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US Economic and Financial Outlook

In this detailed report, UBS's Chief US Economist, Maury Harris, outlines the economic forecasts for the United States as of October 2006. Anticipated real GDP growth is set at 2.0% for the second half of 2006 and 2.4% for 2007, largely influenced by a slowdown in consumer spending. The report discusses key factors impacting growth, including interest rates, inflation, and housing market dynamics. It highlights significant risks and signals to watch, providing a comprehensive view of the potential economic landscape for the coming year.

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US Economic and Financial Outlook

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  1. US Economic and Financial Outlook Maury Harris Chief US Economist 212 713-2472 maury.harris@ubs.com October 19, 2006 This report has been prepared by UBS Securities LLC

  2. U.S. economic forecasts: What and why?

  3. “Bottom line” on UBS U.S. economic forecasts • Real GDP growth at a 2.0% pace in H2(06) and at 2.4% in 2007 (Q4/Q4) mainly due to consumer slowdown. H2(07) growth above H1(07) growth in response to lower rates and dollar. (2.2% for calendar average 2007 GDP growth.) • 5¼% Fed funds peak followed by 2007 easing to 4¼% • 4½% to 5% 10-yr Treasury yield range for most of 2006;4 to 4½% for most of 2007. • Core PCE price index inflation rises from 2.1% in 2005 to 2.4% in 2006 before slowing to 2.0% in 2007.

  4. “Soft landing” growth forecast fundamentals • Terminated real estate boom had added 1% per year to growth,but... • Some 2007 assistance from eventual interest rate relief. • Capex supported by high capacity utilization. • Export assist from expected resumed dollar decline.

  5. Major growth risks • Housing-related uncertainty following unprecedented boom. • Crude oil prices much above our $68/barrel 2007 forecast. • Upside growth risk is hard-to-forecast household formation

  6. Key growth signposts • Jobless claims • Capital goods orders

  7. Inflation forecast crosscurrents • Temporarily accelerating Owners’ Equivalent Rent (OER) • Productivity slowing to trend • Projected lower dollar • Only moderate wage acceleration • Slower output and demand growth

  8. Inflation Other than a pickup in rents, which is arguably a byproduct of weakening in homebuying rather than “overheating,” core PCE inflation has been stable. * Weights based on Q4(05) nominal personal consumption expenditures. Source: Bureau of Economic Analysis and UBS calculations

  9. Interest rate forecast drivers • 5 1/4% Fed funds rate peak “data dependent” on sustained slowing in growth. • Fed and investors start to expect that OER-led core inflation acceleration in 2006 is unsustainable as growth slows • Foreign savings help keep bond yields somewhat below normal, although such “help” now less than in 2005.

  10. US forecasts GDP Source: Bureau of Economic Analysis and UBS estimates

  11. US forecasts Key business indicators, income, and productivity Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board, and UBS estimates

  12. US forecasts Inflation and interest rates Note: Quarterly interest rate forecasts are for end of period yields Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board, and UBS estimates

  13. Global forecast summary

  14. Global forecasts Global real GDP growth *Based on purchasing power parity-adjusted GDP levels. **1981-1989 average ***includes Australia and New Zealand. Source: UBS

  15. Housing

  16. When the new homes sales months’ supply is over 6 months, real new home prices tend to decline. Source: U.S. Census Department

  17. The reported 6.6 months’ supply in August understates the inventory overhang, because reported sales exclude surging cancellations. Source: UBS

  18. Housing’s indirect effects… …have been larger than usual in the current cycle, due to a surge in wealth as home prices have risen. Wealth has been tapped through home equity extraction (HEE). At least some of that extraction has likely been used to finance extra household spending. * Single-family only are available prior to 1999; ** UBS estimate of home equity extraction calculated as increase in residential mortgage debt minus all new residential investment other than home improvements *** Quarterly except latest. Source: Federal Reserve, Bureau of Economic Analysis, National Association of Realtors, OFHEO , and UBS

  19. Global disclaimer

  20. Contact information Maury N. Harris Chief US Economist maury.harris@ubs.com +1-212-713 2472 www.ubs.com

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