December 11, 2013

Economics Group

2014 Economic Outlook

Finding Balance

Sustained subpar growth, low ination, and Fed easing underlie our outlook for 2014. A mixture of positive results for short-run growth have emerged, but also evident are the lingering long-run problems that cannot be solved by another bout of stimulus. Setting a more balanced course for scal and monetary policy will be key to reducing uncertainty and hopefully set the stage for improving, sustainable growth in the years ahead.

This report is available on wellsfargo.com/economics and on Bloomberg at WFRE

2014 Economic Outlook December 11, 2013

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Executive Summary
An Economic Balancing Act Sustained subpar growth, low inflation, Fed easing: repetitive, yes, but these three themes have been a useful guideline to the economic outlook for the past three years and underlie our view for 2014. Sustained, below-trend economic growth reflects caution on both the part of consumers and business decision makers over the past few years. For 2014, growth should improve to 2.4 percent, with much of the improvement in the private sector. We expect a modest gain in consumer spending along with stronger investment in business equipment, structures and housing. In contrast, government spending will remain a drag. The labor market is expected to improve slightly. We look for monthly gains of 180,000190,000 jobs on average in 2014, along with a modest decline in the unemployment rate below 7 percent. Meanwhile, inflation is set to remain low and not a source of concern to investors or the Federal Reserve. Our outlook is for a 1.6 percent rise in the Feds benchmark inflation indicator in 2014, the PCE deflator, compared to an increase of 1.1 percent in 2013. The expected rate of inflation for 2014 remains below the 2 percent Fed benchmark and, therefore, comfortably below any flash point for action from the Federal Reserve. Although growth remains modest and inflation low, interest rates are very low on many safe instruments such as short-term Treasury bills and notes. Therefore, investors have sought higher yields in corporate bonds and emerging market instruments. The benchmark 10-year Treasury yield likely will rise in 2014 as the Fed takes the first steps toward a more traditional policy environment. With the Fed leaving short-term rates alone, we expect a steeper yield curve with the yield on the 10-year Treasury security breaking the 3 percent barrier. Finally, pretax profits likely will continue to record modest growth of 5 percent6 percent. These profit gains will support improvement in employment and business investment in the domestic economy. Monetary Policy, Credit Markets and the Interest Rate Outlook We expect the Fed to gradually reduce its asset purchases as early as March 2014. However, any policy change is likely to be small. After tapering talk began in May 2013, the jump in interest rates and weakness in interest rate-sensitive sectors of the economy were lessons that will lead the Fed to be cautious before signaling a move next time. We do not expect any increase in the fed funds rate until the second half of 2015 at the earliest. The Global Outlook The global economy will likely grow 3.5 percent in 2014 compared to 3.0 percent in 2013. Most major economies should post stronger growth rates in 2014 than in 2013. China likely will grow more slowly in 2014, but should still record one of the strongest growth rates in the world. For emerging economies, the implications of less accommodative U.S. monetary policy on economic growth, currencies and capital flows have been significant as evidenced by the large and sustained decline in currency values for G-20 countries, such as India and Indonesia. Risk assessments on growth have risen for emerging markets with subsequent shifts in capital flows globally. The U.S. Housing Market The national housing market continues to transition away from a market driven primarily by speculators and investors to one being driven by the underlying positive fundamentals for both single- and multifamily housing. Employment and credit availability are improving, albeit modestly, and the pace of the housing recovery varies considerably by region. After several years of dramatic price swings, home prices are set to moderate as supply adjusts to the economys slower long-term growth trend. Demographics Similar to other Western industrial countries, the United States will experience a significant demographic shift due to the aging of baby boomers. Changing demographics have implications for the pace and financial feasibility of federal entitlement spending including Social Security and Medicare. The upcoming echo-boom generation is showing signs of diverging tendencies from generations before it due to the tight labor market and the preponderance of student loan debt, which will likely weigh on the nations economy in the long term. 2

2014 Economic Outlook December 11, 2013

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U.S. Outlook
A Rebalancing of Private and Public Spending In 2014, economic fundamentals will continue to rebalance toward a slightly stronger pace of economic growth. We expect the economy to expand 2.4 percent in 2014, following 1.7 percent growth in 2013 (Figure 1). More important, the composition of growth will become more balanced, with a broader base of drivers, which is a divergence from the recent post-recession trend. So, what is the key difference in the year ahead? Business investment, along with the continued housing market recovery, should help to support stronger headline growth. The only major drag to growth in the outlook comes from government consumption, which is expected to subtract from GDP growth for the fourth year in a row. Even as growth moves closer to the longrun average, overall GDP will remain below potential, although the somewhat faster pace of GDP growth should begin to close the gap between potential and actual GDP.1 Figure 1
U.S. Real GDP
Bars = CAGR 10% GDP - CAGR: Q3 @ 3.6% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% 2000 Forecast GDP - Yr/Yr Percent Change: Q3 @ 1.8% 8% 6% 4% 4% 2% 0% -2% -4% -4% -6% -8% -10% 2002 2004 2006 2008 2010 2012 2014 -6% -8% 2000 PCE - CAGR: Q3 @ 1.4% PCE - Yr/Yr Percent Change: Q3 @ 1.8% 2002 2004 2006 2008 2010 2012 2014 -6% -8% -4% 2% 0% -2% Forecast 4% 2% 0% -2% 6% 6% Line = Yr/Yr Percent Change 10% 8%

We expect the economy to expand at a 2.4 percent pace in 2014.

Figure 2
Real Personal Consumption Expenditures
Bars = CAGR Line = Yr/Yr Percent Change 8%

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

Consumer spending will again remain in the 2 percent range in 2014, following a 1.9 percent increase in 2013 (Figure 2). The story since the end of the recession has been one of demographic and regional inequality in job and income growth. As such, job growth and consumer spending have been primarily concentrated among those with a college education and computer skills, which are also typically higher-income earners. For the most part, middle-income households have seen only modest job and income growth in the wake of the recession. In the year ahead, we expect employment growth to continue to hover around 180,000-190,000 jobs per month, on par with the prior two years, as structural issues continue to plague the labor market (Figure 3). The difference next year is that real disposable income should rise 2.6 percent on a year-over-year basis compared to the slight 0.8 percent rise in 2013. Modest inflation pressures combined with the absence of major tax policy changes in 2014 should help to support more robust real disposable income growth. More than five years after the end of the recession, the small business sector continues to struggle as evidenced by the absence of small business optimism; however, the small business sector should begin to provide support to job and income growth in 2014.2 One key source of funding for small businesses that has been missing has been home equity. With the dramatic negative equity situation in the wake of the housing market crash, new funding has been difficult to procure. The home price appreciation experienced over the past year and the continued housing recovery expected in 2014 should support a more robust pace of improvement in the small business sector. Other key factors holding back small businesses, however, will likely remain in place, including increased healthcare costs and uncertainty around tax policy and regulations.
1 2

Congressional Budget Office. (2013). The Budget and Economic Outlook: Fiscal Years 2013 to 2023. For further reading, see Vitner, M. (Nov. 21, 2013). Wells Fargo Small Business Confidence Stalls in Q4, which is available upon request.

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Figure 3
Nonfarm Employment
Thousands of Employees, Average Monthly Change 400 Forecast 200 200 400

Figure 4
Consumer Price Index
Bars = CAGR 10% 8% 6% 4% 2% Forecast CPI - CAGR: Q3 @ 2.6% CPI - Yr/Yr Percent Change: Q3 @ 1.6% Line = Yr/Yr Percent Change 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% 2002 2004 2006 2008 2010 2012 2014

-200

-200

0% -2%

-400

-400

-4% -6% -8%

-600 Nonfarm Employment: Q3 @ 167.3K -800 2000

-600

-800 2002 2004 2006 2008 2010 2012 2014

-10% 2000

Source: U.S. Dept. of Commerce, U.S. Dept. of Labor and Wells Fargo Securities, LLC

In addition to continued job growth in 2014, another factor supporting consumer spending will be the modest pace of inflation. While inflation will pick up slightly from the low rates of 2013, we continue to expect inflation to remain tame. Consumer prices will likely rise 1.7 percent for the year (Figure 4). Producer prices will begin to accelerate toward the end of 2014 as stronger domestic and global demand increase cost pressures. The personal consumption deflator, the Federal Open Market Committees (FOMC) preferred inflation measure, will slowly increase as the year progresses, reaching 2.0 percent by the fourth quarter of 2014. With the PCE deflator hovering below the Feds target range of 2.0 percent for most of the year, it is unlikely that inflation pressures alone would force the FOMC to reduce the pace of its asset purchases. The FOMC is not likely to change the pace of asset purchases (known as tapering) until the March meeting at the earliest, but long-term rates will likely creep higher ahead of any expected tapering announcement. Our expectation is that the 10-year Treasury will rise to around 3.2 percent by the end of 2014 from its current 2.85 percent. In turn, the conventional mortgage rate will also slowly edge higher from around 4.70 percent in the first quarter of 2014 to 4.90 by the end of the year. Short-term rates will continue to muddle along at low levels as the first fed funds rate hike is not expected until the second half of 2015 at the earliest.
We expect the housing market recovery to continue in the coming year.

We expect the housing market recovery to continue in the coming year as residential investment plays a greater role in supporting headline GDP growth. Home prices will continue to appreciate but not at the pace observed over the past year. The gradual improvement in the fundamentals underlying the housing market should help drive new construction activity higher for the year. We expect housing starts to climb to a 1.1 million-unit pace, in turn, leading to a faster pace of residential investment. While still coming off a low base, residential investment should contribute 0.4 percentage points to headline GDP growth for the year. Business investment will accelerate from 2013s modest 2.5 percent gain to around 4.4 percent in 2014. The faster pace of business investment will be driven by more robust gains in nonresidential structures and a modest increase in equipment and software spending. Structure outlays will continue to see an increase in power and commercial construction, which includes lodging and retail. Growing demand for industrial space should also support further nonresidential construction activity as the reduced need for retail space is replaced with online retail distribution centers and warehouses. Greater investment in equipment, helped by improving credit and higher profits, will also contribute to a stronger pace of business investment spending for the year. Net exports will also play a more dominant role in supporting economic growth in 2014. We expect net exports to contribute 0.3 percentage points to overall GDP growth next year. Exports are expected to grow 6.6 percent, as somewhat stronger global economic growth, along with continued support from the domestic shale gas boom, supports the increased pace of export

2014 Economic Outlook December 11, 2013

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activity. The pace of import growth will also pick up compared to 2013 in lockstep with stronger real final demand growth in the United States. The one sector of the economy that will continue to subtract from GDP growth in 2014 is government, specifically federal government spending. We expect overall government spending to decline 0.5 percent for the year (Figure 5). Implicit in our economic outlook for 2014 is a continuing resolution or series of continuing resolutions that will maintain more or less 2013s spending levels for federal fiscal year 2014 and will include the automatic budget cuts known as sequestration. The result will be a continued drag from federal spending throughout 2014, but the drag will not be as dramatic as observed in 2013. At the state and local level, governments will continue to deal with modest revenue growth, but stronger tax collections should help to support somewhat higher state and local spending in the coming year. Thus, the higher spending at the state and local level will help to offset some of the expected drag from federal spending cuts. Figure 5
Real Government Purchases
Bars = CAGR 10% 8% 6% 4% 2% Forecast 0% -2% -4% -6% -8% 2000 Government Purchases-CAGR: Q3 @ 0.4% Government Purchases-Yr/Yr: Q3 @ -2.7% -8% 2002 2004 2006 2008 2010 2012 2014 -12% 2000 0% -4% -2% -4% -6% -6% -8% -10% Real Priv Fin Sales to Dom. Purch. - CAGR: Q3 @ 2.1% Real Priv Fin Sales to Dom. Purch. - Yr/Yr Pct Chg: Q3 @ 2.4% 2002 2004 2006 2008 2010 2012 2014 -4% -6% -8% -10% -12% Line = Yr/Yr Percent Change 10% 8% 6% 4% 2% -2% -2% 8% 6% 4% 2% 0% Forecast

Government spending will continue to subtract from GDP growth in 2014.

Figure 6
Real Private Final Sales to Domestic Purchasers
Bars = CAGR Line = Yr/Yr Percent Change 8% 6% 4% 2% 0%

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

Next year will again be characterized by an elevated level of domestic fiscal policy and global economic uncertainty. On the domestic front, ongoing wrangling in Washington on the federal fiscal year 2014 budget and the need to raise the nations borrowing limit in the months ahead will increase the risk of disruptions to business investment and consumer spending.3 On the global economic front, ongoing issues within the Eurozone and modest growth in emerging market economies could pose a risk to domestic manufacturing and export activity. Of these two key risk factors, the uncertainty around future federal fiscal policy poses the greatest risk to economic growth in the year ahead. Even with the drag from reduced government spending and ongoing political uncertainty, core aggregate demand, as measured by real private sales, will continue to build momentum throughout the year. The year ahead should be marked by continued modest consumer spending but somewhat stronger business investment. These factors will combine to drive growth in real private final sales of 2.6 percent in the fourth quarter of 2013 to 3.3 percent by the fourth quarter of 2014 (Figure 6). With core economic activity continuing to build momentum in 2014, the prospect of GDP returning to its historical 3.0 percent rate of growth will become increasingly likely in the years ahead.

The year ahead should be marked by continued modest consumer spending but somewhat stronger business investment.

3 The suspension of the federal debt ceiling expires on February 7th; however, the Congressional Budget Office estimates that the Treasurys extraordinary measures will keep the nation under the borrowing limit until at least March. See Congressional Budget Office. (Nov. 20, 2013). Federal Debt and the Statutory Limit, November 2013.

2014 Economic Outlook December 11, 2013

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Monetary Policy, Credit Markets and the Interest Rate Outlook

Balancing Growth, Inflation and Unconventional Policy Measures
Any reduction in the Federal Reserves largescale asset purchase program may start as soon as March 2014.

Three economic fundamentals support our baseline view that any reduction in the Federal Reserves large-scale asset purchase program may start as soon as March 2014. First, overall economic growth looks unlikely to have strengthened in a significant manner in the fourth quarter, and it remains below the Feds desired rate of growth for the economy. Conditions are expected to improve over the course of 2014, however, and fall more in line with the Feds longrun expectations of 2.2 percent2.5 percent growth (Figure 7). This moderate pace of growth has been the experience of the past four years and, while disappointing, is sustainable. Second, the unemployment rate has declined from 7.9 percent in January to 7.0 percent in November (Figure 8). With the drop in labor force participation helping to lower the unemployment rate, the recent rate of unemployment continues to support the case for monetary easing. Yet, job gains have firmed since the start of the Feds most recent round of asset purchases and have picked up over the past four months. We believe the Fed will wish to see a few additional months of sound job improvement before scaling back purchases in light of continued difficulty in lowering the unemployment rate. Figure 7
Real GDP Growth Forecast
Fed Central Tendency Forecast vs. Wells Fargo Forecast 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Central Tendency Forecast Range Historical GDP Growth Wells Fargo Economics Forecast
3.0% 2.4% 1.7%

Figure 8
Unemployment Forecast
Fed Central Tendency Forecast vs. Wells Fargo Forecast 6% Q4-over-Q4 Percent Change 5% 4% 3% 2% 1% 6% 0% 5% -1% -2% -3% -4% -5% -6% 4% 3% 2% 1% 0% 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Q4 Average, FOMC September Forecast Central Tendency Forecast Range Historical Unemployment Rate Wells Fargo Economics Forecast 0% 4% 3% 2% 1% 5% 11% 10% 9% 8% 7%
7.4% 6.8% 6.4%

11% 10% 9% 8% 7% 6%

Source: U.S. Dept. of Commerce, U.S. Dept. of Labor, FRB and Wells Fargo Securities, LLC

Third, inflation continues to run well below the Feds target; the benchmark inflation rate, the personal consumption deflator (PCE deflator), has risen at a 2.0 percent annualized pace over the past three months and 1.1 percent over the past year (Figure 9). In recent months, oil prices have declined, which should support continued modest inflation, even as final demand firms. We look for inflation to pick up over 2014, but to remain within the Feds comfort zone at 1.6 percent. That said, we do not view moderate growth and continued low inflation as reasons enough for the Fed to continue to pursue the current pace of quantitative easing. The periods of 19961999 and 20032006 should illustrate that extended periods of easy money and suppressed interest rates are not good for long-term economic growth and financial stability, as evidenced by the experiences of the 20002001 and 20072009 recessions. With economic fundamentals approaching a sustainable path, discussions have turned to monetary policy taking the first step toward normalization through a reduction in the pace of asset purchases. At this point in the economic and policy cycle, we must remember that quantitative easing is not standard monetary policy with clearly predictable results. Direct purchases of financial assets, in this case U.S. Treasury and mortgage-backed securities, have altered asset prices, with returns on the open market lower and reminiscent of the distorted prices in the period before the Treasury-Fed accord in 1951. Investors will recall that until that accord, Fed purchases of U.S. Treasury assets assisted in lowering the interest expense of federal finance, but once those purchases ended, investors in debtboth Treasury and municipalexperienced significant capital losses. Moreover, quantitative easing, and now its potential end, sets the tone

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for asset pricing throughout the global capital markets, as witnessed by the sharp selloff in emerging market currencies and assets during May 2013September 2013. With Fed officials mere mentioning of tapering setting off tighter financial conditions, the pursuit of tapering will require more than just a mechanical turn of the policy dial, but also Volcker-like conviction to follow-through on the difficult policy decision to take away the punch bowl. Tapering at the intermediate and long end of the Treasury curve is of course distinct from an actual increase in short-term interest rates through a hike in the federal funds rate. The latest projections from the FOMC support the view that the first increase in the federal funds rate will likely occur in the middle of 2015 and will be slow to rise after the initial increase (Figure 10). We note, however, the growing possibility that the first increase in the fed funds rate may be delayed until 2016, given modest inflation and tougher reductions in the unemployment rate should labor force participation stabilize. Figure 9
PCE Deflator Forecast
Fed Central Tendency Forecast vs. Wells Fargo Forecast 4.5% Central Tendency Forecast Range 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Historical PCE Deflator Wells Fargo Economics Forecast Q4-over-Q4 Percent Change Fed Forecast as of September 4.5% 4.0% 3.5% 3.0%

Figure 10
Appropriate Pace of Policy Firming
Target Federal Funds Rate at Year-End 5.0% September 2013 4.5% 4.0% 3.5% 3.0%
2.2% 1.6% 2.5%

There is a growing possibility that the first increase in the fed funds rate may be delayed until 2016.

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2014 2015 2016 Longer Run

2.5%
2.0%

2.0%
1.5% 1.0% 0.5% 0.0%

1.5% 1.0% 0.5% 0.0%

1.1%

Source: U.S. Dept. of Commerce, Federal Reserve System and Wells Fargo Securities, LLC

Recently, there has been some discussion that the FOMC may lower the 6.5 percent unemployment rate threshold for action. Our view is that moving the goal posts will reduce the credibility of Fed policy and create more confusion in credit markets. Instead, decision makers would be better served if policy had followed its legislative guideline of seeking maximum employment and avoided a specific numbersuch as the 6.5 percent unemployment rate that is sensitive to changes in the labor market itself, such as the participation rate. Finally, monetary policy operates in the context of regulatory and fiscal policies that can be counterproductive to the FOMCs objectives. Regulatory policy can have a restrictive effect on credit, while monetary policy is attempting to increase lending. As for fiscal policy, there is neither an agreement on tax and spending priorities nor any serious attempts to reform entitlement spending over the long term. Balance needs to be achieved between monetary, regulatory and fiscal policy for effective decision making by businesses and households. For now, that balance is lacking.
Balance needs to be achieved between monetary, regulatory and fiscal policy for effective decision making.

Interest Rates and Credit Markets in the Post-Tapering Environment

Over the past year, the yield curve has shifted upward as markets anticipate the Fed reducing accommodation and moving closer to a more neutral policy environment (Figure 11). After the Feds decision in September not to reduce asset purchases, intermediate- and long-term interest rates remain higher than before the tapering discussion, including interest rates on mortgagebacked securities. While the economic impact of the rise in interest rates has been modest, this experience will likely prompt the Fed to be more cautious in its rhetoric and its eventual tapering approach. Corporate bond yields are now above 20042006 levels but down from the peak of the

2014 Economic Outlook December 11, 2013

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20082009 period.4 Since May, corporate Aaa and Baa debt yields have risen 93 basis points and 85 basis points, respectively, suggesting markets have at least partially priced in a Fed move to taper quantitative easing (Figure 12).
We expect long-term rates to exhibit an upward bias as Fed tapering moves forward.

In the year ahead, we expect long-term rates to exhibit an upward bias as Fed tapering moves forward. However, the extent of any increase in long-term rates should be modest, given continued low inflation and a reduced federal budget deficit. At the short end of the yield curve, the Feds policy of administered rates will keep the funds rate at zero to 25 basis points. Unfortunately, this means that the yields on short-term Treasury bills, and two- and three- year notes will be less than the rate of inflation and thereby yield negative real returns, even before taxes. Our expectation is for the 10-year yield and benchmark mortgage rates to end 2014 at 3.2 percent and 4.9 percent, respectively. Figure 11
Yield Curve
U.S. Treasuries, Active Issues 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% December 6, 2013 0.5% 0.0% November 8, 2013 December 6, 2012 0.0% 0.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0%

Figure 12
10-Year vs. 2-Year
Yield 4.0%
9/13/2012: QE 3

0.9%
9/18/2013: FOMC Meeting 5/22/2012: JEC Testimony

3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Jan-11

0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1%

10-Year Yield: Dec-9 @ 2.85% (Left Axis) 2-Year Yield: Dec-9 @ 0.30% (Right Axis) Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

Source: Bloomberg LP, Federal Reserve System and Wells Fargo Securities, LLC

As for credit markets, while easy monetary policy may provide some support to the aggregate economy, the current Fed policy is clearly altering asset prices at the sector level. The Feds purchases of mortgage-backed securities are providing a boost to homeowners, but are a negative to renters and future homeowners who will now pay higher home prices. Suppressed Treasury yields have pushed investors into riskier assets, such as equities, high-yield corporate debt and emerging market assets, where returns may not be balanced relative to risks. The allocation of credit may, therefore, reflect a distortion of resource allocation and asset pricing. The large selloff in emerging markets in anticipation of the September tapering is a good example of the global implications of Fed policy and its possible credit misallocation. As asset purchases continue against a firming economic backdrop, the debate over whether the benefits outweigh the costs will intensify pressure to wind down QE. For investors and business decision makers, the reality is that the current level of Treasury interest rates, which serves as a basis for asset pricing, along with pricing of mortgage-backed securities, is being distorted. Despite the modest adjustment after September, not all Fed-related distortions have been removed and yields on the Treasury curve are still suppressed. When markets attempt to return to normal, something has to givethe dollar, inflation, real savings, capital flight, interest rates or growth. This will be the price of a suppressed interest rate policy today as it was in the late 1990s and the first decade of this century.

For discussion of the incentives and strong private credit financing that have resulted from the low interest rate environment, see Silvia, J.E. and Miller, M. (Nov. 1, 2013) Results, Not Rhetoric: Rebuilding the Financial Face of Manufacturing, which is available upon request.
4

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The Global Outlook

Balancing Better Europe, Weaker Emerging Markets After enduring a mild recession from late 2011 until early 2013, economic activity in the 17-member Eurozone is expanding again (Figure 13). Looking forward, we expect that real GDP growth in the euro area will remain positive in 2014 and 2015, but that the pace of expansion will remain weak. Although fiscal drag in most Eurozone economies will fade over the next two years, budgets will remain tight and will continue to exert headwinds on economic growth. In addition, banking systems in many European economies remain fragile and overall loan growth is negative at present. Due to the bank-financed nature of most European economies (capital markets play a much more important role in the financing of the U.S. economy), it is difficult to envision a strong economic recovery in the Eurozone as long as banking systems remain weak and unable to provide meaningful credit growth. With economic growth weak and inflation benign, the European Central Bank (ECB) likely will maintain accommodative monetary conditions throughout our forecast period. Moreover, the risks to the economic outlook in the euro area appear to be skewed to the downside. The European sovereign debt crisis, which rattled financial markets and weakened the Eurozone economy in 2011 and 2012, is on the back burner at present. However, the euro area is hardly fixed. In our view, a full banking union and a more extensive fiscal union are required to make the monetary union sustainable in the long run. Economic integration is proceeding, but progress toward a banking union remains painfully slow. As long as Europe is not fixed, it will remain a source of potential financial instability for the global economy. Figure 13
Eurozone Real GDP
Bars = Compound Annual Rate 8% Compound Annual Growth: Q3 @ 0.4% Year-over-Year Percent Change: Q3 @ -0.4% 4% Forecast 4% 3% Line = Yr/Yr % Change 8% 6% Forecast 3%

Figure 14
U.K. Real GDP
Bars = Compound Annual Rate Line = Yr/Yr % Change 6%

A full banking union and a more extensive fiscal union are required to make the monetary union sustainable in the long run.

0% 0% 0% -3% -4% -4% -6%

0%

-3%

-6%

-8%

-8%

-9% Compound Annual Growth: Q3 @ 3.2% Year-over-Year Percent Change: Q3 @ 1.5%

-9%

-12% 2002 2004 2006 2008 2010 2012 2014

-12%

-12% 2002

-12% 2004 2006 2008 2010 2012 2014

Source: IHS Global Insight and Wells Fargo Securities, LLC

The British economy essentially stalled in 20112012 but real GDP growth has strengthened markedly over the past few quarters (Figure 14). British consumers have deleveraged somewhat over the past few years, and the rebound in house prices not only has helped to repair balance sheets but it also has lifted consumer confidence. Looking forward, real GDP growth should remain solid, if not quite as strong as pre-crisis rates. CPI inflation should remain near the Bank of Englands 2 percent target, which should allow the Monetary Policy Committee to keep its main policy rate at only 0.50 percent, where it has been maintained since early 2009, throughout 2014. Growth in China to Remain Slow, by Chinese Standards The slowdown in economic growth that occurred in China in 2011 and 2012 had some analysts worried about a hard landing in that economy. However, recent data show that Chinese real GDP growth has stabilized and, looking forward, we forecast it to remain in the 7 percent to 8 percent range over the next two years (Figure 15). In our view, however, a return to double-digit rates of economic growth in China is unlikely to occur in the foreseeable future, if ever again. Robust growth in capital spending has driven Chinese economic growth in recent decades, and
A return to double-digit rates of economic growth is unlikely to occur in the foreseeable future.

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the government is attempting to rebalance the economy (less investment spending and more consumer spending) to reduce the chance that overinvestment causes the economy to eventually crash. Could China experience a hard landing in the next two years? Possibly, but it is not our basecase view. Financial leverage in the household sector remains low, and the debt-to-GDP ratio of the central government in Beijing is only 15 percent of GDP. However, leverage in the business sector, where the debt-to-GDP ratio has mushroomed to 140 percent, is a bit worrisome. We are keeping a close eye on financial developments in the Chinese business sector.5 Figure 15
Chinese Real GDP Forecast
Year-over-Year Percent Change 15% 15% 12% 8% 12% 12% 4% 0% -4% 6% 6% -8% -12% 3% 3% -16% Year-over-Year Percent Change: Q3 @ 7.8% 0% 00 02 04 06 08 10 12 14 0% -20% 05 06 07 08 09 10 11 12 13 14 15 Compound Annual Growth: Q3 @ 1.9% Year-over-Year Percent Change: Q3 @ 2.6% -20% -16% Forecast 4% 0% -4% -8% -12%

Figure 16
Japanese Real GDP
Bars = Compound Annual Rate Line = Yr/Yr % Change 12% 8%

9%

Forecast

9%

Source: IHS Global Insight and Wells Fargo Securities, LLC

Guarded Optimism for Japanese Growth The economic policies that have been implemented by the Japanese government since Prime Minister Abe came to power in December 2012, which are commonly referred to as Abenomics, have contributed to stronger economic growth in Japan (Figure 16).6 Despite the slated increase in the consumption tax from 5 percent to 8 percent in April 2014, we project that the recovery will remain intact (after a one-quarter contraction in real GDP in Q2 2014).
We would need to see progress on the third arrow of Abenomics for us to become more bullish on growth prospects in the longer run.

We are guardedly optimistic about the Japanese economy over the next two years, but we would need to see progress on the third arrow of Abenomics for us to become more bullish on growth prospects in the longer run. That is, we would need to see more structural reforms to the Japanese economy. The government has proposed some reforms, but it has not executed most of them yet. In our view, structural reforms hold the key to the long-run success of Abenomics. Developing Economies: Fundamentals Starting to Deteriorate Due to extensive supply chains, developing Asian economies have benefitted enormously from intra-regional trade that the economic rise of China has spawned over the past few decades. Economic growth in commodity-producing countries within Latin America has also been pulled along by Chinas rise. Due to our forecast of slower rates of Chinese real GDP growth, it seems reasonable that economic growth in developing Asia and Latin America likely will be slower as well. We forecast that real GDP in developing economies will grow 4.8 percent in 2014 and 5.0 percent in 2015 (Figure 17). Although these growth rates are stronger than the 4.7 percent rate that we project for the current year, they represent a significant downshift from the 7 percent to 8 percent rates that characterized the 20042007 period.

5 For further reading, see our special report, Bryson, J. H. (Sept. 23, 2013) Does China Have a Debt Problem?, which is available upon request. 6 For further reading, see our special report, Quinlan, T. (Aug. 22, 2013) Is Abenomics Working?, which is available upon request.

10

2014 Economic Outlook December 11, 2013

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Figure 17
Developing Economies GDP
Constant Prices, Percent Change 9% 9%

Figure 18
Developing Economies Current Account
Percent of GDP 5% 4% 5% 4% 3% 2% 1% 0% -1% -2% -3% All Developing Economies: 2013 @ 0.8% Excluding MENA and China: 2013 @ -1.9% 2% -5% 91 93 95 97 99 01 03 05 07 09 11 13 (P) -5% 08 10 12 14 -4%

8%

8% 3%

7% Forecast

7%

2% 1% 0%

6%

6%

5%

5%

-1% -2% -3%

4%

4%

3% GDP Growth: 2012 @ 4.9% 2% 00 02 04 06

3% -4%

Source: International Monetary Fund and Wells Fargo Securities, LLC

As these slower rates of economic growth imply, economic fundamentals in the developing world are not quite as strong as they were before the global financial crisis. Furthermore, the current account surpluses that many developing economies were incurring in the years preceding the global financial crisis have recently turned to deficits (Figure 18). Although we do not believe that a wave of financial crises in the developing world la 19971998 is imminent, the marginal deterioration in economic fundamentals among developing economies bears watching in the years ahead.7 Outlook for the Dollar With Federal Reserve monetary policy about to turn less accommodative, we look for the U.S. dollar to appreciate modestly vis--vis the euro and the Japanese yen over our forecast horizon, which is six quarters. Due to economic weakness and benign inflation, ECB monetary policy could arguably become even more accommodative over the next few quarters. The Bank of Japan will also continue to expand its balance sheet. With the Bank of England unlikely to ease policy further, we look for the greenback to move essentially sideways against the British pound, at least over the next few quarters. The currencies of some developing economies, especially those with large current account deficits (e.g., Brazil, India, Indonesia and Turkey), could experience some volatility as the Fed begins to taper its security purchases. Although we do not believe the volatility will be as pronounced as it was during May 2013August 2013some emerging currencies depreciated 10 percent to 2o percent against the dollar when Fed officials began to publicly discuss the possibility of taperingthese currencies could experience some near-term weakness. Further out, however, many of these currencies likely will rebound vis--vis the dollar as market participants solidify their expectations about the pace of Fed tightening. If, as we forecast, the global economic expansion remains intact, investors should become less risk averse, which should be generally supportive for capital flows to developing economies.

Marginal deterioration in economic fundamentals among developing economies bears watching.

7 For further reading see, Bryson, J. H. and Miller, M. (Oct. 28, 2013) Are Developing Economies Heading for a Crash? and Bryson, J. H. and Miller, M. (Oct. 30, 2013) Developing Economies and Crisis Vulnerability. Both of these special reports are available upon request.

11

2014 Economic Outlook December 11, 2013

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

The U.S. Housing Market

The Housing Recovery Is Set to Take Another Small Step Forward The housing recovery lost its footing around the middle of 2013, as early talk about the Fed beginning to scale back its monthly security purchases sent mortgage rates higher. While interest rates soon settled down and then partially reversed their run-up, demand has been slow to recover and price appreciation has moderated. After topping out this summer, sales of existing homes have been trending lower and recent trends in pending home sales suggest the slowdown has further to go (Figure 19). New home sales have also stumbled following a huge downward revision to sales this past summer (Figure 20). Sales and buyer traffic are still well ahead of their earlier lows but there is no question that sales have lost momentum. The pace of home price appreciation, while still up solidly year-over-year, has also started to moderate. Figure 19
Existing Home Sales vs. Mortgage Rates
Seasonally Adjusted Annual Rate - In Millions 10% 9% 8% 7% 6% 5% 4% 3% 2% 94 96 98 00 02 04 06 08 10 12 6.5 6.0 5.5 1,050 5.0 4.5 4.0 3.5 300 Mortgage Rate: Oct @ 4.19% (Left Axis) Existing Home Sales: Oct @ 4.5 Million (Right Axis) 2.5 0 90 92 94 96 98 00 02 04 06 08 10 12 3.0 150 New Home Sales: Oct @ 444,000 (Left Axis) Wells Fargo NAHB Index: Nov @ 54.0 (Right Axis) 20 10 0 900 750 600 450 70 60 50 40 30 1,500 1,350 1,200

Figure 20
New Home Sales vs. Wells Fargo NAHB Index
Thousands of Units, Index 100 90 80

Source: NAR, FHLMC, U.S. Dept. of Commerce, NAHB and Wells Fargo Securities, LLC

Higher mortgage rates have exposed at least two potential weak spots in the housing market.

While a one percentage point hike from 2013s earlier lows represents a fairly large proportional increase in interest rates, mortgage rates are still near historic lows. The sharp reaction to this past summers rise in mortgage rates raises some serious questions about how much the fundamentals underlying the housing market have improved. Higher mortgage rates have exposed at least two potential weak spots in the housing market. The first is that investor demand for homes has cooled considerably. Second, housing affordability has decreased much more abruptly than would have been expected this early into the recovery process (Figure 21). Figure 21
Housing Affordability, NAR-Home Sales
Base = 100 220 Housing Affordability Index: Sep @ 164.3 200 6-Month Moving Average: Sep @ 169.6 200 220 55% 50% 45% 40% 35% 160 160 30% 25% 20% 120 120 15% 10% 100 100 5% 80 92 94 96 98 00 02 04 06 08 10 12 80 0% 2009 2010 2011 2012 2013 Total Distressed: Oct @ 14.0% 5% 0%

Figure 22
U.S. Distressed Home Sales
Percent of Total Sales 55% 50% 45% 40% 35% 30% 25% 20% 15% 10%

180

180

140

140

Source: National Association of Realtors and Wells Fargo Securities, LLC

Reduced investor demand for single-family homes is hardly a surprise considering that the supply of deeply discounted distressed properties has rapidly been depleted, and prices of existing homes

12

2014 Economic Outlook December 11, 2013

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

have increased dramatically over the past two years (Figure 22). Besides the supply consideration, rising interest rates also make the yields earned from rental housing relatively less attractive, which has slowed capital flows into residential real estate. The net result has been a steady decline in the all-cash share of home purchases, the preferred method by investors. The slide in housing affordability has provided a bigger shock. Affordability had skyrocketed just a few years ago, as home prices tumbled and mortgage rates fell to modern-era lows. The influx of investors into the single-family market pushed prices up sharply, well ahead of the recovery in employment and income. When interest rates began to spike in late spring, affordability took a hit and many potential buyers found themselves priced out of the market. The net result is that we are not as far along in the housing recovery as the rebound in prices would, by itself, suggest. While 2013s reversal in home sales was a setback, the housing recovery was not thrown back to square one. Inventories of both new and existing homes remain exceptionally low and home prices have returned to their historical norms relative to income and rents across most markets. The appraisal process has also normalized and lenders are in a much better position to provide capital to homebuilders, developers and home buyers. Unfortunately the underlying demand fundamentals have improved less than we had hoped. The largest single drag on housing demand has been the sluggish pace of household formations, which have averaged just 638,000 over the past four years compared to a long-term norm of around 1.3 million. Population growth remains sufficient to support household growth, but persistently weak job and income growth, particularly among younger persons, is causing a large proportion of young people to delay moving out on their own or forming families. Demographics still remain positive. Over the past 10 years, the nation added around 2.6 million new residents annually. While household size has increased since the Great Recession, it should gradually return to normal, leading to 1.1 million new households per year. After taking obsolescence into account and adding a cautious estimate of second homes, demand should return to around 1.55 million units per year. Returning to this level will take time and require further improvement in employment and income growth. The housing market will also need to adjust to tighter credit standards and increased constraints on land development. We see demand returning incrementally, with housing starts rising 15.8 percent to 1.1 million units in 2014. Demographics will also help shape the recovery. Homeownership rises with age, with the largest increase occurring with persons in their late 30s (Figure 23). Some of the largest population gains, however, are among persons younger and older than this age cohort, which is driving demand for apartments and active adult housing (Figure 24). First-time homebuyers and tradeup buyers, however, are still largely missing in action. Many homeowners remain in negative or near-negative equity position, making it more difficult to sell their existing home and trade up for another home. Second-home demand will also likely be stunted, even though the number of persons age 45 to 54, which is the age of most first-time, second-home buyers, is solidly growing. Figure 24 Figure 23
Homeownership Rate by Age Group
Percent
Thousands

Unfortunately the underlying demand fundamentals have improved less than we had hoped.

Population by Age Group

In Millions 90% 55 50 45 40 1990 2000 2010 55 50 45 40 35 30 25 20 15 10 5 0 15-24 24-34 35-44 45-54 55-64 65+

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Less than 25 25-29 30-34 35-44 45-54 55-64 65+ 1990 2000 2010

80% 70% 60%

35 50% 40% 30% 20% 10% 0% 0 30 25 20 15 10 5

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

13

2014 Economic Outlook December 11, 2013

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Demographics
U.S. Population Booms: Secular Demographic Shift on the Horizon
The United States will experience a significant demographic shift in the coming decades due to our aging population.

Thus far, our commentary has been focused on the near-term outlook. However, similar to many other industrial countries, the United States will experience a significant demographic shift in the coming decades due to our aging population. The baby-boom generationborn between 1946 and 1964is expected to comprise about 20 percent of the U.S. population in the next two decades. As a result, the nation will be faced with long-run implications for economic growth and fiscal policy. In fact, the aging of the population along with slower population growth will work to reduce the economys potential rate of growth, which could further strain the labor market.8 Another challenge will likely be excess inventory in the residential market, especially in markets with fewer job prospects and slow population growth, as many baby boomers transition to more suitable living arrangements. At the same time, the children of baby boomers, commonly known as echo boomersborn between 1980 to the early 2000swill come of age and will also leave an imprint on the real economy. These young adults are highly educated, technologically savvy and eager to enter the workforce. However, many of these young adults are faced with a tight labor market and significant student loan debt, which may cause them to delay major life decisions. Baby-Boom Generation: Planning for the Future Today One of the most pressing issues for policymakers today is how to plan for the looming budgetary pressures in the years to come. The largest effect will be in spending on Social Security and Medicare. Spending on Social Security and Medicare, which are funded on a pay-as-you-go basis, is expected to double from its long-run average to almost 14 percent of GDP by 2038.9 With this generation projected to live longer than their parents, many are also concerned that low saving could also lead to slower growth in investment, productivity and wages.10

The demographic shift will continue to put downward pressure on the labor force participation rate.

The demographic shift should continue to put downward pressure on the labor force participation rate. The CBO estimates that demographics alone will account for nearly all of the drop in the participation rate between 2007 and 2021.11 When the first baby boomers reached the minimum age for receiving Social Security benefits in 2008, there were five working-age adults in the United States for each person aged 65 and older. Fast forward 20 years, when most baby boomers will have retired, the ratio will have fallen from five to three. All else equal, the expected decline in labor force participation could reduce per capita real GDP and per capita consumption below what these variables would be in the absence of a decline in labor force participation.12 In a speech to the Washington Economics Club, Federal Reserve Chairmen Ben Bernanke noted that, these [demographic] trends are large and unavoidable and the nation will have to face tough decisions that may include higher taxes, less non-entitlement spending, a reduction in outlays for entitlement programs, a sharply higher budget deficit, or some combination.13 While all of these options may be a bitter pill for the nation to swallow, the alternative of living with exorbitant national debt is far less favorable. Excess housing inventory could be an additional obstacle as many baby boomers choose to downsize their home. While there is still a lot of pent-up demand in the housing market, as some homeowners are still underwater on their mortgage and new home inventories remain at a historically low level, younger generations may not share the same preference in housing as baby boomers including size, amenities and location. This standoff in taste could lead to another bout of excess supply especially in suburban areas. An Atlantic Cities article, The Great Senior Sell-Off
8 Bernanke, B. S. (Nov. 20, 2012). The Economic Recovery and Economic Policy. Speech presented at the New York Economic Club, New York, NY. 9 Congressional Budget Office (September 2013). The 2013 Long-Term Budget Outlook. 10 Elmendorf, D. (Nov. 13, 2013). Presentation on Federal Health Care Spending. Presentation to the University of Pennsylvania Wharton School. 11 Congressional Budget Office. (March 2011). CBOs Labor Force Projections Through 2021. 12 Sheiner, L., Sichel, D. and Slifman,L. (2007). A Primer on the Macroeconomic Implications of Population Age. Federal Reserve Boards Finance and Economics Discussion Series. 13 Bernanke, B. S. (Oct. 4, 2006). The Coming Demographic Transition: Will We Treat Future Generations Fairly. Speech presented at the Washington, D.C., Economic Club, Washington, DC.

14

2014 Economic Outlook December 11, 2013

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Could Cause the Next Housing Crisis, examined this looming issue by suggesting that when baby boomers are ready to sell their home, growing markets like Atlanta and Houston will likely have ready and willing buyers (Figure 25).14 However, shrinking and stagnant markets could be challenged due to slowing demand. While this issue bears watching, the biggest determinant will continue to be housing affordability and access to credit, especially for young adults (Figure 26). Another trend to watch is baby boomers transitioning into senior housing. Even though senior adults may prefer senior housing, solid demand and lack of supply have ratcheted up rent growth in this sector and in many cases have made it unaffordable. Figure 25
Employment Growth in Growing Markets
3-Month Moving Averages, October 2013
4%

Figure 26
Residential Loan Standards and Demand
Prime Mortgages, Net Percent of Banks Reporting Change Expanding 80% 60%
San Jose

Recovering
Number of Employees Greater than 2.5 million 1-2.5 million Less than 1.0 million
Boston

80% 60% 40% 20% 0% -20% -40% -60% -80% Apr 08 Apr 09 Apr 10 Apr 11 Apr 12 Apr 13

3%

Raleigh

3-Month Annualized Percent Change

40%
Austin

2%

20%
Seattle Houston

1%

United States San Francisco Atlanta

0% -20% -40% -60%

0%

Washington D.C.

-1%

Tightening Standards: Q4 @ -8.7% Reporting Stronger Demand: Q4 @ -7.2%

Contracting
-2% -2% -1% 0% 1% 2%

Decelerating
3% 4%

Year-over-Year Percent Change

-80% Apr 07

Source: U.S. Dept. of Labor, Federal Reserve System and Wells Fargo Securities, LLC

Echo-Boom Generation: Will Homeownership Be an Option? Although baby boomers are getting all of the media attention, the generation known as echo boomers is also worthy of discussion. The sheer size of this demographic will also have a longlasting effect on the real economy. One key sector to consider is the residential market. Over the past four years, echo boomers have helped fuel a surge in apartment demand, especially in markets concentrated in technology, energy and research and development, such as San Francisco; Austin, Texas; Boston; Houston and New York. Rent growth in these markets skyrocketed and in many cases outpaced income growth. Moreover, the large number of young adults living at home with parents suggests that there is pent-up demand for apartment space as the prime age for renters (20 to 29 years old) hits this demographic.15 With this younger cohort having a higher propensity to rent and the preference for more of a walkable urban surrounding, rental demand should remain robust in the years ahead. A big question is how many of these young adults will shift to owning a home. Income growth in this generation is following trends in the greater economy where higher-educated young adults with readily marketable skills are seeing the most job gains and, therefore, the highest income growth. On the other hand, young adults with skills and majors that are not quickly employable are facing a tough labor market. With many young adults choosing to go back to school and incurring large student loan debt, we suspect that the transition to an owner-occupied home could take a bit longer than for previous generations.

Over the past four years, echo boomers have helped fuel a surge in apartment demand.

14 Badger, E. (March 5, 2013). The Great Senior Sell-Off Could Cause the Next Housing Crisis. The Atlantic Cities Magazine. 15 Fry, R. (Aug. 1, 2013) A Rising Share of Young Adults Live in Their Parents Home. Pew Research Center.

15

Economics Group
Q4 2010 q42013
2013 2012 1Q
q 4 2 0 1 3

U.S. Economic Forecast

Wells Fargo U.S. Economic Forecast
Actual 2013 3Q
q 4 2 01 3 q 4 2 01 3
q 4 2 01 3

Wells Fargo Securities, LLC

Actual 2015 2011 3Q
q 4 2 0 1 3 q 4 2 0 1 3
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Forecast 2014 3Q
q 4 2 0 1 3 q4 201 3
q 4 2 0 1 3

Forecast 2013
## ## # ## # # ## #

2012
## ## ## ##

2014
# # ## # ## #

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2Q
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1Q
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Real Gross Domestic Produc t (a) Personal Consumption Business Fixed Investment Equipment Intellec tual Property Produc ts Struc tures Residential Construc tion Government Purchases Net Exports Pct. Point Contribution to GDP Inventory Change Pct. Point Contribution to GDP Nominal GDP Real Final Sales Retail Sales (b) Inflation Indic ators (b) PCE Deflator Consumer Pric e Index "Core" Consumer Pric e Index Produc er Price Index Employment Cost Index Real Disposable Income (a) Nominal Personal Income (b) Industrial Produc tion (a) Capac ity Utilization Corporate Profits Before Taxes (b) Corporate Profits After Taxes Federal Budget Balance (c ) Current Ac count Balanc e (d) Trade Weighted Dollar Index (e) Nonfarm Payroll Change (f) Unemployment Rate Housing Starts (g) Light Vehicle Sales (h) Crude Oil - Brent - Front Contrac t (i) Quarter-End Interest Rates (j) Federal Funds Target Rate 3 Month LIBOR Prime Rate Conventional Mortgage Rate 3 Month Bill 2 Y ear Note 5 Y ear Note 10 Year Note 30 Year Bond

3.7 2.9 5.8 8.3 1.3 7.0 22.9 -1.4 - 439.2 0.4 89.2 0.4 5.8 3.4 6.6

1.2 1.9 4.5 5.3 1.8 6.9 5.7 0.3 - 435.3 0.1 56.8 -0.9 3.0 2.2 4.9

2.8 1.7 0.3 -3.9 2.8 5.9 14.2 3.5 -436.5 0.0 77.2 0.6 4.9 2.2 5.1

01

0.1 1.7 9.8 8.9 5.7 17.6 19.8 -6.5 -412.1 0.7 7.3 -2.0 1.6 2.2 4.7

1.1 2.3 -4.6 1.6 3.8 -25.7 12.5 -4.2 -422.3 -0.3 42.2 0.9 2.8 0.2 4.0

2.5 1.8 4.7 3.3 - 1.5 17.6 14.2 - 0.4 -424.4 - 0.1 56.6 0.4 3.1 2.1 4.7

3.6 1.4 3.5 0.0 1.7 13.8 13.0 0.4 -422.1 0.1 116.5 1.7 5.6 1.9 4.5

q4 201 3

1.4 2.2 4.4 5.0 0.0 10.0 7.0 -1.1 -410.8 0.3 95.0 -0.5 2.7 2.3 4.0

2.0 2.0 3.8 4.4 3.6 3.0 12.0 -0.9 - 392.9 0.5 75.0 -0.5 3.7 2.5 4.1

2.4 2.1 4.6 4.7 3.8 5.5 14.0 -0.5 -378.3 0.4 63.0 -0.3 4.3 2.7 4.6

2.8 2.2 5.4 5.5 4.2 7.0 14.0 0.2 -367.5 0.3 56.0 -0.2 4.8 3.0 4.9

01

2.9 2.3 5.6 5.7 4.2 7.5 15.0 0.1 -361.9 0.1 55.0 0.0 5.0 3.0 5.3

3.0 2.5 5.8 5.8 4.5 7.5 15.0 - 0.4 -353.5 0.2 54.5 0.0 5.1 3.1 5.4

3.1 2.5 6.0 6.0 4.6 8.0 15.5 - 0.3 -348.1 0.1 54.5 0.0 5.2 3.1 5.2

3.2 2.5 6.1 6.0 4.6 8.5 16.0 0.6 -345.1 0.1 54.5 0.0 5.3 3.2 5.0

3.2 2.6 6.3 6.2 4.6 9.0 16.0 0.7 - 348.0 -0.1 54.5 0.0 5.3 3.2 4.9

1.8 2.5 7.6 12.7 4.4 2.1 0.5 -3.2 - 445.9 0.1 33.6 -0.2 3.8 2.0 7.5

## ##

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2.4 2.8 2.2 3.4 1.9 4.6 4.0 5.4 77.6 12.8 13.3 - 457.2 - 120.8 72.7 262 8.3 0.71 14.2 118.1

0 1

1.7 1.9 2.3 1.1 1.7 1.8 3.8 2.9 77.7 6.9 5.7 - 125.3 - 110.5 74.5 108 8.2 0.74 14.2 108.7

01

1.6 1.7 2.0 1.6 1.9 -0.6 3.1 0.3 77.4 6.3 2.0 -185.0 -106.7 72.7 152 8.0 0.78 14.4 109.0

01

1.7 1.9 1.9 1.7 1.9 9.0 5.8 2.5 77.5 2.7 -0.7 -293.3 -102.3 73.4 209 7.8 0.90 14.9 109.6

01 q

3 4

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1.4 1.7 1.9 1.5 1.9 -7.9 2.8 4.1 78.0 2.1 4.5 -307.2 -104.9 76.2 207 7.7 0.96 15.3 112.2

01

1.1 1.4 1.7 1.5 1.9 4.1 3.2 1.1 77.9 4.5 6.4 90.7 -98.9 77.5 182 7.6 0.87 15.5 103.3

0 1

1.1 1.6 1.7 1.3 1.9 2.9 3.9 2.3 78.0 5.6 8.8 -170.4 -98.0 75.2 167 7.3 0.89 15.7 109.1

q4 201 3

1.0 1.2 1.7 0.8 2.0 2.1 1.9 3.3 79.1 5.0 4.4 -281.6 -100.0 76.5 191 7.1 0.94 15.8 109.4

0 1 q

3 4

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1.2 1.4 1.7 1.2 2.2 2.5 3.7 4.2 79.7 4.1 3.5 - 130.0 -95.0 77.0 185 7.0 0.98 15.9 116.0

01

1.7 1.9 1.8 2.2 2.2 2.4 3.4 4.3 79.8 5.4 4.8 -88.4 -90.0 78.0 185 6.9 1.07 16.0 118.0

01

1.7 1.7 1.9 1.8 2.3 2.6 3.1 4.4 80.0 5.5 4.9 -150.0 -90.0 79.0 190 6.7 1.18 16.2 119.0

01

2.0 2.0 2.1 2.3 2.3 2.7 3.3 4.5 80.2 5.6 5.0 -170.0 -85.0 79.3 195 6.6 1.21 16.4 120.0

01 q

3 4

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2.2 2.0 2.1 2.4 2.7 2.8 3.5 4.8 80.3 5.5 4.9 -155.0 -85.0 79.5 195 6.5 1.22 16.5 121.0

0 1

2.1 2.2 2.1 2.4 2.6 2.9 3.8 4.9 80.4 5.6 5.0 -100.0 - 90.0 79.8 200 6.4 1.23 16.6 122.0

0 1

2.2 2.3 2.1 2.6 2.6 3.0 4.2 4.9 80.6 6.0 5.4 -175.0 - 90.0 79.8 200 6.3 1.26 16.7 123.0

0 1

2.2 2.4 2.2 2.7 2.7 3.1 4.7 4.9 80.8 6.5 5.9 - 170.0 -95.0 79.5 200 6.2 1.27 16.8 124.0

2.4 3.1 1.7 6.0 2.1 2.4 6.1 3.4 76.5 7.9 9.7 -1296.8 - 457.7 70.9 175 8.9 0.61 12.7 110.6

## ##

## ##

1.8 2.1 2.1 1.9 1.9 2.0 4.2 3.6 77.6 7.0 4.7 -1089.2 - 440.4 73.5 183 8.1 0.78 14.4 111.3

## ##

1.1 1.5 1.8 1.3 1.9 0.8 2.9 2.4 78.2 4.3 6.0 -680.2 -401.8 76.4 187 7.4 0.95 15.5 108.5

# ## # # ## #

1.6 1.7 1.9 1.9 2.3 2.6 3.4 3.7 79.9 5.2 4.6 -538.4 -360.0 78.3 189 6.8 1.10 16.1 118.3

# # ## # ## #

2.2 2.2 2.1 2.5 2.6 2.8 4.0 4.7 80.5 5.9 5.3 -600.0 -360.0 79.6 199 6.4 1.25 16.7 122.5

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0.25 0.47 3.25 3.95 0.07 0.33 1.04 2.23 3.35

0 1

0.25 0.46 3.25 3.68 0.09 0.33 0.72 1.67 2.76

01

0.25 0.36 3.25 3.50 0.10 0.23 0.62 1.65 2.82

01

0.25 0.31 3.25 3.35 0.05 0.25 0.72 1.78 2.95

01 q

3 4

01

0.25 0.28 3.25 3.57 0.07 0.25 0.77 1.87 3.10

01

0.25 0.27 3.25 4.07 0.04 0.36 1.41 2.52 3.52

0 1

0.25 0.25 3.25 4.49 0.02 0.33 1.39 2.64 3.69

q4 201 3

0.25 0.25 3.25 4.55 0.05 0.30 1.45 2.85 3.85

0 1 q

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0.25 0.25 3.25 4.70 0.05 0.35 1.50 3.00 3.90

01

0.25 0.25 3.25 4.80 0.10 0.50 1.60 3.10 4.00

01

0.25 0.30 3.25 4.80 0.15 0.60 1.70 3.10 4.00

01

0.25 0.30 3.25 4.90 0.20 0.70 1.80 3.20 4.10

01 q

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0.25 0.30 3.25 4.90 0.30 0.80 1.90 3.20 4.10

0 1

0.25 0.30 3.25 5.00 0.40 1.00 2.10 3.30 4.20

0 1

0.50 0.60 3.50 5.10 0.60 1.10 2.20 3.40 4.30

0 1

0.75 0.80 3.75 5.20 0.70 1.20 2.30 3.50 4.40

0.25 0.34 3.25 4.46 0.05 0.45 1.52 2.78 3.91

## ##

## ##

0.25 0.43 3.25 3.66 0.09 0.28 0.76 1.80 2.92

## ##

0.25 0.26 3.25 4.17 0.05 0.31 1.26 2.47 3.54

# ## # # ## #

0.25 0.28 3.25 4.80 0.13 0.54 1.65 3.10 4.00

# # ## # ## #

0.44 0.50 3.44 5.05 0.50 1.03 2.13 3.35 4.25

0 1

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0 1

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0 1

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# # ## # ## #

0 1

01

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# ## # # ## #

# # ## # ## #

0 1

01

01

01 q

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Forecast as of: December 11, 2013 Notes: (a) C ompound Annual Growth Rate Quarter-over-Quarter (b) Year-over-Year Percentage C hange (c) Quarterly Sum - Billions USD; Annual Data Represents Fiscal Yr. (d) Quarterly Sum - Billions USD (e) Federal Reserve Major C urrency Index, 1973=100 - Quarter End

(f) Average Monthly C hange (g) Millions of Units (h) Quarterly Data - Average Monthly SAAR; Annual Data - Actual Total Vehicles Sold (i) Quarterly Average of Daily C lose (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

16

Economics Group

International Economic Forecast

Wells Fargo International Economic Forecast
(Year-over-Year Percent C hange)

Wells Fargo Securities, LLC

GDP 2013 Global (PPP weights) Global (Market Exchange Rates) Advanc ed Economies United States Eurozone United Kingdom Japan Korea Canada
1

CPI 2015 3.8% 3.3% 2.6% 3.0% 1.9% 2.5% 1.6% 3.5% 2.6% 5.0% 7.0% 5.6% 3.3% 2.9% 3.2% 2013 4.0% n/a 1.3% 1.5% 1.3% 2.6% 0.3% 1.1% 0.9% 6.7% 2.7% 10.1% 3.7% 6.2% 6.8% 2014 4.0% n/a 1.5% 1.7% 1.1% 2.1% 1.5% 2.4% 1.5% 6.4% 3.0% 9.2% 3.5% 5.0% 5.7% 2015 4.2% n/a 1.8% 2.2% 1.4% 2.3% 1.1% 3.0% 2.0% 6.5% 3.2% 8.9% 3.7% 5.6% 5.7%

2014 3.5% 2.9% 2.1% 2.4% 1.3% 2.4% 1.9% 3.7% 2.1% 4.8% 7.3% 5.5% 2.1% 2.6% 2.2%

3.0% 2.6% 1.2% 1.7% -0.4% 1.4% 1.8% 2.8% 1.7%

Developing Economies China India Mexic o Brazil Russia

1

4.7% 7.6% 5.2% 1.1% 2.3% 1.3%

Forecast as of: December 11, 2013 Aggregated Using PPP Weights

Wells Fargo International Interest Rate Forecast

(End of Quarter Rates)

U.S. Japan 1 Euroland U.K. 2 Canada

1

2013 Q4 0.25% 0.15% 0.20% 0.50% 1.28%

Q1 0.25% 0.15% 0.15% 0.50% 1.28%

2

3-Month Libor 2014 Q2 Q3 0.25% 0.30% 0.15% 0.15% 0.15% 0.15% 0.50% 0.50% 1.28% 1.28%

Q4 0.30% 0.15% 0.20% 0.55% 1.35%

2015 Q1 0.30% 0.15% 0.25% 0.65% 1.50%

2013 Q4 2.85% 0.65% 1.80% 2.85% 2.60%

Q1 3.00% 0.70% 1.90% 2.95% 2.70%

10-Year Bond 2014 Q2 Q3 3.10% 3.10% 0.75% 0.80% 2.10% 2.25% 3.10% 3.20% 2.80% 3.00%

Q4 3.20% 0.90% 2.40% 3.50% 3.25%

2015 Q1 3.20% 1.00% 2.60% 3.80% 3.50%

Forecast as of: December 11, 2013 10-year German Government Bond Yield 3-Month C anada Bankers Acceptances

Source: U.S. Department of Commerce, IHS Global Insight and Wells Fargo Securities, LLC

17

Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg John E. Silvia, Ph.D. Mark Vitner Jay H. Bryson, Ph.D. Sam Bullard Nick Bennenbroek Eugenio J. Alemn, Ph.D. Anika R. Khan Azhar Iqbal Tim Quinlan Michael A. Brown Sarah Watt House Michael T. Wolf Sara Silverman Zachary Griffiths Mackenzie Miller Blaire Zachary Peg Gavin Cyndi Burris Global Head of Research, Economics & Strategy Chief Economist Senior Economist Global Economist Senior Economist Currency Strategist Senior Economist Senior Economist Econometrician Economist Economist Economist Economist Economic Analyst Economic Analyst Economic Analyst Economic Analyst Executive Assistant Senior Admin. Assistant 704-410-1801 212-214-5070 704-410-3275 704-410-3277 704-410-3274 704-410-3280 212-214-5636 704-410-3273 704-410-3271 704-410-3270 704-410-3283 704-410-3278 704-410-3282 704-410-3286 704-410-3281 704-410-3284 704-410-3358 704-410-3359 704-410-3279 704-410-3272 diane.schumaker@wellsfargo.com john.silvia@wellsfargo.com mark.vitner@wellsfargo.com jay.bryson@wellsfargo.com sam.bullard@wellsfargo.com nicholas.bennenbroek@wellsfargo.com eugenio.j.aleman@wellsfargo.com anika.khan@wellsfargo.com azhar.iqbal@wellsfargo.com tim.quinlan@wellsfargo.com michael.a.brown@wellsfargo.com sarah.house@wellsfargo.com michael.t.wolf@wellsfargo.com sara.silverman@wellsfargo.com zachary.griffiths@wellsfargo.com mackenzie.miller@wellsfargo.com blaire.a.zachary@wellsfargo.com peg.gavin@wellsfargo.com cyndi.burris@wellsfargo.com

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