The Economic Outlook. Economic Growth Forecast in 2015: Strongest Growth of the Recovery to Date. December Outlook Review.

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1 The Economic Outlook December 2014 Economic Growth Forecast in 2015: Strongest Growth of the Recovery to Date Outlook Review The United States forecast is for solid economic growth in 2015 that is expected be the fastest in the economic recovery to date. Strengthening employment conditions, continual improvements in consumer finances and steadily rising housing markets are likely to reassert the consumer s lead role in the U.S. economy. The U.S. unemployment rate is expected to remain on a declining trend from 5.8% in October to 5.3% in Q Overall labor compensation gains will likely increase, and labor force participation is expected to improve, especially for those with skills in high demand. Low energy prices should provide an added boost to inflation adjusted personal incomes in the coming months. Capital investment in equipment and structures is expected to grow at a solid pace throughout the year as businesses continue to benefit from rising revenue and cash flow growth generated primarily from the domestic economy. Slower foreign economic growth and a stronger dollar reduce export and profit growth from the previous forecast, but upward revisions to domestic consumption offset downward revisions in international business in the 2015 forecast. U.S. federal spending will likely remain constrained by budget tightening efforts, but state and local spending is expected to accelerate gradually as a result of rising tax revenues. Conditional on solid growth in the U.S. economy and jobs in 2015, the Federal Reserve is forecasted to begin gradually raising its policy interest rates by the second half of the year. Inflation is forecasted to remain in line with the experience of recent years, but money supply growth will likely accelerate alongside economic growth in 2015, thereby requiring the beginnings of monetary policy firming. Long term interest rates are also expected to rise given stronger domestic economic growth, but the relative strength of the international economy next year will also influence long term interest rates in the coming year, keeping forecast risks for long term interest rates elevated. Economic Risks The risk of recession is relatively low in the next year as momentum in labor markets builds and expansionary monetary policy remains supportive of economic growth even if policy rates gradually begin to rise as forecasted. Policy uncertainty has been reduced at the macroeconomic level with passage of the 2014 federal budget and the lifting of the debt ceiling, but policy and international uncertainties are not likely to disappear in At the federal level, corporate taxation, regulatory policies and immigration policy will likely attain the highest degree of debate. Global debt in excess of $100 trillion in conjunction with slowing demographic trends in the United States and other developed economies probably poses the greatest known risk to sustained economic growth in the longterm future. High debt can ultimately deplete private sector expansion through its eventual impact on interest rates, taxation and the reduction of essential government spending. High debt also raises long term inflation risks as high debt relative to GDP may require extraordinarily high levels of monetary stimulus to counter, as recently exemplified in Japan. In the worst case scenarios, the Ukraine/Russia conflict and Middle East crises pose risks to the recovery, worldwide stability of energy markets and international commerce, especially to the regional economies directly impacted by the crises. Job Openings Surpass Pre Recession Highs Prepared by: George Mokzran, Ph.D. Director of Economics, Huntington National Bank 1

2 Positive Long term Factors Improving consumer balance sheets; strong corporate balance sheets; improving housing markets; improving average state and local government finances; strong potential export growth; resurging manufacturing sector; natural gas and resource richness. The International Energy Agency projects the U.S. will be the top oil producer by 2015, and could become energy independent by 2035 through its success in exploiting shale deposits. Negative Long term Factors High long term government debt and deficits; rising taxes; sharp near term government spending cuts; slowing productivity growth; long term risks to inflation, interest rates and exchange rates; geo political risks; rising regulatory costs; weak real disposable personal income growth; cyber risks. Household Debt Drops to Lowest Point Relative to Disposable Personal Income since U.S. Household and Non-Profit Debt As Percent of Nominal Disposable Personal Income Most Recent Data: Second Quarter Interest Rates Expected to Head Upwards Inflation After a surge in consumer and producer prices during the second quarter, a sustained drop in energy and other commodity prices brought a reprieve to consumers in the second half of Goods prices have generally slowed as the dollar strengthened and the world economy weakened. A plentiful harvest and abundant domestic energy production are expected to help maintain inflation below the 2% annual growth rate for the remainder of 2014 and early However, as the U.S. economy advances toward higher utilization of resources and aggregate demand next year, inflation is expected to accelerate gradually. Pricing power of firms will likely gradually strengthen in 2015 as the U.S. expansion gains traction, liquidity rises and resources become increasingly constrained. Rents and services will probably be the areas of highest inflation next year. Offsetting some of the strength in the U.S. economy, a weaker than expected world economy will likely slow demand growth for energy, commodity and finished goods next year. Hence, average annual inflation forecast for 2015 was revised downwards from 2.1% to 1.7%. However, the quarterly rate of inflation is forecasted to accelerate as the year progresses to a 2.5% pace in the second half of the year. By this time, historically expansionary monetary policy in the advanced economies outside of the U.S. will likely begin to accelerate worldwide economic growth and start to transmit inflationary pressures across borders through commodity markets. Treasury Yield Curve The short end of the Treasury yield curve will likely remain low and in line with the Fed Funds rate target for the remainder of this year, and gradually rise with the Fed Funds rate target in Long term Treasury interest rates have been suppressed by the Federal Reserve s bond purchases, geo political stresses, central bank interest rate policies globally and weakening economies in Europe, Japan and China that have kept long term interest rates low worldwide. Despite the end of additional Federal Reserve bond purchases, high demand for Treasury bonds for liquidity, regulatory, or asset diversification purposes have probably put further downward pressure on long term interest rates. These combined downward forces including the recent sharp declines in government bond interest rates in Europe have resulted in declines in the 10 year Treasury interest rate in This onslaught of forces has now largely been priced into bonds and is not likely to intensify further. Continued solidifying of the U.S. economy and labor markets are expected to reassert upward pressure on long term interest rates in 2015, bringing the 10 year Treasury up to 3.0% by year end, but lower than the previous forecast of 3.36% due to increased international headwinds. The expectation that long term interest rates will rise is predicated on strengthening in real GDP growth in the U.S to a sustainable pace of 2.7% the GDP forecast. The interest rate forecast also hinges on containment of recent geopolitical crises and a gradual improvement in the world economy overall in the next year. Long term risks: The Congressional Budget Office (CBO) projects federal debt held by the public to decline gradually from 74.4% of GDP in 2014 to 72.8% in Federal Debt to GDP subsequently begins a firm upward trend to 77.2% in 2024 that would likely be even higher should a recession occur in the next decade. A recession is not forecastable at this time, but history says it is likely to occur sometime within that time period. Furthermore, based on current CBO projections, federal debt relative to GDP begins to escalate substantially in about a decade based on demographic and government policy projections. Hence, long term interest rate risks and the risks they might pose to the economy are probably high. 2

3 Monetary Policy A strengthening U.S. economy, a relatively low unemployment rate moving towards 5% and the likely continuation of solid money supply growth will probably set the stage for gradual monetary policy firming to begin in The Federal Reserve is forecasted to raise the Fed Funds rate target from its current range between 0 and 25 basis points to exactly 0.25% in the second quarter of The first full 25 basis point increase to 0.50% is forecasted to occur during the third quarter of Further policy interest rate increases will probably be more gradual than the historical norm, as financial markets are expected to need time to adjust to a changing interest rate environment. The Fed Funds rate target is expected to end the year at 0.75%, and move up at a pace of approximately one quarter point per quarter in A world economy weighed down by historically high debt levels poses a downward force on world interest rates that will likely keep the Federal Reserve on a somewhat slower trajectory than previously estimated. Potential long term GDP growth of the U.S. economy may have also slowed from its post WWII norm, thereby requiring a somewhat more gradual rate of ascent than the norm. Maintained somewhat higher than the Fed Funds rate target, the interest rate paid on excess reserves (IOER) will likely rise along with the Fed Funds rate target, and is expected to support the Federal Reserve s monetary policy in a normalizing rate environment. The new Overnight Reverse Repurchase agreement (ON RRP) is potentially another policy interest rate tool in a rising rate environment, as it could be set precisely by the Federal Reserve, and it could put a firm floor under money market interest rates. Given the extraordinary levels of liquidity in financial markets, the actual Fed Funds rate will likely deviate more from the Federal Reserve s target during the early stages of policy rate increases than it has done during past periods when the Fed Funds rate target was raised. The new monetary policy tools IOER and ON RRP should aid the Federal Reserve in reducing this potential volatility. The Federal Reserve ended its outright purchases of securities after its October FOMC meeting, although it plans to continue its reinvestment of principal payments on its portfolio into agency mortgage backed securities (MBS) and to roll over maturing Treasury bonds upon their maturity. According to Chairwoman Yellen in the September FOMC news conference, the Federal Reserve s intention is to gradually reduce the size of its assets to a level consistent with no more than it needs to effectively perform monetary policy. This downsizing will likely take a significant period of time. Chairwoman Yellen estimates that the desired size of the Federal Reserve s balance sheet won t be achieved until the end of this decade. Hence, the Federal Reserve plans to maintain its large balance sheet and the monetary stimulus it provides for the next several years, even as it raises its policy interest rates. However, the Federal Reserve s guidance on future monetary policy is based on their forecasts of economic developments, and their actual policy action(s) could change if developments in the economy or inflation differ from their expectations. Recent FOMC statements emphasize the data dependent nature of future monetary policy. Hence, the guidance is for interest rates to be low for a considerable and therefore lengthy period of time, but actual policy will ultimately respond to events as they occur. This is probably the most significant monetary policy clarification from the October FOMC meeting, and it is probably designed to anchor confidence that the Federal Reserve will do whatever is required to meet its dual objectives of low cyclical unemployment and inflation close to 2%. The Bank of Japan has committed to continue its extraordinary monetary policy into 2015, which is the highest relative to GDP in the world. The European Central Bank recently cut its policy interest rate to an historic low of 0.1%, effectively charging banks for depositing reserves, and is projected to pursue a highly accommodative monetary policy for at least the next 2 years including asset purchase program to support the European banking system and stimulate lending. In contrast to the ECB, the Bank of England is beginning to signal a potential tightening of monetary policy and lifting of policy interest rates to counter rising inflationary pressures in the United Kingdom. Dollar The dollar exchange against major currencies is expected to continue gaining support from stronger U.S. economic growth and gradually firming domestic monetary policy. Much of the recent dollar gains have been due to the combined weakening of the euro and yen against most major currencies a trend that could continue into next year. The currencies of emerging market countries that have minimal domestic inflation risks and have continued to exhibit strong economic growth in the last year should continue to perform well in the next year overall. Profits Aggregate corporate profits should continue to grow at a solid annualized rate in line with a stronger U.S. economy in However, overall GDP profit growth was revised downwards somewhat in 2015 due to expectations of a somewhat slower world economy and a somewhat stronger dollar next year. A strengthened dollar should benefit companies that do most of their business within the U.S. relative to those that maintain significant operations overseas. 3

4 The International Economy The EU 28 muddled at a 1.20% annual growth rate in the third quarter, virtually equal to the slow 1.29% growth spanning Q to Q Solid growth in the United Kingdom, Sweden, Ireland, Poland and other emerging economies of central Europe was offset by significant weakness in Italy, France, Finland and Austria. Building on nascent structural reforms, Spain and Greece exhibited respectable growth in the last year. The remaining countries had relatively tepid growth with a slowdown in Germany attracting the most attention due to the large exporter s size and exposure to energy supplies from Eastern Europe. Germany s 10 year government bond yield dipped below 1%, but barring a wider escalation in the Ukraine/Russia conflict, Germany s economy is on fundamentally sound footing. In the last year in Germany, employment grew 0.9%, exports rose 5.4% and the unemployment rate dipped to 5.0%. High overall debt levels, weak demographic trends, inflation moving dangerously low towards deflation and geopolitical risks threatening Europe s borders and security will likely continue to weigh on the continent s economy. The European Central Bank introduced a purchase program of covered bonds and asset backed securities from its banks for a period of at least 2 years to provide monetary stimulus. The ECB is less powerful than the Federal Reserve in that it has multiple country constituencies with widely divergent perspectives on massive monetary stimulus programs. The purchase of government bonds is especially controversial in Europe as it accommodates government debt financing. However, the central bank will likely continue to implement monetary stimulus initiatives as warranted by the underlying economic situation in Europe. Recent central bank sabre rattling has centered on inflation being dangerously low to deflationary levels, but pro growth fiscal policies and structural reforms will likely be needed before historically stimulative monetary policy becomes effective. The European Union unemployment rate has been on a recent declining trend to 10.1% in the entire third quarter, but this could reverse to a rising tilt by early next year. Japan s economy recorded 2 consecutive quarters of GDP declines and an annual drop in real GDP of 1.1% in the third quarter as an anticipated April sales tax increase from 5% to 8% accelerated purchases before the tax hike took effect and depressed sales afterwards. Taxes were raised to help finance Japan s enormous government debt comprising 230% of GDP. Prime Minister Abe has called for an election and may forestall a further planned sales tax increase to 10% next year. Meanwhile, the Bank of Japan plans to extend its historic asset purchases program into China has been growing at a subpar pace relative to its history of the last decade, prompting China s central bank to lower its policy lending rate for the first time since China will likely continue to grow at a subpar pace in the next year relative to its recent history as policymakers grapple with structural reforms in China s financial system and other areas of its transforming economy. Outside of Japan and China, the old Asian Tigers plus India have grown strongly in the last year. The large South Korean economy grew an impressive 3.2% in the last year, India grew 5.6% (second quarter annual) and the Philippines grew 6.2% (second quarter annual). Only Thailand has experienced real GDP growth significantly below 3% in the last year among the new Asian Tigers. The U.S. Outperforms World Average Export Growth since 2003 In the other major areas of the world, real GDP has declined in Brazil and Argentina in the last year. Growth was also modest in Chile as traditional commodity rich exporters have been slowed by subdued commodity prices worldwide. However, Canada and Mexico have exhibited solid growth of 2.6% and 2.1%, respectively in the last year. Columbia and Ecuador grew at a strong pace of 4.3% and 3.5%, respectively. Australia has grown a solid 3.1% in the last year. Of the larger economies in the Middle East and Africa, real GDP has only declined in the last year in Egypt. Hence, the international economic picture is far from uniformly weak with many countries on virtually all continents exhibiting solid economic growth. Although lingering weaknesses in some of the large developed economies outside of the U.S. can temper the overall international recovery, expansionary monetary policies and low interest rates worldwide have reduced capital flow pressures on emerging market economies in the interim. Expansionary monetary policies should also help accelerate economic growth in the weakest developed economies and generally support rising demand for many commodities the lifeblood of many emerging market economies. Overall, the forecast for a moderately strengthening world economy in 2015 should gradually lift international trade worldwide, provide stimulus to emerging and developed economies alike, and nurture a generally improving business climate. 3

5 Table 1 GDP Forecast November 25, 2014 Annualized Real Growth Rates (bln Chained 2009 Dollars) 14-I 14-II 14-III 14-IV 15-I 15-II 15-III 15-IV REAL GROSS DOMESTIC PRODUCT Real GDP Annualized Growth Rate quarter % change CONSUMPTION % change DURABLE GOODS % change NON-DURABLE GOODS % change SERVICES % change GROSS PRIV. DOM. INVESTMENT % change FIXED INVESTMENT % change NON-RESIDENTIAL* % change NON-RESIDENTIAL STRUCTURES % change EQUIPMENT % change RESIDENTIAL % change CHANGE IN INVENTORIES NET EXPORTS EXPORTS % change IMPORTS % change GOVERNMENT PURCHASES % change FEDERAL % change STATE & LOCAL % change Note: Data and percent changes are expressed at seasonally adjusted annual rates. *Non-Residential Fixed Investment includes Intellectural Property Investment not shown separately. 4

6 Table 2 Economic Indicators: November 21, 2014 KEY ECONOMIC INDICATORS 14-I 14-II 14-III 14-IV 15-I 15-II 15-III 15-IV Gross Domestic Product (bln $) * Implicit GDP Price Deflator * Consumer Price Index -- CPI-U * Producer Price Index * FEDERAL FUNDS RATE -- average YEAR T-NOTE -- average U.S. DOLLAR (FRB Index) AVERAGE MONTHLY CHANGE (Thou UNEMPLOYMENT RATE (%) Existing Home Sales (Thous SAAR) Housing Starts (Millions) Motor Vehicle Sales (Millions SAAR) Industrial Production Growth (SA) * Consumer Credit * C & I * CORPORATE PROFITS (Bil. of $) % change * (Profits generated through U.S. GDP) * Annualized Growth Rates Red -- First Period Forecasted Brown -- Annual Averages Data Source: Haver Analytics Forecasts: Huntington This publication contains general information: the views and strategies described may not be suitable for all investors, and individuals should consult with their investment advisor regarding their particular circumstances. Any forecasts presented are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. Content herein has been compiled or derived in part from sources believed reliable and contain information and opinions that are accurate and complete. However, Huntington is not responsible for those sources and makes no representation or warranty, express or implied, in respect thereof, and takes no responsibility for any errors and omissions. The opinions, estimates and projections contained herein are as of the date of this publication and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Investing in securities involves risk, including possible loss of principal amount invested. Past performance is no guarantee of future results. and Huntington are federally registered service marks of Huntington Bancshares Incorporated Huntington Bancshares Incorporated. 5