GS Outlook

Economic Outlook
Moving Over the Hump
Jan Hatzius
Chief Economist Jan.Hatzius@gs.com 212-902-0394
February 2013
Goldman Sachs Global Economics, Commodities and Strategy Research
A Gradual Acceleration in Global Growth

Real GDP Growth % yoy USA Japan Euro Area Germany France Italy Spain UK China India Brazil Russia Developed Markets Emerging Markets World 2011 1.8 -0.6 1.5 3.1 1.7 0.6 0.4 0.9 9.3 7.5 2.7 4.3 1.7 6.9 3.8 2012 2.2 2.0 -0.4 0.9 0.1 -2.0 -1.3 0.0 7.8 5.4 1.0 3.4 1.3 5.5 3.0 2013 1.8 0.9 -0.2 0.7 0.0 -0.8 -1.7 1.4 8.2 6.5 3.5 3.8 1.3 6.1 3.3 2014 2.9 1.3 0.9 1.9 0.6 0.6 -0.2 2.0 8.4 7.2 4.3 4.8 2.2 6.6 4.1 2015 3.2 0.7 1.3 2.1 1.2 0.9 1.0 2.3 8.3 7.2 4.0 4.3 2.3 6.5 4.2 2016 3.0 1.2 1.5 2.2 1.5 1.2 1.8 2.6 8.2 7.5 4.0 3.1 2.5 6.4 4.3
Source: GS Global ECS Research.

GS Global ECS Research 1
Spare Capacity in DM But Not EM
Percent of GDP 4 Forecast 2
Percent of GDP 4
-2 Output Gaps: -4 EM
-2
-4
DM
World -6 04 05 06 07 08 09 10 11 12 13 14 15 16
-6
GS Global ECS Research
Key US Economic Indicators: GS vs. Consensus

Ann. % chg. 5
Growth (Real GDP)

Forecast
Ann. % chg. 5
Inflation (Core PCE)

Percent change, year ago 3.0 2.5
Percent change, year ago 3.0

2.5
4
3 2 1 0 -1 2011
4
3
2.0
2
2.0
1.5 Range* GS Consensus 1.0 Forecast 0.5
Range* GS Consensus
1 0 -1
1.5 1.0 0.5 2011
2012
2013
2014
2012
2013
2014
* Top 10 avg - bottom 10 avg.
* Top 10 avg-bottom 10 avg.
Percent 2.0 GS 1.5
Fed Funds Rate
Percent 2.0
Fed Securities Holdings

Trillions of dollars 5 GS Consensus 4 3 Trillions of dollars 5 4 3
Consensus
1.5
1.0
1.0
2
1
0.5
0.5
1
0.0
2H 2012 1H 2H 1H 2H 1H 2H 1H 2016 2013 2014 2015
0.0
0
1H 2013 2H 1H 2014 2H 1H 2015 2H 1H 2016 2H
Actual Data
Growth consensus from Blue Chip Consensus Forecasts (February 2013) Inflation consensus from Bloomberg Fed consensus from Survey of Primary Dealers (December 2012)
3
Source: Dept. of Commerce. Bloomberg. FRB New York. GS Global ECS Research.
Temperature Check Current Activity Indicator Slows in January

Percent change, annual rate 5 Current Activity Indicator (CAI) 4 3 2 1 0 -1 Jul 2011 Oct Jan 2012 Apr Jul Oct Jan 2013 Housing Employment Consumer Industry 4 3 2 1 0 -1 Percent change, annual rate 5
* First principal component of 25 key weekly and monthly US economic indicators. Source: GS Global ECS Research.
Temperature Check Upside Data Surprises Have Stopped

Standard deviation 3 2 1 Standard deviation 3 2 1
0
-1 -2 -3 -4 Jan Mar 2011 May Jul Sep Nov Jan 2012 Mar May Jul Sep Nov Jan Mar 2013
0
-1 -2 -3 -4
US-MAP Surprise Index*
* Weighted index of US economic data surprises, linearly weighted 3-month average. Source: GS Global ECS Research.
US Growth Outlook Private Boost, Public Drag

Percent of GDP 12 9 6 3 0 -3 -6 -9 -12 1960 Private Sector Financial Balance General Government Budget Balance -12 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 1960-2011 Avg = 1.9% Percent of GDP 12 9 6 3 0 -3 -6 -9
Source: Department of Commerce. GS Global ECS Research.
US Growth Outlook Fiscal Drag Peaks in Mid-2013

Percentage points 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 Q1 2012 Q2 Q3 Q4 Q1 2013 Q2 Q3 Q4 Q1 2014 Q2 Q3 Q4 Impact of Federal Fiscal Policy on Real GDP Growth: Tax Spending (Ex Sequester) Sequester Percentage points 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0
US Growth Outlook Capital Spending Looks Very Profitable
Percent 8 Profit Margin, Domestic Industries (left) Growth Rate of Real Private Capital Stock (right) 7
Percent 6
2 1950
1960
1970
1980
1990
2000
2010
Source: Department of Commerce.
US Growth Outlook Homebuilding Has a Long Way to Rise

Thousands 2800 2400 2000 1600 1200 800 400 0 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
* Assumed demolition rate of 300,000 per year. Source: Department of Commerce. GS Global ECS Research.
Thousands 2800 Housing Starts Household Formation Demolitions* Housing Starts Household Formation Forecast 2400 2000 1600 1200 800 400 0
US Growth Outlook Excess Housing Supply Has Fallen Sharply

Percent 3.0 Homeowner Vacancy Rate* Percent 3.0
10
2.5
2.5
2.0
2.0
1.5 1980-2005 Average = 1.6% 1.0 1980
1.5
1.0 1985 1990 1995 2000 2005 2010
* Vacant homes for sale in percent of housing stock for owner occupation. Source: Department of Commerce.
10
Labor Market Slack and Its Implications Employment Still Far Below Potential
Percent of labor force 3 2 1 0 -1 -2 Percent of labor force 3 2 1 0 -1 -2
11
-3
-4 -5 -6 1994
-3 Unemployment Gap
Participation Gap -4 -5 -6 1996 1998 2000 2002 2004 2006 2008 2010 2012
Source: Department of Labor. GS Global ECS Research.
11
Labor Market Slack and Its Implications Wages and Unit Labor Costs Still Weak
Percent change, year ago 15 Average Hourly Earnings Employment Cost Index* 10 Unit Labor Costs** 10 Percent change, year ago 15
12
-5 1975
-5 1980 1985 1990 1995 2000 2005 2010
* Private industry workers. ** Nonfarm business sector. Source: Department of Labor.
12
Labor Market Slack and Its Implications Implication #1: Profit Margins Expand
Percent 11 10 9 8 7 6 5 4 3 70 75 80 85 90 95 00 05 10 15
** After-tax adjusted profits as percent of GDP. Source: Department of Commerce. GS Global ECS Research.
13
Percent 11
Corporate Profit Margins*:

Actual Forecast
10 9 8 7 6 5 4 3
13
Labor Market Slack and Its Implications Implication #2: Low Core Inflation
Percent change, year ago 5 Core PCE Inflation: Actual 4 Fed Forecast 4 Percent change, year ago 5
14
GS Forecast
3 3
1 Fed Inflation Target = 2.0% 0 90 92 94 96 98 00 02 04 06 08 10 12 14

Source: Department of Commerce. Federal Reserve Board.
14
Fed Policy Stays Easy Visualizing the Shifts in Fed Policy

Liftoff from Funds Rate = 0 Inflation (%) 4.0 3.5 3.0 2.5
Optimal Control Approach
15
Inflation (%) 4.0 3.5 3.0 2.5

Pre-CrisisTaylor Rule
2.0 1.5 1.0
2.0 1.5 1.0
December 2012
0.5
0.0 0 2
Current Threshold Guidance
0.5
0.0
6 Unemployment (%)
10
12
15
A Gradual Increase in Bond Yields The Bond Term Premium

Percentage points 6 5 4 3 2 1 0 -1 2000 10-year Term Premium (left)* 10-year Yield (right) 6 5 4 3 2 1 2002 2004 2006 2008 2010 2012 Percentage points 8 7
16
*As estimated by the Kim-Wright Term Structure Model. Source: Federal Reserve Board. GS Global ECS Research.
16
A Gradual Increase in Bond Yields Is Unlikely to Rise Quickly as QE Persists

Basis points 0 -20 -40 -60 -80 -100 -120 -140 -160 Total Portfolio Balance Effect on 10yr Yield Term Premium: QE3+Mid-2015 Twist 2 2014 Fwd Guidance Twist 2013 Fwd Guidance QE2 Reinvest MBS QE1 Basis points 0 -20 -40 -60 -80 -100 -120 -140 -160
17
Mar 2009
Sep
Mar 2010
Sep
Mar 2011
Sep
Mar 2012
Sep
Note: Assumes no change in expectations between announcements. Source: GS Global ECS Research.
17
The Truth about the Deficit Deficit Should Decline in Coming Years
18
Percent of GDP 0
Percent of GDP 0
-2
-2
-4 US Federal Budget Deficit: Actual GS Forecast Forecast -8
-4
-6
-6
-8
-10
-10
-12 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: CBO. GS Global ECS Research.
-12
18
The Truth about the Deficit Healthcare Holds the Key

Percent of GDP 35 Actual 30 25 20 15 Healthcare 10 5 Social Security 0 1970 0 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 10 5 Total Primary Spending CBO's Long-Term Alternative Fiscal Scenario Projected 30 25 Other Noninterest Spending 20 15 Percent of GDP 35
19
Revenues
Source: Congressional Budget Office.
19
Where Shale Matters Energy Supply Gets More Elastic
20
20
0
Saudi Arabia ('69 - '74)

US ('11 - '16)
Russia ('99 - '04) Iran ('68 - '73)

Millions of barrels per day 6
US ('65 - '70)
Libya('65 - '70)
Iraq ('94 - '99) Kuwait ('91 - '96) Mexico ('77 - '82) Nigeria ('68 - '73)
Iraq ('83 - '88)

UK ('75 - '80)
5 year Increase in Oil Production
Iraq ('74 - '79) Iran ('86 - '91)

Norway('91 - '96)
Where Shale Matters A Big Supply Boost in Absolute Terms
UAE ('86 - '91)

UAE ('69 - '74)
Angola ('03 - '08)

0 1 2 3 4 5
Millions of barrels per day 6
21
21
Kuwait ('91 - '96)

Angola ('03 - '08)
Percent of GDP 25 131 84 78
Saudi Arabia ('69 - '74) Saudi Arabia ('87 - '92) Saudi Arabia ('75 - '80) UAE ('86 - '91)
Russia ('99 - '04)
35
27
Iran ('86 - '91)

Norway('91 - '96)
Saudi Arabia ('99 - '04) Mexico ('77 - '82) UAE ('69 - '74) UK ('75 - '80)
US ('11 - '16)
Where Shale Matters But a Much Smaller One Relative to US GDP
5-year Increase in Oil Production
Percent of GDP 25
22
22
The European Crisis ECB Addresses Part of the Vicious Cycle
23
Bank Solvency & Liquidity Concerns LTRO
Fiscal Crisis
Lower Tax Receipts Expected Bailout Costs ESM & OMT Loan Losses
Fiscal Austerity
Banking Crisis
Reduced Loan Supply
Economic Crisis
23
The European Crisis ECB Has Reduced Spillover Risk

Index 100.6 100.4 100.2 100.0 99.8 99.6 99.4 99.2 99.0 Jan Apr 2010 Jul Oct Jan Apr 2011 Jul Oct Jan Apr 2012 Jul Oct Jan Apr 2013 GSFCI* (left) Euro Risk** (right, inverted) 0.95 0.90 0.85 Worse Index 0.75
24
0.80
1.00
* Wt avg of riskless int rates, spreads, equities, FX and house prices, based on ef f ects on1-yr f wd US GDP growth. ** First principal component of European bank stocks, bank CDS, svrgn CDS, and EUR/USD cross-currency basis spread. Source: GS Global ECS Research.
24
The European Crisis Periphery FCIs Only a Bit Easier

Index (2007=100) 108 106 104 102 100 98 96 94 05 06 07 08 09 10 11 12 13
25
Index (2007=100) 108 Tighter 106 104 102 100
Financial Conditions Index:

Germany France Italy Spain
98 96 94
25
The European Crisis Fiscal Drag Intensifies in Spain and France

Percentage points 0.2 0.0 -0.2 -0.4 Percentage points 0.2 0.0 -0.2 -0.4
26
-0.6
-0.8 -1.0 -1.2 -1.4 -1.6 -1.8 Germany
-0.6
-0.8 -1.0 Fiscal Drag on Real GDP Growth: 2012 2013 2014 France Italy Spain -1.6 -1.8 -1.2 -1.4
26
The European Crisis ULCs Have Only Adjusted Partially

Index (2000Q1=100) 150 Unit Labor Costs: 140 Germany France Ireland Italy Spain Greece Portugal 140 Index (2000Q1=100) 150
27
130
130
120
120
110
110
100
100
90 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: National Statistics. Haver Analytics. GS Global ECS Research.
90
27
28
Key Numbers in the US Economic Outlook

2011 OUTPUT AND SPENDING Real GDP Consumer Expenditure Residential Fixed Investment Business Fixed Investment Structures Equipment & Software Federal Government State and Local Government Net Exports ($bn, '05) Inventory Investment ($bn, '05) Industrial Production, Mfg INFLATION (% ch, yr/yr) Consumer Price Index (CPI) Core CPI Core PCE* Unit Labor Costs LABOR MARKET Unemployment Rate (%) 2012 (f)
2.2 1.9 11.9 7.7 9.6 6.9 -2.2 -1.3 -406 45 4.1 2.1 2.1 1.7 0.6 8.1
2013 (f)
1.8 1.7 13.7 5.7 2.5 6.9 -5.3 0.1 -393 42 0.9 1.7 1.7 1.3 1.2 7.7
2014 (f)
2.9 2.5 14.8 9.0 7.0 9.8 -5.9 1.2 -411 49 2.8 1.8 1.8 1.5 1.5 7.3
2015 (f)
3.2 2.7 13.4 7.5 5.9 8.1 -2.5 1.8 -433 57 3.7 2.0 1.9 1.6 1.7 6.7
2016 (f)
3.0 2.5 12.5 5.8 5.0 6.1 -1.2 2.0 -445 57 3.1 2.1 2.1 1.8 2.1 6.3
Q1
2.0 2.4 20.6 7.5 12.8 5.4 -4.2 -2.2 -416 57 9.8 2.8 2.2 1.9 0.2 8.2
2012 Q2 Q3
1.3 1.5 8.4 3.6 0.6 4.8 -0.2 -1.0 -407 41 0.7 1.9 2.3 1.8 0.4 8.2 3.1 1.6 13.6 -1.8 0.0 -2.6 9.5 0.3 -395 60 -0.8 1.7 2.0 1.6 0.0 8.0
Q4
-0.1 2.2 15.3 8.4 -1.1 12.5 -15.0 -0.7 -404 20 0.0 1.9 1.9 1.5 1.9 7.8
Q1
2.8 1.2 13.9 5.0 3.4 5.6 2.5 0.1 -393 38 1.0 1.5 1.8 1.2 0.4 7.8
2013 Q2 Q3
1.5 1.5 12.5 6.5 4.0 7.5 -12.5 0.0 -389 45 2.0 1.8 1.6 1.2 1.1 7.8 0.13 0.30 0.30 0.90 2.00 3.05 -2.9 1.40 87 2.0 2.0 15.0 8.6 5.0 10.0 -10.0 1.0 -392 43 2.0 1.8 1.7 1.3 2.1 7.7 0.13 0.30 0.35 1.00 2.10 3.05 -3.0 1.40 87
Q4
2.5 2.0 15.0 9.3 7.5 10.0 -5.0 1.0 -396 43 2.0 1.7 1.7 1.5 1.4 7.6 0.13 0.30 0.40 1.20 2.20 3.25 -3.0 1.40 87
1.8 2.5 -1.4 8.6 2.8 11.0 -2.8 -3.4 -408 31 4.3 3.1 1.7 1.4 1.9 8.9
FINANCIAL SECTOR Federal Funds** (%) 0.00 0.00 0.13 0.13 0.13 1.25 0.00 0.00 0.00 0.00 0.06 3-Month LIBOR (%) 0.07 0.16 0.30 0.30 0.30 1.50 0.13 0.16 0.14 0.16 0.23 Treasury Yield Curve** (%) 2-Year Note 0.56 0.31 0.40 0.60 1.50 2.00 0.47 0.47 0.39 0.31 0.30 5-Year Note 0.26 0.26 1.20 1.75 2.50 3.00 0.34 0.29 0.26 0.26 0.58 10-Year Note 0.89 0.70 2.20 2.75 3.25 3.75 1.02 0.71 0.67 0.70 1.35 30-Year Bond 1.98 1.72 3.25 3.65 4.00 4.25 2.17 1.62 1.72 1.72 2.39 FOREIGN SECTOR Current Account (% of GDP) -3.1 -3.0 -2.9 -3.2 -3.5 -3.8 -3.5 -3.0 -2.7 -2.9 -2.9 Euro ($/)** 1.32 1.31 1.40 1.40 1.35 1.25 1.32 1.25 1.29 1.31 1.36 Yen (/$)** 78 84 87 87 100 110 82 79 78 84 85 * PCE = Personal consumption expenditures. ** Denotes end of period. *** Profits are after taxes as reported in the national income. and product accounts (NIPA), adjusted to remove inventory profits and depreciation distortions. NOTE: Published figures are in bold.
28
29
Disclosure Appendix
I, Jan Hatzius, hereby certify that all of the views expressed in this report accurately reflect my/our personal views, which have not been influenced by considerations of the firms business or client relationships.
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Economic Outlook

Moving Over the Hump

Goldman Sachs Global Economics, Commodities and Strategy Research

A Gradual Acceleration in Global Growth

Source: GS Global ECS Research.

Spare Capacity in DM But Not EM

Percent of GDP 4 Forecast 2

GS Global ECS Research

Key US Economic Indicators: GS vs. Consensus

Growth (Real GDP)

Inflation (Core PCE)

Percent change, year ago 3.0

1.5 1.0 0.5 2011

* Top 10 avg - bottom 10 avg.

* Top 10 avg-bottom 10 avg.

Percent 2.0 GS 1.5

Fed Funds Rate

Fed Securities Holdings

Temperature Check Current Activity Indicator Slows in January

GS Global ECS Research

Temperature Check Upside Data Surprises Have Stopped

US-MAP Surprise Index*

GS Global ECS Research

US Growth Outlook Private Boost, Public Drag

Source: Department of Commerce. GS Global ECS Research.

GS Global ECS Research

US Growth Outlook Fiscal Drag Peaks in Mid-2013

Source: GS Global ECS Research.

GS Global ECS Research

US Growth Outlook Capital Spending Looks Very Profitable

Source: Department of Commerce.

GS Global ECS Research

US Growth Outlook Homebuilding Has a Long Way to Rise

GS Global ECS Research

US Growth Outlook Excess Housing Supply Has Fallen Sharply

1.5 1980-2005 Average = 1.6% 1.0 1980

1.0 1985 1990 1995 2000 2005 2010

GS Global ECS Research

Source: Department of Labor. GS Global ECS Research.

GS Global ECS Research

-5 1980 1985 1990 1995 2000 2005 2010

* Private industry workers. ** Nonfarm business sector. Source: Department of Labor.

GS Global ECS Research

Corporate Profit Margins*:

GS Global ECS Research

1 Fed Inflation Target = 2.0% 0 90 92 94 96 98 00 02 04 06 08 10 12 14

GS Global ECS Research

Fed Policy Stays Easy Visualizing the Shifts in Fed Policy

Inflation (%) 4.0 3.5 3.0 2.5

2.0 1.5 1.0

2.0 1.5 1.0

Current Threshold Guidance

Source: GS Global ECS Research.

GS Global ECS Research

A Gradual Increase in Bond Yields The Bond Term Premium

GS Global ECS Research

A Gradual Increase in Bond Yields Is Unlikely to Rise Quickly as QE Persists

GS Global ECS Research

-4 US Federal Budget Deficit: Actual GS Forecast Forecast -8

GS Global ECS Research

The Truth about the Deficit Healthcare Holds the Key

Source: Congressional Budget Office.

GS Global ECS Research

Where Shale Matters Energy Supply Gets More Elastic