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The Economic Outlook: Fasten Your Seatbelts David Wyss Chief Economist Standard & Poor’s March 27, 2008 CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Copyright (c) 2008 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. The U.S. Is In Recession • The economy has moved into recession. • Housing has been in recession for two years, subtracting over a percentage point from GDP growth in 2007. • But that was offset by strength in nonresidential construction and the closing of the trade gap, each of which added back over a half point. • Weaker overseas growth will mean less benefit from the trade deficit, despite the declining dollar. • Nonresidential construction is beginning to decline • The fiscal stimulus package will cause the fiscal 2008 deficit to more than double, and could beat the 2004 record. But it should boost the economy in Q3. • The Fed has cut rates sharply. • Recession seems nearly certain. • But it should be relatively short and mild because of the fiscal and monetary stimulus. CONFIDENTIAL AND PROPRIETARY. 2. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Home Prices Were Too High (Ratio of average home price to average household disposable income) 4.5 4 3.5 3 2.5 2 1975 1979 1983 1987 1991 1995 1999 2003 2007 Existing New Quality-adjusted Source: BEA, Census CONFIDENTIAL AND PROPRIETARY. 3. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Bubbles Were Almost Everywhere (Percent increase in home prices, 1997-2005) US Canada Germany Switzerland Netherland Britain Ireland Italy Sweden France Spain Japan Australia China NewZealan Hong Kong -100 -50 0 50 100 Source: Mortgage Bankers’ Association and S&P CONFIDENTIAL AND PROPRIETARY. 4. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 150 200 250 Most Weakness Is In The Bubble Cities (S&P/Case-Shiller Home Price Indexes) Top 5 Charlotte Portland, OR Seattle Dallas Atlanta National average Bottom 5 Miami Phoenix Las Vegas San Diego Detroit 2002-2005 Foreclosure Dec-07 average rate (12-month percent change) 2.3 4.1 1.4 1.2 13.1 0.6 0.5 12.2 0.5 -2.4 2.7 1.7 -3.4 4.3 2.5 -9.1 14.3 1 -17.5 -15.3 -15.3 -15.0 -13.6 19.9 20.6 17.5 17.2 3.1 2.7 1.9 4.2 1.8 4.9 Source: Standard & Poor’s, RealtyTrac CONFIDENTIAL AND PROPRIETARY. 5. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The Fed Will Continue To Cut Rates (Percent) 10 8 6 4 2 0 1995 1997 1999 2001 Federal Funds Rate 2003 2005 2007 10-Yr Bond Yield Source: Federal Reserve CONFIDENTIAL AND PROPRIETARY. 6. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2009 2011 Mortgage rate Foreign Money Is Coming Into Private Bonds (Net inflows of long-term capital, Millions of dollars) 1400000 1200000 1000000 800000 600000 400000 200000 0 2001 2002 2003 2004 2005 2006 2007 Treasury Agency Private Source: US Treasury. CONFIDENTIAL AND PROPRIETARY. 7. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Equity Quality Spreads Are Widening From Record Lows (Spread over Treasury yields, percentage points) 12 10 8 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Default rate (12-month) Old spread series Credit spread Source: Standard & Poor’s Global Fixed Income Research CONFIDENTIAL AND PROPRIETARY. 8. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. World Growth Remains Strong (Real GDP, % change) 10 8 6 4 2 0 US Canada Eurozone 2005 2006 Japan 2007 Other Asia 2008 Source: Global Insight and S&P CONFIDENTIAL AND PROPRIETARY. 9. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Latin America 2009 And Comes Mostly From Asia (IMF purchasing power weights, 2006) Other 20% US 20% Other 17% US 12% Eurozone 9% East Eur 7% Japan 3% East Eur 11% Eurozone 15% India 6% Japan 6% China 15% Other Adv 7% India 11% Other Adv 11% Percent of World GDP China 30% Percent of World Growth Source: IMF CONFIDENTIAL AND PROPRIETARY. 10. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Can the Consumer Keep Spending? • Consumer spending has led the expansion • But wealth is down because home prices declined and • Stock are weak • Borrowing is more difficult, and home equity loans much less available • Confidence has dropped • Consumers are likely to save more • But rebates will provide some quick cash • Most of which will be spent CONFIDENTIAL AND PROPRIETARY. 11. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Oil Prices Hit New Records ($/barrel, WTI and deflated by CPI; household energy purchases as percent of disposable income) 120 9% 100 8% 80 7% 60 6% 40 5% 20 4% 0 1980 3% 1985 Oil price (WTI) 1990 1995 2005 dollars 2000 2005 % of disp. income (right) Source: BEA CONFIDENTIAL AND PROPRIETARY. 12. 2010 Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. No Savings, But Lots of Debt (Percent of after-tax income) 10 140% 8 130% 6 120% 4 110% 2 100% 0 90% -2 80% 1990 1993 1996 1999 2002 2005 2008 2011 Saving rate Debt/income (right) Source: BEA and Federal Reserve CONFIDENTIAL AND PROPRIETARY. 13. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Aging Populations Will Boost Government Spending (Ratio of over 65 population to labor force) 60 50 40 30 20 10 0 US Canada France Germany Italy UK Japan AustraliaMexico OECD 2000 Source: OECD CONFIDENTIAL AND PROPRIETARY. 14. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2020 Borrowing Against Your Home $700.00 $600.00 $500.00 $400.00 $300.00 $200.00 $100.00 $0.00 1994 1996 1998 2000 Home equity cashed out 2002 2004 Home equity loans Source: Freddie Mac CONFIDENTIAL AND PROPRIETARY. 15. 2006 Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2008 Advertising Helped By Olympics And Election 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% 1995 1997 1999 2001 2003 2005 Source: Universal McCann, S&P projection CONFIDENTIAL AND PROPRIETARY. 16. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2007 Bottom Line: The Economy Will Recover Slowly • The recession is expected to be short and mild • But fiscal policy stimulus will end • If financial markets remain locked up • Home prices continue to fall • And oil prices continue to rise • This could turn into a “W”-shaped recession • But could be better if productivity stays stronger • Financial markets regain confidence • And oil prices fall CONFIDENTIAL AND PROPRIETARY. 17. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Risks to the Economy (Real GDP, percent change year ago) 6% 4% 2% 0% -2% -4% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Baseline Pessim Source: BEA, S&P projections CONFIDENTIAL AND PROPRIETARY. 18. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Optim