BBVA Research U.S. Economic Outlook July 2018 / 1. U.S. Economic Outlook July 2018

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1 BBVA Research U.S. Economic Outlook July 218 / 1 U.S. Economic Outlook July 218

2 Economic Outlook High growth and inflation will continue in 218 & 219 We now anticipate that the Fed will raise rates three times in 219; for 218, we maintain our baseline scenario of hikes in Sept. & Dec. Despite elevated volatility in the employment surveys we maintain our outlook for ongoing tightening in the labor market; unemployment rate to reach 3.7% With the additional tailwinds from the expansionary fiscal policy, we expect core PCE to rise above 2% Economic fundamental continue to support gradual rise in 1-year Treasury yields The yield curve slope between the 1-year and 2-year Treasuries will flatten further, but remain positive Oil prices to converge to long-run equilibrium despite short-term volatility

3 BBVA Research U.S. Economic Outlook July 218 / 3 Economic activity Real-Time Economic Indicator Heat Map 3-months ago 2-months ago 1-month ago Current ISM Manufacturing Small Business Optimism Industrial Production IP-Manufacturing IP-Mining IP- Nonenergy High-Tech Capital Goods ex Aircraft Private Construction Building Permits Core Logic Home Prices Consumer Confidence Private Nonfarm Payrolls Prime-Age Participation Marginally Attached (PA) Average Hourly Earnings Real Disposable Income Personal Savings Rate Productivity Industrial activity remains strong, but is slowing Favorable oil prices supporting growth in mining strong, as excess capacity shrinks Durable goods orders excluding aircrafts slowing after torrid pace in 2Q Moderate rebound in labor productivity in 1Q Solid growth in disposable income Home prices growing on account of tight supply conditions Below Average Above Average Source BBVA Research

4 Economic trends: Growth in mining sector stabilizing BBVA Research U.S. Economic Outlook July 218 / 4 Industrial Production (Year-over-year %) 1% Real Personal Consumption (Year-over-year %) 1 8% 6% 8 6 4% 2% 4 % 2-2% -4% -6% Oil & Gas High-Tech Motor Vechicles Consumer Gds Biz Equip Headline (lhs) -2-4 Avg. '- '16 Avg. '7- ' Source: BBVA Research, FRB & BEA

5 oct-214 ene-215 abr-215 jul-215 oct-215 ene-216 abr-216 jul-216 oct-216 ene-217 abr-217 jul-217 oct-217 ene-218 abr-218 May-218 Mar-218 Jan-218 Nov-217 Sep-217 Jul-217 May-217 Mar-217 Jan-217 Nov-216 Sep-216 Jul-216 May-216 Mar-216 Jan-216 Nov-215 Sep-215 Jul-215 May-215 Mar-215 Jan-215 Nov-214 BBVA Research U.S. Economic Outlook July 218 / 5 Economic trends: Export activity strong despite trade-war build up Real Exchange Rates and Exports (Year-over-year %) 2% Real Exports (Contribution to year-over-year %) 1 15% 8 6 1% 4 2 5% % -2-5% % Consumer Goods ex Food Food & Bev. Industrial Supplies Autos Real Trade Weighted FX Real Exports Other Cap Goods ex Autos Source: BBVA Research, FRB & Census

6 216Q1 216Q2 216Q3 216Q4 217Q1 217Q2 217Q3 217Q4 218Q1 218Q BBVA Research U.S. Economic Outlook July 218 / 6 Economic trends: Strong GDP growth in 2Q with stable recession risk Real GDP (QoQ SAAR, %) Probability of Recession in 12 Months (%) GDP Nowcast GDP growth (Actual) Recession 12 months before the recession Probability Source: BBVA Research

7 Labor Market In June, nonfarm payroll increased by 213,, supported by professional and business services (5K), manufacturing (36K) and health care (25K) With 21.6K jobs lost over the second quarter, the retail sector continues to be a source of weakness The unemployment rate unexpectedly edged up to 4% from 3.8% on the back of a large increase (61K) in the labor force and soft gains in household employment Given the volatility inherent to the household survey we are not changing our outlook for the labor market in 218; we continue to expect unemployment rate to reach 3.7% by mid-219

8 Labor market: Another month of strong employment growth ex retail and government BBVA Research U.S. Economic Outlook July 218 / 8 Nonfarm Payrolls (Monthly Change, K) Industry Employment (Annualized % change) Mining Construction Transportation & Warehousing Professional & Business Services Manufacturing Education & Health Services Other Services Leisure & Hospitality Financial Activities Wholesale Trade Local Government Retail Trade Federal Government -1 State Government Information Services Actual Forecast Monthly Change Year-over-year Source: BBVA Research & BLS

9 may-8 nov-8 may-9 nov-9 may-1 nov-1 may-11 nov-11 may-12 nov-12 may-13 nov-13 may-14 nov-14 may-15 nov-15 may-16 nov-16 may-17 nov-17 may-18 may-8 nov-8 may-9 nov-9 may-1 nov-1 may-11 nov-11 may-12 nov-12 may-13 nov-13 may-14 nov-14 may-15 nov-15 may-16 nov-16 may-17 nov-17 may-18 may-27 dic-27 jul-28 feb-29 sep-29 abr-21 nov-21 jun-211 ene-212 ago-212 mar-213 oct-213 may-214 dic-214 jul-215 feb-216 sep-216 abr-217 nov-217 jun-218 may-27 dic-27 jul-28 feb-29 sep-29 abr-21 nov-21 jun-211 ene-212 ago-212 mar-213 oct-213 may-214 dic-214 jul-215 feb-216 sep-216 abr-217 nov-217 jun-218 BBVA Research U.S. Economic Outlook July 218 / 9 Labor market: Hours worked continue to trend near post-crisis highs Average Weekly Hours (number & 5mcma) Average Hourly Earnings (YoY% & 5mcma) % 3.5% 3.% 2.5% 2.% 1.5% 1.%.5%.% Prime Age Labor Force Participation (%) Prime Age Employment-to-Population (%) Pre-Crisis Avg. Pre-Crisis Avg. Source: BBVA Research & BLS

10 may-8 nov-8 may-9 nov-9 may-1 nov-1 may-11 nov-11 may-12 nov-12 may-13 nov-13 may-14 nov-14 may-15 nov-15 may-16 nov-16 may-17 nov-17 may-18 BBVA Research U.S. Economic Outlook July 218 / 1 Labor market: Slack to continue to abate, but downside risk to UR limited by inflows U-6 (%) Unemployment Rate (%) Pre-Crisis Avg. Source: BBVA Research & BLS

11 Inflation Headline PCE in May accelerated to 2.3% year-over-year, the highest in six years, while core PCE surged to 2.% Energy prices, services and housing costs largest contributors price increases in 218; headline and core CPI increased 2.8% and 2.2% in May After trending upwards, inflation expectations have stabilized slightly above the 2% target; no major changes in survey-based expectations Fears of excessive inflation exaggerated as probability of entering highinflation regime remains low With the additional tailwinds from the expansionary fiscal policy, we expect core PCE to rise to 2.2% in 219 before returning to 2.1% in 221

12 mar-2 feb-21 ene-22 dic-22 nov-23 oct-24 sep-25 ago-26 jul-27 jun-28 may-29 abr-21 mar-211 feb-212 ene-213 dic-213 nov-214 oct-215 sep-216 ago-217 BBVA Research U.S. Economic Outlook July 218 / 12 Inflation: Core prices reach Fed 2% target Consumer Price Inflation (12m change) 14% 12% 1% 8% Energy Core Inflation Measures (12m change) 4.% 3.5% 3.% 2.5% 2.% 6% 4% 2% % -2% OER Comm. ex Food/ Energy Food Rent Relative Importance Trans. Services Med Services Edu & Comm. Services Other Services 1.5% 1.%.5%.% Core CPI Core PCE Weighted Median Source: BBVA Research, BLS & BEA

13 mar-2 may-21 jul-22 sep-23 nov-24 ene-26 mar-27 may-28 jul-29 sep-21 nov-211 ene-213 mar-214 may-215 jul-216 sep-217 nov-218 ene-22 mar-221 may-222 Inflation: Expectations remain anchored reinforcing our baseline for only short-term overshooting BBVA Research U.S. Economic Outlook July 218 / 13 Inflation Expectations (%) 3.5% Headline & Core CPI (Year-over-year %) 6 3.% % 2.% % 1.%.5% % Y Implicit 5Y Forward Core Headline Source: BBVA Research & Haver Analytics

14 ene-7 ago-72 mar-75 oct-77 may-8 dic-82 jul-85 feb-88 sep-9 abr-93 nov-95 jun-98 ene-1 ago-3 mar-6 oct-8 may-11 dic-13 jul BBVA Research U.S. Economic Outlook July 218 / 14 Inflation: Regime change probability remains low Core PCE and Inflation Regimes (Quarter-over-quarter %) Probability of Entering High Inflation Regime (%) Core PCE High Inflaiton Regime Low Inflaiton Regime. Source: BBVA Research

15 Monetary Policy: Federal Reserve June s FOMC statement, economic projections and press conference confirm our view that the Fed has fully transitioned to a new phase of monetary policy, leaving behind the post-crisis era Fed to continue actively managing interest rate corridor, suggesting possible future adjustments in interest paid on excess reserves Although doubts remain about the prescience of the yield curve, the minutes confirmed that members are concerned about an inversion and its signaling power Although many district surveys have shown anecdotal effects from the trade war, the committee stills views trade disputes as a potential risk to their outlook Our baseline now assumes three rate increases in 219; for 218, we maintain our baseline scenario of two additional rate increases (Sept. & Dec.)

16 BBVA Research U.S. Economic Outlook July 218 / 16 Fed: Our baseline assumes two rate increases in 218 and three in BBVA & Dealers Projections of Fed Funds (%, Effective) FOMC Projections of Fed Funds (Year-over-year %, Mid-point) L-Term BBVA-Baseline Median 75th Percentile 25th Percentile BBVA-Upside BBVA-Downside Median-218 Median-217 Source: BBVA Research & FRB

17 1/1/218 24/1/218 7/2/218 21/2/218 7/3/218 21/3/218 4/4/218 18/4/218 2/5/218 16/5/218 3/5/218 13/6/218 27/6/218 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-2 Apr-2 Jul-2 Oct-2 BBVA Research U.S. Economic Outlook July 218 / 17 Monetary policy: Fed futures edging up with anticipation of strong growth and higher inflation Fed Funds Implied Probability (%) 1% 9% 8% 7% 6% 5% 4% 3% 2% Fed Funds Futures & BBVA Baseline (%) % %.8.5 FFR + BBVA Forecast 5/1/218 September (2.25%) December(2.5%) 1/1/217 12/1/217 7/5/218 Source: BBVA Research & Bloomberg

18 ene-7 mar-71 may-72 jul-73 sep-74 nov-75 ene-77 mar-78 may-79 jul-8 sep-81 nov-82 ene-84 mar-85 may-86 jul-87 sep-88 nov-89 ene-91 mar-92 may-93 jul-94 sep-95 nov-96 ene-98 mar-99 may- jul-1 sep-2 nov-3 ene-5 mar-6 may-7 jul-8 sep-9 nov-1 ene-12 mar-13 may-14 jul-15 sep-16 nov-17 BBVA Research U.S. Economic Outlook July 218 / 18 Fed: Current deviation from Taylor-rule and inflation conditions suggest low probability of shift in monetary policy regime Fed Deviation from Taylor Rule and Probability of Monetary Policy Regime Change (%) Regime Probability Deviation From Taylor rule Source: BBVA Research & FRB

19 Interest rates: Interest rate corridor remains a source of concerns for FOMC BBVA Research U.S. Economic Outlook July 218 / 19 Fed Funds & Repo Rates (%) 2.25 Balance Sheet Attrition (US$bn, Cumulative) sep-14 abr-15 nov-15 jun-16 ene-17 ago-17 mar ene-18 feb-18 mar-18 abr-18 Upper Bound Effective Lower Bound SOFR U.S Govt Securities MBS Source: BBVA Research & FRB

20 Interest Rates Despite some idiosyncratic issues with short-term rates and the fed funds target range, we continue to expect a gradual rise in short-term rates Global uncertainty, monetary policy and domestic policy uncertainty continue compressing term-premium Long-term rates have lost some momentum as inflation expectations major driving force behind increases- stabilize around 2.% Baseline continues to assume 1-year Treasury yield at 3.1% by year-end 218 and 3.6% by year-end 219 The yield curve slope between the 1-year and 2-year Treasuries to flatten further, but remain positive

21 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 BBVA Research U.S. Economic Outlook July 218 / 21 Interest rates: Demand-side conditions remain stable Net Treasury Supply & Change in Private Domestic Demand (US$bn & 3qcma) Private Demand for Treasuries (US$bn, 4qma) Net Issuance Private Demand Foreign Mutual Funds Money Market Households Domestic Banks Total Private Source: BBVA Research & U.S. Treasury

22 BBVA Research U.S. Economic Outlook July 218 / 22 Interest rates: Term premium compressed, inflation expectations close to Fed target 1-Year Treasury Yield Decomposition (%) Real Rate Term Premium Inflation Expectations Yield Source: BBVA Research, ACM & Haver Analytics

23 ene.27 may.27 sep.27 ene.28 may.28 sep.28 ene.29 may.29 sep.29 ene.21 may.21 sep.21 ene.211 may.211 sep.211 ene.212 may.212 sep.212 ene.213 may.213 sep.213 ene.214 may.214 sep.214 ene.215 may.215 sep.215 ene.216 may.216 sep.216 ene.217 may.217 sep.217 ene.218 may.218 sep.218 ene.219 may.219 sep.219 ene.22 may.22 sep.22 ene.221 may.221 sep.221 ene.222 may.222 sep.222 BBVA Research U.S. Economic Outlook July 218 / 23 Interest rates: 1-year treasury yield to reach 3.1% by year-end 218 and 3.6% in Year Treasury Yield (%) Historic Baseline upside Downside Risk NABE (EOP) SPF(EOP) Blue Chip(Yr. Avg) OMB (Yr.Avg) CBO(Yr. Avg) Source: BBVA Research, ACM & Haver Analytics

24 ene-215 jul-215 ene-216 jul-216 ene-217 jul-217 ene-218 jul-218 ene-219 jul-219 ene-22 jul-22 ene-221 jul-221 ene-222 jul-222 BBVA Research U.S. Economic Outlook July 218 / 24 Interest rates: Baseline scenario continues to assume no yield curve inversion Yield Curve Slope (Bp) Yield Curve (%, eop) Y 2Y 3Y 5Y 7Y 1Y 2Y 3Y 3Yr-1yr 1Yr-2Yr 1-Year Average (f) 219 (f) 22 (f) Source: BBVA Research

25 BBVA Research U.S. Economic Outlook July 218 / 25 Economic Scenarios Probability (%) Current Previous Macro Scenarios Upside 1 1 Baseline Downside GDP Upside Downside UR Upside Downside CPI Upside Downside Fed [eop] Upside Downside Yr [eop] Upside Downside Subject to revision without notice

26 Energy Prices OPEC+ agreed to boost production to compensate the shortfall left by Iran and Venezuela Geopolitics, the US-China trade war, and concerns on OPEC spare capacity will continue to add short-term volatility Prices will remain supported by robust demand from China, India and the U.S. We continue to expect prices to converge with long-term equilibrium, as demand growth returns to historical trend and U.S. export capacity increases In the long-run, unexpected price increases could arise from insufficient E&P CAPEX We expect domestic natural gas prices to trade around $2.6-$3.1 per MMBTU, which is low enough to support domestic growth and exports

27 3/21 3/28 4/4 4/11 4/18 4/25 5/2 5/9 5/16 5/23 5/3 6/6 6/13 6/2 6/27 7/4 7/11 BBVA Research U.S. Economic Outlook July 218 / 27 Oil prices: Geopolitics and concerns on OPEC spare capacity are driving oil prices Crude oil prices ($ per barrel) April 1. U.S. trims 218 production forecast 2Q18 actual average May 8. U.S. abandons the nuclear deal with Iran May 26. Saudi Arabia and Russia agree to increase output May 29. OPEC may keep output cuts through the year June 22 OPEC+ agreed to increase production by 1Mb/d July 1 Oil prices rise on supply outage in Norway July 11 U.S. China trade war intensifies 65 6 April 11. Ballistic missiles fired by Yemen s Houthi rebels at Riyadh and Jizan 2Q18 projected average June 26 US state department urges countries to eliminate Iranian oil imports Source: BBVA Research and Haver Analytics

28 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Oil prices: In the U.S., transportation bottlenecks limit impact on international prices BBVA Research U.S. Economic Outlook July 218 / 28 U.S. Crude oil exports (Million barrels/day) WTI Midland-Cushing differential ($/b) Source: BBVA Research, Haver Analytics & Bloomberg U.S. Estimated crude oil production (Thousand barrels/day)

29 BBVA Research U.S. Economic Outlook July 218 / 29 Oil prices: Forecasts Short-term oil prices forecast (Brent, $/b) 16 Oil prices forecast (Brent, $/b) Actual BBVA Forecasts 95% futures upper confidence interval Source: BBVA Research, Bloomberg & EIA BBVA Research (June) Bloomberg (June) Rystad Energy (June) World Bank (April) Energy Information Administration (STEO, May)

30 BBVA Research U.S. Economic Outlook July 218 / 3 DISCLAIMER This document was prepared by Banco Bilbao Vizcaya Argentaria s (BBVA) BBVA Research U.S. on behalf of itself and its affiliated companies (each BBVA Group Company) for distribution in the United States and the rest of the world and is provided for information purposes only. Within the US, BBVA operates primarily through its subsidiary Compass Bank. The information, opinions, estimates and forecasts contained herein refer to the specific date and are subject to changes without notice due to market fluctuations. The information, opinions, estimates and forecasts contained in this document have been gathered or obtained from public sources, believed to be correct by the Company concerning their accuracy, completeness, and/or correctness. This document is not an offer to sell or a solicitation to acquire or dispose of an interest in securities.

31 BBVA Research U.S. Economic Outlook July 218 / 31 U.S. Economic Outlook July 218