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Key financial market driver 2 — US policy Key questions e Will the economic outlook deteriorate? Will QE3 become necessary? e How will the election outcome change fiscal policy deliberations? ° Can politicians find an agreement to avoid sharp fiscal contraction in early 2013 ("fiscal cliff")? ClO View (Probability: 65%*) No QE3, political gridlock and some fiscal tightening ¢ The economy stays on a moderate growth path, coupled with stable core PCE inflation close to the Fed’s target of 2%. UBS forecasts real GDP growth of 1.5% in 2Q 2012 (consensus: 2.1%) and 2.3% in 3Q 2012 (consensus: 2.4%), with some downside risk due to rising uncertainty. The Fed has decided to extend so called "Operation Twist" until the end of the year. More near-term monetary easing is still possible, but it is currently not our central scenario. ¢ In the elections, Republicans will likely lose seats in the House overall, but retain a majority; we also expect them to win a narrow majority in the Senate. Obama will likely retain the White House. Such an electoral outcome would confirm the existing gridlock between Republicans and Democrats. e Against the backdrop of ongoing political gridlock, we expect only moderate fiscal tightening of about 0.9% of GDP in 2013. The government will likely let unemployment benefits and the payroll tax cut expire, but postpone income tax hikes and sequestration spending. A Positive scenario (Probability: 10%*) ¢ Propelled by ultra-expansive monetary policy and improved confidence, cyclical forces surmount the structural hindrances and thus growth accelerates. More rapid growth leads to higher inflation, and the Fed responds by tightening monetary policy sooner. ¢ The improved economic outlook raises the odds for an Obama re-election and makes it harder for Republicans to win a majority in the Senate. US fiscal consolidation efforts are facilitated by faster rising tax collections. A Democratic stronghold leads to some tax hikes and limited spending cuts. Fiscal policy tightens by about 1.2% of GDP in 2013. Negative scenario (Probability: 25%*) QE3, political dysfunction and huge fiscal tightening ¢ Structural hindrances dominate and weigh on the cyclical recovery, thus growth weakens or turns negative. The Fed embarks on QE3, most likely in the form of agency MBS and Treasury purchases. e Weaker economic conditions raise the odds for a larger Republican majority in Congress, but Obama remains President. The debt limit is reached earlier and the Treasury runs out of money before year-end. The political gridlock becomes dysfunctional, thus fiscal policy tightens by USD 600 billion (3.7% of UBS estimate of 2013 GDP) in 2013 (“fiscal cliff”). The US credit rating is downgraded. No QE3, Democratic sweep and more fiscal tightening Key dates 2 July ISM manufacturing PMI for June 6 July Nonfarm payrolls and unemployment rate for June 6 Nov US Presidential and Congressional elections 36 UBS US moderate growth to continue US real GDP and its components, quarter-over-quarter annualized in % q/q annualized UBS CIO forecasts 2% 4% 6% 8% -10% -12% Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 li Consumption mi Capital expenditures @ Inventories li Government Commercial real estate investment Residential investment Net Exports Real GDP (q/q annualized) Source: Thomson Datastream, UBS CIO, as of 20 June 2012 US fiscal cliff at year-end 2012 Fiscal effects of change in provisions under current law, USD billion annualized 1Q13 2Q13 3Q13 4Q13 CY2013 a 5 -68 = 16) =e) 270) S15 I NA aE ie) -374 -125 ae) fs -94 “114-114-114 -109 a KR aly aii aly any a2 -433 -847— -587) -534 -600 Source: Goldman Sachs, UBS CIO, as of 20 June 2012 * Scenario probabilities are based on qualitative assessment. Note: Past performance is not an indication of future returns. For further information please contact US economist Thomas Berner, thomas.berner@ubs.com 2 Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_024144