U.S Outlook 2Q 2017

Outlook United States 2nd QUARTER 2017

U.S Outlook 2Q 2017

Risks remain balanced

2

Economy

1. Economy at or near full employment

2. GDP growth will remain on a sustainable path

3. Investment gaining traction

4. Upward price pressures from energy and housing expected to moderate going forward

Monetary Policy

• Fed more comfortable as economic indicators align with their views

• Gradual policy normalization will continueTwo more 25bp rate increases in 2017

• High probability of taking action on reinvestment policy

Policy

• Tight calendar for Congress: FY2017 spending bill, FY2018 appropriations and budget, debt ceiling/suspension

• Expect modest progress on deregulation, tax reform, healthcare and infrastructure

U.S Outlook 2Q 2017

Financial markets: risk appetite fading

3 Source: Garanti Research, Bloomberg

Market Risk Indicators

CBOE Market Volatility (%)

S&P 500EnergyConstructionConsumerBanks3-Month Yield10-Year YieldCorporate Spreads-AAACorporate Spreads-BBBMarket Volatility IndexCrude Oil Volatility IndexC&I LoansReal Estate LoansCRE LoansCredit Card LoansBrazilItalyTurkeyVenezuelaArgentinaFinancial StressBusines Conditions IndexExchange RateMis

c.

Current1-month

ago3-months

ago6-monts

ago1-year

ago

Eq

uiti

es

Bo

nd

s

Volatility

Cre

dit

So

vere

ign

s (

CD

S)

10

30

50

70

90

10

20

30

40

50

2011 2012 2013 2014 2015 2016 2017

Equities Crude Oil (rhs)

SP Equity Indexes (July-2016=100)

60

80

100

120

140

160

jun-16 ago-16 oct-16 dic-16 feb-17

Energy Information Transportation

Banks Multiline Retail

U.S Outlook 2Q 2017

Several obstacles in Congress and in judicial review

Executive order (1/25) House approval Senate approval Sign into law Build wall Mexico pays for it

Executive Memorandum (1/24) State Department approval

•Repeal & replace ACA

•Reinstate global gag rule

•Withdraw from TPP

•Approve Keystone XL

•Build the border wall

•Immigration ban

•Supreme Court justice

•Impose tariffs

•Cut taxes

•Infrastructure Investment

•Cabinet confirmations

Executive Memorandum (1/23)

Executive Order (1/20) Propose a plan House approval Senate approval Sign into law

Executive Memorandum (1/23)

Executive order (1/27) Executive order 2.0 (3/6) Appeal judicial blocks?

Announce nominee (1/31) Senate hearing Senate approval

Propose plan House approval Senate approval Sign into law

Propose plan House approval Senate approval Sign into law

Propose plan House approval Senate approval Sign into law

Defense Mattis (98-1)

DHS Kelly (88-11)

Transportation Chao (93-6)

State Tillerson (56-43)

Education DeVos (51-50)

Justice Sessions (52-47)

Health Price (52-47)

Interior Zinke (68-31)

Commerce Ross (72-27)

Labor Acosta

Housing Carson (58-41)

Energy Perry (62-37)

Agriculture Perdue (87-11)

Treasury Mnuchin (53-47)

VA Shulkin (100-0)

New administration’s agenda

4

U.S Outlook 2Q 2017

U.S. economic dashboard

Source: BBVA Research & Haver Analytics

U.S. Economic Heat Map Domestic Auto Sales (YoY % change)

Real PCE (YoY % change)

Slowing Improving

ISM ManufacturingISM NonmanufacturingSmall Business Optimism Capacity UtilizationIndustrial ProductionCapital Goods New OrdersNondurable Goods OrdersRetail SalesUnemployment RatePrivate Nonfarm PayrollsEmployment to PopulationAverage Hourly EarningsAuto SalesReal Disposable IncomePersonal Savings RateRetail Sales ex auto & gasConsumer ConfidenceTotal Private ConstructuionMonth's SupplyHousing StartsHome PricesNew Home SalesExportsPolicy Uncertainty

1-yearagoCurrent

1-monthago

3-months ago

6-montsago

-20,0%

-10,0%

0,0%

10,0%

20,0%

30,0%

12 13 14 15 16Cars Trucks

-4-202468

10

70 73 75 78 80 83 85 88 90 93 95 98 00 03 05 08 10 13 15

Avg. '00- '16 Avg. '70- '00

5

U.S Outlook 2Q 2017

Exchange rate pressures easing

Source: BBVA Research & Haver Analytics

Real Exchange Rates & Real Exports (YoY % change)

Real Exports (contribution to YoY % change)

Stronger global trade and growth underlie rebound in exports

-6

-4

-2

0

2

4

6

8

10

Feb-

2017

Dec

-201

6O

ct-2

016

Aug

-201

6Ju

n-20

16A

pr-2

016

Feb-

2016

Dec

-201

5O

ct-2

015

Aug

-201

5Ju

n-20

15A

pr-2

015

Feb-

2015

Dec

-201

4O

ct-2

014

Aug

-201

4Ju

n-20

14A

pr-2

014

Feb-

2014

Dec

-201

3O

ct-2

013

Aug

-201

3

Consumer Goods ex Food Food & Bev.Industrial Supplies AutosOther Cap Goods ex Autos

-6,0%

-4,0%

-2,0%

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

16,0%

Real Trade Weighted FX Real Exports

6

U.S Outlook 2Q 2017

Consumption & investment

Real Private Fixed Investment* Year-over-year %

Solid business fixed investment to offset slowing consumption growth

*Forecasts from 2Q17-4Q17

Real Personal Consumption Expenditures* Year-over-year %

Source: BBVA Research & BEA

-2

0

2

4

6

8

10

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

Autos HomeFurnishings

MedicalServices

Trans. Services

RecServices

Total

-60

-40

-20

0

20

40

60

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

3Q15

1Q16

3Q16

1Q17

3Q17

Manu. Mining Info & Software

IP Sngl Fam Multifam Total

7

U.S Outlook 2Q 2017

Labor market overview

Nonfarm Payrolls by Industry (%)

Labor Utilization & Employment-to-population (%)

Manufacturing and mining sectors positive contributors to job gains

Source: BBVA Research, BLS & Haver Analytics

-2

-1

0

1

2

3

4

5

Year-over-year

2010-20150,0

2,0

4,0

6,0

8,0

10,0

12,0

14,0

16,0

18,0

56,0

57,0

58,0

59,0

60,0

61,0

62,0

63,0

jun-

2008

dic-

2008

jun-

2009

dic-

2009

jun-

2010

dic-

2010

jun-

2011

dic-

2011

jun-

2012

dic-

2012

jun-

2013

dic-

2013

jun-

2014

dic-

2014

jun-

2015

dic-

2015

jun-

2016

dic-

2016

Employment-to-Population U-6 (rhs)

8

U.S Outlook 2Q 2017

Labor market outlook

0

5

10

15

20

25

30

1950 1954 1959 1963 1978 1987 1997 2005 2017

Average

Time until next recession conditional on closing UR gap # Quarters

Nonfarm Payrolls (K per month)

-1000

-800

-600

-400

-200

0

200

400

600

ene-

2003

dic-

2003

nov-

2004

oct-2

005

sep-

2006

ago-

2007

jul-2

008

jun-

2009

may

-201

0ab

r-201

1m

ar-2

012

feb-

2013

ene-

2014

dic-

2014

nov-

2015

oct-2

016

sep-

2017

ago-

2018

jul-2

019

jun-

2020

Job growth will slow as unemployment rate gap narrows

Source: BBVA Research & BLS 9

U.S Outlook 2Q 2017

Market inflation expectations under more “normal” conditions, survey measures still pricing in reflationary scenario

Survey Inflation Expectations (%)

0,50

1,00

1,50

2,00

2,50

3,00

3,50

Jan-

14

Apr-

14

Jul-1

4

Oct

-14

Jan-

15

Apr-

15

Jul-1

5

Oct

-15

Jan-

16

Apr-

16

Jul-1

6

Oct

-16

Jan-

17

Apr-

17

Forward Swap Breakeven

1,70

1,80

1,90

2,00

2,10

2,20

2,30

2,40

2,50

2,60

12 13 14 15 16 17

1Yr 5yr 10yr

Market Inflation Expectations (%)

Inflation expectations

Source: BBVA Research & Haver Analytics 10

U.S Outlook 2Q 2017

Outlook & forecasts

U.S. Short-term Real GDP Forecast (SAAR %)

U.S. Real GDP Economic Scenarios (Year-over-year %)

Seasonal factors and slowing consumption suggest moderate growth in first quarter. Medium-run outlook remains positive

Source: BBVA Research & Haver Analytics

-5

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-1

0

1

2

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5

09 10 11 12 13 14 15 16 17 18 19 20

Upside Downside Basline

*Current

0,00%

0,50%

1,00%

1,50%

2,00%

2,50%

3,00%

3,50%

4,00%

Q2-

16

Q3-

16

Q4-

16

Q1-

17

Bas

elin

e

Atl

Fed*

NY

Fed

2017

2014

-202

0

Forecast1Q17

Baeline

11

U.S Outlook 2Q 2017

Monetary policy

Source: BBVA Research, Federal Reserve Board & Bloomberg

Upcoming meetings will likely focus on the evolution of the labor market, balance sheet normalization strategy, and risks from abroad

FOMC will continue crafting a Balance Sheet(BS) strategy to be set in motion by the end of the year.

Potential for faster pace of interest rate increases based on committee’s desire to decouple rate increase and BS normalization

Baseline remains for 2 more rate increase in 2017

Decoupling preference increases probability of additional hike this year (4 total), lowers probability of brisk pace of rate increases in ‘18

Fed Funds Rate %, upper limit

0,0

1,0

2,0

3,0

4,0

5,0

6,0

2007 2009 2011 2013 2015 2017 2019

BBVA Baseline FOMC Dot Plot OIS-Implied Rate

12

U.S Outlook 2Q 2017

March Statement & Minutes What do we expect? Projections

• Minutes confirm that move in March was not a function of a change in participants outlook

• First explicit reference to fiscal policy factoring in to members projections, but bias for some members towards major reform softening

• Balance sheet addendum to minutes opens door for ceasing reinvestment policy, possibly as early as this year

• Fears of taper tantrum 2.0 suggests committee will offer explicit guidance on timing, pace and desired long-run levels of the balance sheet

• President Dudley (NY) speech March 30, 2017: “…financial conditions would tighten by more if we were to end reinvestments earlier and more abruptly. This suggests a better course may be to taper reinvestments gradually and predictably”

• President Williams (SF) speech March 29, 2017: “With an economy at full employment, inflation nearing the Fed’s 2 percent goal, and the expansion now in its eighth year, the data have spoken and the message is clear: We’ve largely attained the hard-sought recovery we’ve been after for the past nine years.”

25bp increase at June meeting (implied market probability ~70%)

Timing and magnitude of tightening path could be effected by balance sheet normalization

Committee to produce plan for ceasing principal reinvestment by yearend in order to promote a predicative and passive wind down of reserve balances.

Debate likely to shift from sustainability of recovery to how to balance financial market conditions and a multifaceted policy normalization strategy

Fed

Timeline Exit

Strategy 2018

5th FFR Increase September 2017

Cease reinvestment policy June 2017

4th FFR Increase

Three rate increases

in 2017

Two rate increase in 2018

Elevated policy

uncertainty

Fed Funds Rate:

Dec 17: 1.5

Dec 18: 2.0

6th FFR Increase January 2018

Monetary policy

13

U.S Outlook 2Q 2017

Monetary policy

Source: BBVA Research & FRB

Fed Balance Sheet $ Trillion

-5,0

-4,0

-3,0

-2,0

-1,0

0,0

1,0

2,0

3,0

4,0

5,0

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0,0

1,0

2,0

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5,0

2007 2010 2013 2016 2019 2022 2025 2028

Treasury(A) MBS(A) Other(A) Currency (L) Reserves(L) Other(L)

"It wouldn't surprise me if some time later this year or some time in 2018, should the economy perform in line with our expectations, that we will start to gradually let the securities mature rather than reinvesting them,“ Dudley 3/31/17

“Now that the policy rate has been increased, the FOMC may be in a better position to allow reinvestment to end or to otherwise reduce the size of the balance sheet,” Bullard 2/28/17

14

U.S Outlook 2Q 2017

A more (less) aggressive strategy involves draining reserves quickly (slowly) & greater (lesser) reliance on MBS Money demand, multiplier & velocity will also determine when balances stabilize

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

5,0

0,00,20,40,60,81,01,21,41,61,82,0

2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

0,00,51,01,52,02,53,03,5

2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

Total Assets $ Trillions

Treasuries, $ Trillions

MBS, $ Trillions

Balance sheet normalization

Source: BBVA Research, FRBNY & FRB 15

U.S Outlook 2Q 2017

0

20

40

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160

Cautious Gradual FullCumulative Plus Duration

0

20

40

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160

180

Cautious Gradual Full-1 sd +1 sd & duration

2018-2022: 10YTN Equivalent Impact Basis Points

2018-2022: 10YTN Equivalent Impact Basis Points

Market perceptions, eventual balance sheet size and composition to determine impact on 10-year treasury Balance sheet normalization

Source: BBVA Research 16

U.S Outlook 2Q 2017

Fiscal policy

3 tax brackets of 10%, 25% and 35% Doubling the standard deduction Maintain the Earned Income Tax Credit Maintain mortgage interest and charitable gift tax deductions Repeal the Alternative Minimum Tax Repeal the estate tax Repeal the 3.8% ACA investment tax 15% business tax rate Territorial tax system One-time foreign-earned income repatriation relief Reduce corporate tax breaks

Comprehensive tax reform seems unlikely

-8

-6

-4

-2

0

2

4

6

8

Revenues Debt

Individual Corporate Estate Interests

Source: BBVA Research, the White House & the Tax Policy Center

Trump’s Tax Plan Impact on Tax Revenues and Debt, ($ Trillions)

17

U.S Outlook 2Q 2017

Macro scenarios: too early to deviate from baseline

Fed Funds Target Rate %

Consumer Price Index Year-over-year% change

Unemployment Rate %

Source: BBVA Research

Lack of progress from administration does suggest probability of reaching upside in 2017 is decreasing

0

1

2

3

4

5

09 10 11 12 13 14 15 16 17 18 19 20

Baseline Downside Upside

-2-1012345

09 10 11 12 13 14 15 16 17 18 19 20

Upside Downside Baseline

3

4

5

6

7

8

9

10

11Downside Upside Baseline

18

U.S Outlook 2Q 2017

Key macroeconomic indicators

U.S. Macroeconomic Indicators

Medium-run inflation outlook subdued despite undershooting of long-run UR

Source: BBVA Research

2016 2017 2018 2019 2020 Real GDP (% SAAR) 1.6 2.3 2.4 2.1 2.0

Real GDP (Contribution, pp)

PCE 1.9 2.0 1.6 1.5 1.3

Gross Investment -0.3 0.3 0.5 0.4 0.5

Non Residential -0.1 0.2 0.4 0.4 0.5

Residential 0.2 0.1 0.1 0.1 0.1

Exports 0.1 0.7 0.6 0.6 0.5

Imports -0.2 -1.0 -0.5 -0.6 -0.7

Government 0.1 0.1 0.2 0.2 0.2

Unemployment Rate (%, average) 4.9 4.5 4.2 4.3 4.3

Avg. Monthly Nonfarm Payroll (K) 208 185 171 167 181

CPI (YoY %) 1.3 2.6 1.9 2.0 2.1

Core CPI (YoY %) 1.3 2.2 1.9 2.0 2.0

Fiscal Balance (% GDP) -3.1 -2.5 -2.4 -2.9 -3.1

Current Account (bop, % GDP) -2.8 -3.0 -3.1 -3.1 -3.2

Fed Target Rate (%, eop) 0.75 1.50 2.00 2.50 2.75

Core Logic National HPI (YoY %) 5.4 6.6 6.2 6.1 5.2

10-Yr Treasury (% Yield, eop) 2.49 2.70 2.96 3.25 3.35

Brent Oil Prices (dpb, average) 45.2 57.0 58.7 59.6 59.6

19

U.S Outlook 2Q 2017

Outlook United States 2nd QUARTER 2017