Gina MartinWachovia Economics704.383.6805gina.martin@wachovia.com

Economic OutlookOil, the Fed, and Housing – Oh My!

National Marine Bankers AssociationSeptember 13, 2005

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0.5

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1.5

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2.5

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3.5

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U.S. Japan Euroland U.K. Canada

Av

era

ge

An

nu

al G

row

th in

GD

P

2004 2005 2006

Economic Growth Slowing Down

What’s Behind Slower Growth in 2006?

•Business Cycle – Expansion Sets In

•Oil Prices - $65 and $2.50 (or more!)

•Housing – ATM Starting to Run Low

•Autos – Borrowing from Future Sales

•Rates – 250 bps in 14 months, More to Come

•Long Rates – Where Do Rates Go From Here?

Income Keeps Consumers SpendingPersonal Income and Spending

0

1

2

3

4

5

6

7

1999

2000

2001

2002

2003

2004

2005

Disposable Personal Income, July at 2.6%

Real Spending, July @ 3.9%

Both Series Are Year over Year % Change of 3 Month Moving Average

Income Keeps Consumers SpendingPart II

Household Income Trends Support Spending(Average Annual Growth 2003-2008)

-1.6% -1.5% -1.2%-0.4%

0.9%

2.8%

6.1%

8.0% 8.2%

9.7%

< $15K $15K-$24K

$25K-$34K

$35K-$49K

$50K-$74K

$75K-$99K

$100K-$149K

$150K-$249K

$250K-$499K

$500K+

Consumers Indeed Better OffHousehold Net Worth, Billions of Dollars

20000

25000

30000

35000

40000

45000

50000

550001

99

0

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

2000 Peak: $43.5 TrillionCurrent: $48.8 Trillion

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2

4

6

8

10

12

14

16

18

20

1970

1972

1974

1976

1978

1980

1982

1983

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

$tr

illio

n

Homeowners Equity

Single-Family Mortgage Debt

$7.2 trillion(2001)

$10 trillion

$7.7 trillion

Homeowners Equity and Mortgage Debt

HPI- Pacific

150

160

170

180

190

200

210

220

230

Dec-87 Sep-88 Jun-89 Mar-90 Dec-90 Sep-91 Jun-92 Mar-93 Dec-93 Sep-94 Jun-95 Mar-96 Dec-96 Sep-97

Source: OFHEO

HPI - New England

160

200

240

280

320

Mar-85

Mar-86

Mar-87

Mar-88

Mar-89

Mar-90

Mar-91

Mar-92

Mar-93

Mar-94

Mar-95

Mar-96

Mar-97

Mar-98

Source: OFHEO

Past Declines in Housing Prices

HPI - Mountain

100

110

120

130

Mar-81 Mar-82 Mar-83 Mar-84 Mar-85 Mar-86 Mar-87 Mar-88 Mar-89 Mar-90

Source: OFHEO

HPI - Mid Atlantic

160

180

200

220

240

260

Dec-85

Dec-86

Dec-87

Dec-88

Dec-89

Dec-90

Dec-91

Dec-92

Dec-93

Dec-94

Dec-95

Dec-96

Dec-97

Source: OFHEO

Past Declines in Housing Prices

HPI - West South Central

100

105

110

115

120

125

130

135

Sep-81

Sep-82

Sep-83

Sep-84

Sep-85

Sep-86

Sep-87

Sep-88

Sep-89

Sep-90

Sep-91

Sep-92

Sep-93

Sep-94

Source: OFHEO

HPI - East North Central

80

85

90

95

100

105

110

Sep-78 Mar-79 Sep-79 Mar-80 Sep-80 Mar-81 Sep-81 Mar-82 Sep-82 Mar-83 Sep-83 Mar-84 Sep-84

Source: OFHEO

Past Declines in Housing Prices

Corporate Profits Revive Business Sector(In Billions of Dollars, SAAR)

Low Rates Have Helped Clean Up Balance Sheets

Interest Expense as % of Cash FlowNonFinancial Corporations

10

15

20

25

30

35

80 82 84 86 88 90 92 94 96 98 00 02 04

Merrill Lynch Corporate Bond Index less Merrill Lynch Government Bond Index

Businesses Have Cash To Burn

Both Series Are Year over Year % ChangeCorporate is Net Cash Flow with Inventory Valuation and Capital Consumption Adjustments, 12 quarter

moving average

-15

-10

-5

0

5

10

15

20

25

1980 1983 1986 1989 1992 1995 1998 2001 2004

Capital Expenditures Corporate Cash Flow

Steady Employment Gains Boost IncomeNonfarm Employment Growth

-500-400-300-200-100

0100200300400500600

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

Monthly Change, In Thousands, Seasonally Adjusted

August @ 169,000

Longer Term Challenges RemainU.S. Unemployment Rate by Education Level

7.60%

4.80%

2.40%

Less Than High School High School Degree Bachelors Degree

Short Rates Still Accommodative, But the Gap is Closing

0

1

2

3

4

5

6

7

8

9

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Fed Funds Rate Nominal GDP

Fighting Future InflationProductivity and Unit Labor Costs

-2-10123456

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Yr/

Yr

% C

hang

e

Unit Labor Costs Productivity

Oil – Will Energy Inflation Pass Through?

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Personal Consumption of Gasoline and Oil as a Percent of Disposable

Income

Spot Price of a Barrel of Oil

0

10

20

30

40

50

60

70

80

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

$ P

er B

arre

l

Refined Product Prices Continue to Trend Higher

Gasoline Average Price (Regular Unleaded, $ Per Gallon, U.S. DOE)

$1.40

$1.60

$1.80

$2.00

$2.20

$2.40

$2.60

$2.80

$3.00

$3.20

Jan-03 Jul-03Jan-04 Jul-04

Jan-05 Jul-05

Heating Oil Price(NY Harbor No. 2, US Cents Per Gallon)

50

70

90

110

130

150

170

190

210

230

Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05

What About Long Term Rates?

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2

4

6

8

10

12

14

16

18

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

Per

cent

10 Year Treasury Yr/Yr Change in CPI

3

4

5

6

7

8

9

40

45

50

55

60

65

10-Year Treasury (left) ISM Manufacturing Index (right)

10-Year and Inflation 10-Year and Growth

A Little HelpNet Purchases of U.S. Treasuries by the Rest of the World

Total Net Foreign Purchases of U.S. Treasurys by World Region

-100,000

-50,000

0

50,000

100,000

150,000

200,000

Ne

t F

ore

ign

Pu

rch

ase

s o

f U

.S. T

rea

su

rys (

$ M

illio

ns)

Japan

Europe

Latin America & Caribbean

China

Twin Deficits Remain a Weight

-7

-6

-5

-4

-3

-2

-1

0

1

2

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Federal Budget Deficit as % of GDP

Current Account Deficit as % of GDP

0

500

1000

1500

2000

2500

1999 2000 2001 2002 2003 2004 2005

Entitlements

Nondefense Discretionary

Defense Spending

Government ExpendituresSeasonally Adjusted Annual Rates, Billions of $

Entitlements: A Major Threat Going Forward

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5

10

15

20

25

30

2000 2010 2020 2030 2040 2050 2060 2070 2080

Social Security, Medicare, and Medicaid Spending as a Percent of GDP

Per

cen

t o

f G

DP

Note: Social Security and Medicare projections based on the intermediate assumptions of the 2004 Trustees’ Reports. Medicaid projections based on CBO’s January 2004 short-term Medicaid estimates and CBO’s December 2003 long-term Medicaid projections under mid-range assumptions.

Source: GAO analysis based on data from the Office of the Chief Actuary, Social Security Administration, Office of the Actuary, Centers for Medicare and Medicaid Services, and the Congressional Budget Office.

Medicare

Medicaid

Social Security