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Exhibit 31: US Cyclical Spending There is scope for business and consumer spending to increase in the US economy. % of Potential GDP Recession 32 4 US Cyclical Spending = — — = = Average 30 28 26 + 24 22 20 18 = = 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Data through 03 2016. Note: 4-quarter average. Cyclical spending is business fixed investment plus consumer durables spending. Source: Investment Strategy Group, Datastream. Exhibit 32: US Inflation Normalizing energy prices account for much of the inflation increase we expect. % YoY 45 Mas Energy Contribution to Headline Inflation Forecast “s. ----- Headline Inflation f ‘ Core Inflation* 3 ’ ‘ 1 A | \ 2.4 \t \ x 2 . 3 as o~ Z - q* ‘ ‘ , ‘ ’ ‘ ¢ I a eel lee ahd : ms | 11111 1 A 2011 2012 2013 2014 2015 2016 2017 Data as of 03 2016. Note: ISG forecasts from 04 2016. For informational purposes only. There can be no assurance the forecasts will be achieved. Source: Investment Strategy Group, Datastream. * Core inflation excludes food and energy. three culprits: economic imbalances, excessive Federal Reserve tightening and/or exogenous shocks (most commonly in the form of spiraling oil prices). As we survey these risks today, none are particularly alarming. The depth of the financial crisis and the lackluster pace of the recovery have allowed the US to avoid the imbalances that would typically be evident this far into an expansion (see Section I of this year’s Outlook). If anything, there is scope for spending in cyclical parts of the US economy relative to overall GDP to move toward its long-term average (see Exhibit 31). There is also less risk of disruptive Federal Reserve tightening, given how few signs we see of economic overheating. Headline inflation remains below the Federal Reserve’s 2.0% target, and though we expect it to move higher this year, normalizing energy prices are a key driver (see Exhibit 32). Further, while the November 2016 unemployment rate of 4.6% suggests the economy is near full employment, broader measures of labor slack, as well as today’s depressed labor force participation rate, argue that the central bank is not “behind the curve” (see Exhibit 33). Lastly, our expectation for continued modest gains for the US dollar and a rebound in productivity growth from generational lows (see Exhibit 34) provides a natural offset to inflation pressures, even as wages continue to rise. Exhibit 33: US Unemployment Indicators There are still signs of slack in the labor market. % % 14 Overall Employment Population Ratio (Right, Inverted) r 55 i= Unemployment Rate ? + Natural Rate of Unemployment* t 57 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 Data through November 2016. Source: Investment Strategy Group, Federal Reserve Economic Data, Datastream. * Long-term rate. Of equal importance, the Federal Reserve is acutely aware of the risks that tighter monetary policy poses to the business cycle, which is apparent in both its willingness to step back from planned rate hikes last year as well as Chair Yellen’s acknowledgment that an “abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession.”!*! With neutral real interest rates Outlook | Investment Strategy Group 39 HOUSE_OVERSIGHT_014572