WINTER 2017LOCAL ECONOMIC REPORT

FORECAST REPORT 2017

PG. 2SONOMAEDB.ORG

ECONOMIC DEVELOPMENT BOARDB

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PAM CHANTER, CHAIR JORGE ALCAZAR TERRI DENTE TERRY GARRETT KATHRYN HECHT LINDA KACHIUWAYNE LEACH MICHAEL NICHOLLS MICHAEL TOMASINIBEN STONE, Executive Director

EDB FOUNDATION SPONSORS

PRESENTING LEVEL

EXECUTIVE LEVEL

FOUNDATION LEVEL PREMIER LEVEL

MEDIA LEVEL

AMERICAN AGCREDIT

AMERICAN RIVER BANK

COMCAST

GEORGE PETERSEN INSURANCE

KEEGAN & COPPIN CO.

MIDSTATE CONSTRUCTION

NORBAR

SONOMA COUNTY ALLIANCE

SUMMIT STATE BANK

VANTREO INSURANCE

ZAINER RINEHART CLARKE

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CONTENTS

4. EXECUTIVE SUMMARY

6-8. SONOMA COUNTY ECONOMY

9-10. MOODY’S EXECUTIVE SUMMARY

11. MOODY’S FORECAST RISKS

PG. 4SONOMAEDB.ORG

WINTER 2017 LOCAL ECONOMIC REPORT

EXECUTIVE SUMMARY January 2017

The Sonoma County Economic Development Board (EDB), in partnership with the Sonoma County Workforce Investment Board (WIB), is pleased to present the Winter 2017 Local Economic Report. Our research partner, Moody’s Analytics, provided the research for this report.

HIGHLIGHTS

Food and beverage producers continue to push non-durable goods manufacturing employment higher. This area of manufacturing will continue to make a large contribution to job and income growth in the county, especially as sales of organic and artisanal food product sales rise nationally as disposable incomes rise.

Low unemployment ratespersists in Sonoma County,which boasts one of thelowest unemployment ratesamong California’s counties.The county’s persistent lowunemployment rate createdcompetition for labor and lifted wage and personal incomegrowth in the County, placing it above comparable mid-sized California metro areas.

Home sales in the County approach prerecession levels and the pace of single-family homebuying further accelerates, which boosts construction payrolls. Better wage gains brought about by the tightening labor market will allow more households to save for a down-payment, which will increase home sales even further.

Thank you for your interest in the Economic Development Board’s research. For additional information, questions, comments, or suggestions please contact us at (707) 565-7170 or visitwww.sonomaedb.org.

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SONOMA COUNTY CAMETRO

Monter

EMPLOYMENT GROWTH RANK RELATIVE COSTS VITALITYCOMPARISON

ey

LIVING BUSINESS RELATIVE RANK

County 255 (4th quintile)

Best=1, Worst=409 U.S.=100% U.S.=100% Best=1, Worst=402

Sonoma County 77 (1st quintile) 102 (2nd quintile) 126% 101% 102% 134Santa Barbara County 134 (2nd quintile) 147 (2nd quintile) 126% 105% 107% 95Santa Cruz County 94 (2nd quintile) 71 (1st quintile) 134% 100% 110% 78Sacramento MSA 96 (2nd quintile) 97 (2nd quintile) 106% 103% 111% 75Monterey County 255 (4th quintile) 231 (3rd quintile) 231 (3rd quintile) 117% 117% 101% 101% 92% 92% 221221

STRENGTHS & WEAKNESSESSTRENGTHS

» World-class wineries serve as a lucrative draw for high-income tourism.

» Living and business costs are low relative to San Francisco and Silicon Valley.

WEAKNESSES» Limited land availability for new wineries and

commercial construction hinders growth.» Tech companies prefer Silicon Valley or lower-cost

alternatives.

SHORT TERM

FORECAST RISKS

LONG TERM

RISK EXPOSURE Highest=1 Lowest=402

X X

80 1st quintile

UPSIDE» Improving demand from East Asian economies

boosts medical device and wine industries.» Tech-producing industries rediscover the area’s

quality of life and skilled labor force.

DOWNSIDE» Persistent drought curtails size of grape harvest

and damages grape quality.» A stronger dollar boosts bulk importing and

forces discounting of lower-price wines.

Lowest=402

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Tech companies prefer Silicon Valley or lower-cost

ANALYSIS

Recent Performance. Sonoma County hit a the U.S. raise disposable incomes, world class spa peed bump in the second half of 2016, but its and wellness centers and a vibrant dining and art xpansion remains on firm ground. Job growth scene will encourage visitors to extend their stays as cooled in recent months, but tamer gains owe in Sonoma County. The rise in overnight visits will

n large part to a thinning supply of idle workers. boost spending at local wineries and hospitality reater competition for labor has lifted wage and and healthcare establishments. ersonal income growth, which has pulled slightly Goods producers. After several lean years, head of the midsize California metro areas Santa manufacturing is back on its feet and will make arbara, Sacramento, Santa Cruz and Salinas. a larger contribution to job and income growth Despite rising tourist visits, leisure/hospitality in 2017. Rising U.S. sales of organic and artisanal

stablishments pared workers over the past year, food products will drive net gains in employment. nding a nearly five-year run of gains. Though As the local labor market tightens, better wage odest, the decline stands in contrast to steady gains will enable more households to save for a

eisure/hospitality job gains in rival destinations down payment, boosting home sales and con-anta Barbara and Santa Cruz. However, with struction of new single-family homes. Though otel occupancy and room rates in Sonoma slow population growth will restrain household ounty cresting new heights, the retrenchment formation, the release of pent-up demand will ill prove short-lived. hoist construction payrolls. Goods producers have demonstrated they are Creatives. Sonoma County boasts one of the ore than capable of picking up the tab. County largest concentrations of creative arts employ-

ood, wine and craft beverage producers remained ment in the state and is fast emerging as a hub n the offensive in 2016, pushing total factory for visual and graphic design. However, creative mployment higher even as high-tech manufac- professional services will grow only moderately urers stumbled. Meanwhile, with house prices on over the next few years as employment in scien-he cusp of their prerecession peak, single-family tific and tech-related services stagnates. Top tech omebuilding has accelerated, boosting construc- employers Keysight Technologies and Medtronic ion payrolls. Foreign markets have proved a reli- continue to maintain a large research presence in ble source of demand, bucking the state and na- the county but will gradually shift research and ional trends. Powered by sales of high-end wines, development jobs to lower-cost centers in the ounty exports eked out a healthy gain, topping all U.S. and overseas. idsize California metro areas save Sacramento. Sonoma County’s expansion will strength-Body, mind and spirits. Vacationers’ search en this year as disposable incomes rise locally

or holistic health and wellness experiences will be and nationally, boosting sales of higher-end boon for the important hospitality and health- wines and specialty food products. Longer are industries and will help to draw a new gen- term, the county’s status as a premier desti-ration of health enthusiasts to wine country. nation for wine tourism and restorative care estination spending on wellness treatments has will enable the county to keep pace with the utpaced overall travel spending in recent years U.S. and other midsize California metro areas s health-conscious travelers seek out unique spa, in job and income growth.utdoor recreation, and culinary experiences. As Jesse Rogers 1-866-275-3266etter wage gains in the Bay Area and the rest of January 2017 help@economy.com

MOODY’S RATING

Aa2 SANTA ROSA AS OF JAN 30, 2013

2010

Aa22011 2012 2013 2014 2015 INDICATORS 2016 2017 2018 2019 2020 2021

21.5 22.1 22.1 22.6 23.7 25.1 Gross metro product (C09$ bil) 26.0 26.8 27.6 28.3 28.7 29.2 1.1 2.5 0.1 2.3 5.0 5.7 % change 3.8 2.9 3.2 2.3 1.6 1.8

167.5 169.5 172.6 181.0 191.2 197.1 Total employment (ths) 202.3 206.6 210.0 212.8 213.9 213.9 -2.0 1.2 1.8 4.9 5.6 3.1 % change 2.6 2.1 1.7 1.3 0.5 0.0 10.7 10.1 8.8 6.9 5.5 4.5 Unemployment rate (%) 3.9 3.8 3.5 3.3 3.5 4.1 2.3 6.3 4.7 3.8 7.2 7.2 Personal income growth (%) 5.3 4.9 5.1 5.0 4.8 4.2

62.2 61.2 61.8 63.6 64.8 66.7 Median household income ($ ths) 69.6 71.9 74.4 76.9 79.3 81.5 484.8 487.8 490.7 495.0 499.7 502.1 Population (ths) 504.5 507.5 510.4 513.2 515.8 518.4

1.1 0.6 0.6 0.9 0.9 0.5 % change 0.5 0.6 0.6 0.5 0.5 0.5 3.6 1.6 1.8 3.0 3.6 1.1 Net migration (ths) 1.3 1.9 1.8 1.7 1.5 1.5

287 449 312 453 419 431 Single-family permits (#) 556 1,023 1,234 1,367 1,275 1,281 190 183 248 593 244 190 Multifamily permits (#) 396 414 369 313 244 253

194.0 180.1 179.8 208.4 239.3 261.0 FHFA house price (1995Q1=100) 281.7 291.9 301.8 309.8 319.4 333.9

MOODY’S ANALYTICS / Précis® U.S. Metro / West / January 2017 6

PRÉCIS® U.S. METRO WEST �� Sonoma County CA

ECONOMIC HEALTH CHECK3 MONTH MOVING AVERAGE

Jun 16 Jul 16 Aug 16 Sep 16 Oct 16 Nov 16Employment, change, ths 0.1 0.4 0.9 1.0 0.3 -0.4Unemployment rate, % 3.8 3.9 4.0 4.1 4.1 4.0Labor force participation rate, % 63.6 63.6 63.7 64.0 64.0 64.1Employment-to-population ratio, % 61.1 61.1 61.2 61.4 61.4 61.5Average weekly hours, # 33.2 33.2 33.0 33.1 33.2 NDIndustrial production, 2007=100 103.9 104.0 104.1 104.3 103.9 104.0Residential permits, single-family, # 588 598 674 529 539 599Residential permits, multifamily, # 195 185 74 349 394 382

Better than prior 3-mo MA Unchanged from prior 3-mo MA Worse than prior 3-mo MASources: BLS, Census Bureau, Moody’s Analytics

CURRENT EMPL TRENDSOYMENT CURRENT EMPLOYMENT TRENDS

Mar 16 Jul 16 Nov 16Total 2.8 2.6 1.7Mining Construction

-0.6-0.3

0.0 0.3

-0.21.2

Manufacturing Trade

0.9 1.2

2.2 1.3

1.11.4

Trans/Utilities Information

-1.5-0.6

0.0 0.0

1.4-0.2

Financial Activities 2.3 1.3 1.8Prof & Business Svcs. 7.6 9.4 8.5Edu & Health Svcs. 3.6 1.7 -1.7Leisure & Hospitality Other Services

6.8 3.8

3.8 1.6

0.21.2

Sources: BLS, Moody’s Analytics

CURRENT EMPLOYMENT TRENDS

7 MOODY’S ANALYTICS / Précis® U.S. Metro / West / January 2017

PRÉCIS® U.S. METRO WEST �� Sonoma County CA

TOP EMPLOYERSKaiser Permanente 2,640Graton Resort & Casino 2,000St. Joseph Health System 1,578Keysight Technologies 1,300Safeway Inc. 1,200Sutter Santa Rosa Regional Hospital 936Amy’s Kitchen 870Medtronic CardioVascular 840Jackson Family Wine 800Cyan 700Wal-Mart Stores Inc. 650Hansel Auto Group 605AT&T 600Lucky 550River Rock Casino 500Pacific Gas and Electric Co. 500Petaluma Acquisitions 455Ghilotti Construction Co. 425Exchange Bank 400The Home Depot U.S.A. Inc. 390

Source: North Bay Business Journal: Book of Lists, 2016

PUBLICFederal 1,309State 5,069Local 25,415

2015

1,3095,069

25,415

MIGRATION FLOWS

INTO SONOMA COUNTY CANumber of

MigrantsSan Rafael CA 1,886San Francisco CA 1,435Oakland CA 1,303Sacramento CA 796Los Angeles CA 599San Jose CA 544Napa CA 487Vallejo CA 440San Diego CA 362Riverside CA 294Total in-migration 15,868

FROM SONOMA COUNTY CASan Rafael CA 1,167Oakland CA 1,009Sacramento CA 899San Francisco CA 762Vallejo CA 533Napa CA 509Los Angeles CA 382San Diego CA 326San Jose CA 312Portland OR 226Total out-migration 13,809

Net migration 2,059

Sources: IRS (top), 2014, Census Bureau, Moody’s Analytics

COMPARATIVE EMPLOYMENT AND INCOMESECTOR % OF TOTAL EMPLOYMENT AVERAGE ANNUAL EARNINGS

SON CA U.S. SON CA U.S.Mining 0.1% 0.2% 0.5% $36,220 $103,355 $120,418Construction 5.8% 4.5% 4.5% $76,856 $68,931 $61,574Manufacturing 11.0% 8.1% 8.7% $81,042 $97,208 $79,044 Durable 38.9% 62.7% 63.0% nd $108,407 $80,519 Nondurable 61.1% 37.3% 37.0% nd $79,235 $76,577Transportation/Utilities 2.2% 3.4% 3.8% nd $65,085 $65,923Wholesale Trade 3.8% 4.5% 4.1% $71,483 $79,954 $82,045Retail Trade 12.5% 10.4% 11.0% $38,916 $40,311 $33,469Information 1.4% 3.0% 1.9% $84,957 $153,868 $107,082Financial Activities 4.1% 5.0% 5.7% $39,437 $58,700 $52,630Prof. and Bus. Services 10.5% 15.6% 13.9% $47,276 $71,629 $65,291Educ. and Health Services 16.4% 15.3% 15.5% $52,325 $52,930 $52,394Leisure and Hosp. Services 12.5% 11.4% 10.7% $27,221 $32,407 $26,315Other Services 3.6% 3.4% 4.0% $42,812 $38,192 $35,748Government 16.1% 15.3% 15.5% $77,636 $93,619 $73,979

Sources: Percent of total employment — BLS, Moody’s Analytics, 2015, Average annual earnings — BEA, Moody’s Analytics,2014

Source: Moody’s Analytics, 2015

MOODY’S ANALYTICS / Précis® U.S. Metro / West / January 2017 8

2012 2013 2014 2015Domestic 1,350 2,383 2,879 404Foreign 477 571 690 717Total 1,827 2,954 3,569 1,121

LEADING INDUSTRIES BY WAGE TIER

Location Employees NAICS Industry Quotient (ths)6221 General medical and surgical hospitals 0.6 4.2

HIG

H 6214 Outpatient care centers 3.5 3.86211 Offices of physicians 0.8 3.05511 Management of companies and enterprises 0.7 2.2GVL Local Government 1.3 25.3

MID 3121 Beverage manufacturing 25.1 7.9

GVS State Government 0.7 5.12382 Building equipment contractors 1.0 2.87225 Restaurants and other eating places 1.1 16.6

LOW 6241 Individual and family services 2.5 7.7

4451 Grocery stores 1.7 6.3FR Farms 1.6 6.0

EMPLOYMENTThsThs % of% of totatotall

SON 8.6 4.4

U.S. 6,767.6 4.8

EMPLOYMENTThsThs % of% of totatotall

SON 22.5 11.4

U.S. 13,151.2 9.3

Source: Moody’s Analytics, 2015

9 MOODY’S ANALYTICS / Précis® U.S. Macro / December 2016

BROAD VIEW �� Executive Summary

Trump EffectsBY MARK ZANDI

Recent PerformanceThe economic outlook has changed

meaningfully because of the election of Donald Trump as president of the United States. Precisely what economic policies Trump implements and when are highly un-certain. It will take time to nail things down as he works to assemble his government. With that done, he will be able to move quickly given the president’s substantial authority. He can make many decisions unilaterally, and although they will likely be challenged in the courts, it will take years to sort out. A Republican-controlled House and Senate will smooth the way for more policy becoming law—the Senate filibuster is no longer the legislative handcuff it used to be.

Markets reactFinancial markets are already discounting

the coming policy changes. Stock prices are up more than 5% since Election Day, with the biggest gains in the shares of financial institu-tions, and energy and industrial companies. Long-term Treasury yields have risen sharply, with 10-year yields up nearly 80 basis points to almost 2.6%, pushing fixed mortgage rates back up to well over 4%. Corporate credit spreads have narrowed, so borrowing costs for businesses have not risen nearly as much.

The U.S. dollar has appreciated, par-ticularly against the yen and the euro. On a

broad-trade weighted basis, the dollar is as strong as it has been since the year 2000. Oil and metals prices are also up since the election.

Consistent with the higher stock prices and narrower credit spreads are investor expectations of corporate tax reform. Trump has proposed a 15% top marginal corporate rate, down from its current 35%, and the adoption of a territorial taxation system with a onetime 10% rate on repatriated for-eign earnings. His strong support of deregu-lation has also cheered investors. Financial stocks have gotten a pop in anticipation of changes to Dodd-Frank, as have healthcare stocks given the likely “repeal” of the Afford-able Care Act. Energy and environmental deregulation seems near certain, a plus for energy producers and related industries.

Investors also appear to anticipate fis-cal stimulus measures—deficit-financed tax cuts and increases in government spend-ing. This is clearest in the rise in long-term Treasury yields, which can be traced to higher inflation expectations; expected real short-term rates, which reflect anticipated monetary policy; and the term premium (see Chart 1).

Investors understand that a stimulus ap-plied to a full-employment economy will result in more wage and price pressures and a faster normalization of monetary policy.

Judging from the big swing in the term pre-mium from negative to positive since the election, which is sensitive to expectations regarding the government’s fiscal situation, investors also appear to believe Trump’s policies will add to budget deficits.

Tighter financial conditionsThe strong reaction in financial markets

net out to a tightening in financial condi-tions, which, if sustained, will ding economic growth next year (see Chart 2). It will still be a very good year, as the president-elect will inherit a fundamentally strong economy. Job creation is robust, the economy is near full employment, and wage growth is accelerat-ing. It would take a severe shock to derail the economy, but it will not be nearly as good a year.

Higher stock prices are a plus for growth, primarily via the wealth effect on consumer spending. Household stockholdings are worth about $1 trillion more since the elec-tion. If sustained, this should prompt more spending and add to growth in 2017. But this will be largely washed out by the stronger U.S. dollar and the resulting widening in the trade deficit. Higher interest rates will also bite. With fixed mortgage rates back over 4%, refinancing has already been curtailed since the average coupon on outstanding mortgages is close to 4%. Home sales and

21

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

10 11 12 13 14 15 16

Inflation expectationsTerm premiumExpected path of real short-term rates

Markets Anticipate Fiscal Stimulus Under Trump 10-yr Treasury yield decomposed, %

Sources: Federal Reserve, Moody’s Analytics

-0.50

-0.25

0.00

0.25

16Q3 16Q4F 17Q1F 17Q2F 17Q3F 17Q4F

Oil pricesReal $S&P 50010-yr Treasury yieldTotal

Financial Conditions Tighten% change in real GDP due to change in financial conditions

Source: Moody’s Analytics

As of Dec 2016

MOODY’S ANALYTICS / Précis® U.S. Macro / December 2016 10

BROAD VIEW �� Executive Summary

house prices will also feel it, as more trade-up buyers will have to pay a higher rate on their new mortgage—a big change as home-buyers have enjoyed more or less declining mortgage rates since the early 1980s.

Other potential near-term fallout from the election includes heightened policy uncertainty as the new administration struggles to articulate its policies. This could cause businesses to delay investment and hiring decisions, and consumers will pause to see how things are proceeding. However, consumer and business confidence could get a lift given the prospects for change, given that frustration over gridlock in Washington may have been weighing on confidence.

More cyclical economyLike financial markets, we expect Trump

to implement an expansionary fiscal policy of deficit-financed tax cuts and greater gov-ernment spending. This will result in stronger growth over the next two to three years as the stimulus ramps up, but weaker growth by the end of his term when the stimulus fades. There will thus be bigger ups and downs in the business cycle (see Chart 3).

The expected tax cuts will not be as large as Trump proposed during the campaign, but the price tag will likely still be sizable, at close to $1 trillion over the next decade. This includes cuts to both personal and corporate income taxes. Government spending also seems set to increase by at least $500 bil-lion over the next decade. This will include more government spending on veterans’

benefits and the military. More infrastruc-ture spending is not as sure given skepticism among congressional Republicans about the costs, but Trump appears all-in on it.

Growth should peak by mid-2018, when the tax cutting and spending increases are in full swing. Diluting the power of the Trump stimulus is the full-employment economy. Tax and spending multipliers—the growth due to the stimulus—are much smaller than they would be if the economy was strug-gling with high unemployment, as it was in the Great Recession when the highly effec-tive 2009 Recovery Act was implemented.

In a full-employment economy, expan-sionary fiscal policy is crowded out by a less accommodative Federal Reserve and global investors, so-called bond vigilantes, who push up long-term interest rates in anticipation of more inflation and bigger deficits. Higher in-flation and interest rates are part of our base-line scenario, with core consumer price infla-tion breaching 3% on a sustained basis, well above the Fed’s inflation target (see Chart 4). The Fed responds by increasing the federal funds rate to nearly 4% by early 2020, and the vigilantes push the 10-year Treasury yield to as high as 4.5%. These are classic symp-toms of an overheating economy, which have historically ended in recession.

2% growth, not 4%Trump’s policies are not expected to

materially change the economy’s long-term growth prospects. Prior to the election, the economy’s long-run potential real GDP

growth—that rate consistent with stable un-employment—was projected to be 2% per annum. Post-election, our estimate of the economy’s potential has not changed.

To be sure, long overdue corporate tax reform should provide a meaningful boost to the economy’s potential. Lower marginal rates and the adoption of a territorial tax system will lower the cost of capital for businesses and prompt greater investment. More investment and a larger capital stock will lift labor productivity growth and the economy’s growth potential. But this boost will need time to develop, much longer than Trump’s term as president, and although it will be a meaningful addition to growth in the long run, it is not the game changer that the new president is hoping for. The econ-omy’s growth potential may increase from 2% to 2.25%, not Trump’s stated 4% goal.

Moreover, Trump’s anti-globalization stance will eventually catch up to the economy. It will lead to a smaller workforce as some undocumented workers leave the country and fewer legal immigrants come. Global trade also suffers as the nation pulls away from trade deals and skepticism around our trading relationships increases, all of which impedes competition and productivity growth.

Economic policy during the Trump presi-dency can take many alternative paths, and Moody’s Analytics will consider many of them. However, under most scenarios the economy is more cyclical and its long-run growth potential is unchanged.

3 4

1

2

3

4

16 17F 18F 19F 20F 21F

Pre-election baselineTrump baseline

A More Cylical Economy…Real GDP growth, % change yr ago

Sources: BEA, Moody’s Analytics

1.5

2.0

2.5

3.0

3.5

16 17F 18F 19F 20F 21F

Pre-election baselineTrump baseline

…With Higher InflationCore PCE inflation, % change yr ago

Sources: BEA, Moody’s Analytics

MOODY’S ANALYTICS / Précis® U.S. Macro / December 2016 11

BROAD VIEW

Forecast RisksBY MICHAEL FERLEZ

Trade and immigration After the initial shock, U.S. equity mar-

kets surged to record highs in the weeks following the U.S. presidential election. Still, financial markets will remain volatile over the coming months as market participants assess the potential impact on the economy. Donald Trump’s upset victory increases uncertainty both in the U.S. and abroad. A Trump presidency will likely take an anti-globalization stance on trade and immigra-tion, with important consequences for the global economy. Immigration will add to uncertainty as undocumented workers leave the country, leading to a contraction in the labor force. It is possible that deportations could reduce the labor force by 2.16 million or 1.4%. Additionally, foreign immigration into the U.S. will likely slow. Given the in-crease in uncertainty, businesses will likely delay investment and hiring decisions, and consumers will pause to take stock. Ulti-mately, the economic impact will depend on what policies the new administration actually pursues.

Geopolitical tensionsU.S. tensions with China over Taiwan, if

allowed to escalate, could trigger a broader trade war. Inputs from China, notably steel, are critical in U.S. vehicle produc-tion, and U.S. multinationals’ profits are affected by capital controls China has imposed; they include a closer scrutiny of dividend remittances.

In addition, geopolitical tensions out-side the U.S. pose an indirect threat to the U.S. economy, transmitted through inter-national trade, consumer sentiment and financial markets. Britain’s vote to leave the European Union elevates uncertainty not only about the relationship between the U.K. and EU but also about the future of Europe itself. Brexit and the Trump election victory are energizing Eurosceptic political parties throughout Europe. The rise of anti-immigrant populist sentiment may have as its next victim the euro zone. Earlier this

month, Italians voted in a referendum to reject constitutional reforms by a decisive margin. The reaction in financial markets was muted, but the outcome prompted the resignation of Italian Prime Minister Matteo Renzi. Next year will be a pivotal one for the future of the EU with France, Germany and Netherlands all holding presidential elec-tions. The odds have increased that previ-ously fringe political parties could take pow-er and cause the euro zone to fracture. That would bring an end to the global economic expansion, including the U.S. expansion.

Conflicts in Iraq and Syria threaten to further destabilize the Middle East. Although the war against the Islamic State has been confined to Iraq and Syria, it could spread to other Middle Eastern countries. The worse-case scenario involves an escalation of ten-sions in the region that could cause not only a spike in oil prices but also greater turmoil in global financial markets, leading to a drop in trade and slower global growth.

China A hard landing for China’s economy

would reverberate across the world econo-my. The slowdown in China is already weigh-ing on its trading partners in Asia and Latin America and has fanned financial market volatility. Although conditions have stabi-lized, the global recovery remains fragile and could suffer a setback should growth in Chi-na falter significantly. Growth in the world’s second largest economy will decelerate as the government attempts to transition away from excessive reliance on industry and more toward consumption of services.

The uncertainty lies in China’s ability to maintain sturdy growth and the possible impact of its interventions in the foreign exchange market on other global markets. China’s economic growth has been supported by a huge buildup in credit that poured into residential and nonresidential investments. Should property prices tumble, that moun-tain of debt could prove unsustainable. More-over, an unstable yuan could set off financial

markets. China has already burned through more than $500 billion in foreign reserves in 2015 in an attempt to stabilize the yuan. Last year’s surprise yuan devaluation roiled mar-kets, causing a global selloff of risky assets.

Å Monetary policyNear-term economic uncertainty stem-

ming from the surprise election victory of Trump could affect monetary policy decisions, especially if markets become unhinged. Fed funds futures are pricing in a 94% probability of a Federal Reserve rate hike in December. The Fed will face the same challenges as it tries to normalize monetary policy. If the Fed were to raise interest rates too quickly it could spook markets and potentially derail the U.S. expansion, which would force the Fed to reverse course and introduce a new round of quantitative eas-ing or even negative interest rates. Another risk, if there is a substantial expansion in fis-cal policy when the economy is at or above full employment, is that the Fed will have to tighten monetary policy more aggressively in 2018 and 2019 to prevent the economy from overheating.

ProductivityProductivity growth has been lackluster

in the aftermath of the financial crisis. Since the recession, nonfarm business productivity has averaged a disappointing 1% per annum, and even less than that more recently. The decline in productivity that stems from a pullback in business investment is especially concerning. Restrictions on legal immigra-tion and the accelerated deportation of un-documented workers could affect long-run productivity as immigrants have historically been a key driver of business creation and have played an important role in increasing productivity growth and in the growth of tech industries. With the U.S. fast approach-ing full employment, unless productivity gains improve, the economy will not deliver on GDP, income, profits, tax revenue and as-set returns.

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