.3 1.5 8.4 3.6 0.6 4.8 -0.2 -1.0 -407 41 0.7 1.9 2.3 1.8 0.4 8.2 3.1 1.6 13.6 -1.8 0.0 -2.6 9.5 0.3 -395 60 -0.8 1.7 2.0 1.6 0.0 8.0

Q4
-0.1 2.2 15.3 8.4 -1.1 12.5 -15.0 -0.7 -404 20 0.0 1.9 1.9 1.5 1.9 7.8

Q1
2.8 1.2 13.9 5.0 3.4 5.6 2.5 0.1 -393 38 1.0 1.5 1.8 1.2 0.4 7.8

2013 Q2 Q3
1.5 1.5 12.5 6.5 4.0 7.5 -12.5 0.0 -389 45 2.0 1.8 1.6 1.2 1.1 7.8 0.13 0.30 0.30 0.90 2.00 3.05 -2.9 1.40 87 2.0 2.0 15.0 8.6 5.0 10.0 -10.0 1.0 -392 43 2.0 1.8 1.7 1.3 2.1 7.7 0.13 0.30 0.35 1.00 2.10 3.05 -3.0 1.40 87

Q4
2.5 2.0 15.0 9.3 7.5 10.0 -5.0 1.0 -396 43 2.0 1.7 1.7 1.5 1.4 7.6 0.13 0.30 0.40 1.20 2.20 3.25 -3.0 1.40 87

1.8 2.5 -1.4 8.6 2.8 11.0 -2.8 -3.4 -408 31 4.3 3.1 1.7 1.4 1.9 8.9

FINANCIAL SECTOR Federal Funds** (%) 0.00 0.00 0.13 0.13 0.13 1.25 0.00 0.00 0.00 0.00 0.06 3-Month LIBOR (%) 0.07 0.16 0.30 0.30 0.30 1.50 0.13 0.16 0.14 0.16 0.23 Treasury Yield Curve** (%) 2-Year Note 0.56 0.31 0.40 0.60 1.50 2.00 0.47 0.47 0.39 0.31 0.30 5-Year Note 0.26 0.26 1.20 1.75 2.50 3.00 0.34 0.29 0.26 0.26 0.58 10-Year Note 0.89 0.70 2.20 2.75 3.25 3.75 1.02 0.71 0.67 0.70 1.35 30-Year Bond 1.98 1.72 3.25 3.65 4.00 4.25 2.17 1.62 1.72 1.72 2.39 FOREIGN SECTOR Current Account (% of GDP) -3.1 -3.0 -2.9 -3.2 -3.5 -3.8 -3.5 -3.0 -2.7 -2.9 -2.9 Euro ($/)** 1.32 1.31 1.40 1.40 1.35 1.25 1.32 1.25 1.29 1.31 1.36 Yen (/$)** 78 84 87 87 100 110 82 79 78 84 85 * PCE = Personal consumption expenditures. ** Denotes end of period. *** Profits are after taxes as reported in the national income. and product accounts (NIPA), adjusted to remove inventory profits and depreciation distortions. NOTE: Published figures are in bold.

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Disclosure Appendix
I, Jan Hatzius, hereby certify that all of the views expressed in this report accurately reflect my/our personal views, which have not been influenced by considerations of the firms business or client relationships.
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