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The President’s Report to the Board of Directors June 3, 2010 CURRENT ECONOMIC DEVEOPMENTS - June 3, 2010 Data released since your last Directors' meeting are consistent with an economy that is slowly recovering. Manufacturing output and investment continued to improve while the stimulus rebate boosted home sales. Downside risks remain though as job opportunities remain scarce, especially when compared to the number of people laid off during the recession. In addition, the housing market must now stand on its own and jitters over the European debt crisis continue to effect domestic and global financial markets. Initial claims for unemployment insurance were unchanged in May, and remain elevated. Consumers have become a bit more optimistic, but overall attitudes have showed little change since their initial recovery last spring. The increased optimism in future business conditions and job opportunites has helped prop up consumption, despite only small rises in incomes. Consumption expenditures were flat in April, however, following a strong first quarter. The housing market surged in April, boosted by the expiring home buyer stimulus rebate. Existing home sales posted another solid increase and new home sales registered a two-year high. Housing starts also rose in April, but building permits fell back to a six-month low, suggesting new construction activity may slow in the coming months. In the manufacturing sector, the ISM index remained high in May and the employment index continued to improve. Industrial production and capacity utilization both rose again in April, while new orders for durable goods also continued to recover. Deflation concerns still outweighed inflation concerns in April, as headline price indices eased and core consumer prices slowed to their slowest annual growth rate in nearly 50 years. Oil prices fell for most of May before rebounding a bit at the end of the month. After falling steadily through most of 2009, initial claims were flat in May, and overall have been little changed through the first half of 2010. Initial Claims Thousands of Units at Annual Rates Thousands of Units at Annual Rates 700 700 650 650 600 600 550 550 500 500 450 450 400 400 350 350 300 300 250 250 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Source: Department of Labor, Employment and Training Administration / Haver Analytics. Consumer confidence rose again in May, posting its third consecutive monthly gain. Consumer sentiment also improved, but stands at the same level seen in February. Job market and general business conditions continue to be the primary concerns, but there have been signs of increased optimism in those areas. Income expectations, however, remain downbeat. Consumer Confidence Consumer Sentiment Index, 1966:Q1 = 100 Index, 1985 = 100 90 100 Consumer Expectations Future Expectations Present Situation 75 Current Conditions 80 70 50 60 25 Consumer Sentiment Consumer Confidence 0 May-08 Nov-08 May-09 Nov-09 Source: The Conference Board / Haver Analytics. May-10 May-08 Nov-08 May-09 Nov-09 50 40 May-10 Source: The University of Michigan / Haver Analytics. Total lightweight vehicle sales picked up a bit in May, offsetting the dip seen in April. Sales continue to be much stronger than during the same periods last year, with an average selling rate of 11.1 million compared to the 2009 rate of 10.3 million. Industry experts expect final 2010 sales to approach 12 million units. Total Auto and Light Truck Sales Millions of Units, Annualized Millions of Units, Annualized 20.0 20.0 18.0 18.0 16.0 16.0 14.0 14.0 12.0 12.0 10.0 10.0 8.0 8.0 6.0 6.0 4.0 4.0 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Source: Bureau of Economic Analysis / Haver Analytics. Real disposable income posted a modest increase in April, but the higher incomes didn't carry-over to higher consumption, which was essentially unchanged. Real DPI and Consumption Percent Change, Previous Month Percent Change, Previous Month 6.0 6.0 4.0 4.0 Real Consumption 2.0 2.0 0.0 0.0 -2.0 -2.0 Real Disposable Income -4.0 Apr-07 Oct-07 Jul-07 Apr-08 Jan-08 Oct-08 Jul-08 Apr-09 Jan-09 -4.0 Apr-10 Oct-09 Jul-09 Jan-10 Source: Bureau of Economic Analysis / Haver Analytics. Home sales surged in April as consumers rushed to complete purchases before the expiration of the stimulus tax credit, much like they did in the fall before the plan was originally schedule to end. Unlike in the fall, however, the credit also boosted sales of new homes, which reached a two-year high. Of interest going forward is how the market will respond in the absence of any government incentive for the first time since April 2008. New and Existing Home Sales Thousands of Units, Annualized Thousands of Units, Annualized 1200 7000 6500 Existing Home Sales 1000 6000 New Home Sales 800 5500 600 5000 400 4500 200 4000 0 3500 Apr-07 Oct-07 Jul-07 Apr-08 Jan-08 Oct-08 Jul-08 Apr-09 Jan-09 Oct-09 Jul-09 Apr-10 Jan-10 Source: U.S. Census Bureau (new homes sales) and National Association of Realtors (existing home sales) / Haver Analytics. In April, housing starts continued the slight upward trend seen since October, leading to an 18-month high. Building permit data was disappointing, however, nearly erasing the gains seen over the past six months. Housing Starts and Building Permits Thousands of Units, Annualized Thousands of Units, Annualized 1800 1800 1600 1600 1400 1400 Building Permits 1200 1200 1000 1000 800 800 600 600 400 400 Housing Starts 200 200 0 0 Apr-07 Oct-07 Jul-07 Apr-08 Jan-08 Oct-08 Jul-08 Apr-09 Jan-09 Oct-09 Jul-09 Apr-10 Jan-10 Source: U.S. Census Bureau / Haver Analytics. The ISM manufacturing index eased a bit in May, but remains well above 50 signalling continued economic expansion. The employment component of the index rose further in May to reach its highest level in six years. ISM Index Index (50+ = Economic Expansion) Index (50+ = Economic Expansion) 70.0 70.0 60.0 60.0 ISM Index 50.0 50.0 40.0 40.0 30.0 Employment Index 30.0 20.0 20.0 May-07 Nov-07 Aug-07 May-08 Nov-08 May-09 Nov-09 May-10 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Source: Institute of Supply Management / Haver Analytics. Industrial production rose again in April, its ninth gain in the past ten months. Capacity utilization also continued to improve. Industrial Production and Capacity Utilization Percent Change, Previous Month Percent of Capacity 3.0 85.0 Industrial Production 2.0 80.0 1.0 0.0 75.0 -1.0 70.0 -2.0 -3.0 Capacity Utilization (manufacturing) -4.0 -5.0 Apr-07 Oct-07 Jul-07 Apr-08 Jan-08 Oct-08 Jul-08 Apr-09 Jan-09 60.0 Apr-10 Oct-09 Jul-09 65.0 Jan-10 Source: Federal Reserve Board of Governors / Haver Analytics. Durable goods posted another significant year-over-year gain in April, and also posted a healthy increase from their March level. Despite a drop from the previous month, orders of nondefense captial goods, excluding aircraft, exhibited the biggest year-over-year improvement in the series' 18 year history. New Orders Percent Change, Year-Over-Year Percent Change, Year-Over-Year 30.0 30.0 Durable Goods 20.0 20.0 Capital Goods Nondefense, Excluding Aircraft 10.0 10.0 0.0 0.0 -10.0 -20.0 -30.0 -10.0 Percent change, month-over-month Feb-10 Mar-10 Dur. 0.46 0.10 2.78 Cap. 2.97 6.66 -2.65 -40.0 Apr-07 Oct-07 Jul-07 Apr-08 Jan-08 Source: U.S. Census Bureau / Haver Analytics. -20.0 Apr-10 -30.0 Oct-08 Jul-08 Apr-09 Jan-09 -40.0 Apr-10 Oct-09 Jul-09 Jan-10 Headline consumer prices slowed in April, offsetting most of the increase seen in March. Core prices also slowed further, resulting in the index's slowest year-overyear growth in 47 years. Total prices also slowed for producers, but core prices rose slightly. Consumer Price Index Percent Change, Year-Over-Year Percent Change, Year-Over-Year 8.0 8.0 6.0 Consumer Price Index 6.0 Consumer Price Index, excluding food and energy 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 -4.0 Apr-07 Aug-07 Dec-07 Apr-08 Dec-08 Apr-09 Aug-09 Producer Price Index Percent Change, Year-Over-Year 12.0 9.0 Producer Price Index 6.0 3.0 0.0 -3.0 -6.0 -9.0 Apr-07 Aug-07 Dec-07 Aug-08 Dec-09 Percent Change, Year-Over-Year Producer Price Index, excluding food and energy Apr-08 Aug-08 Dec-08 -4.0 Apr-10 Apr-09 Aug-09 Dec-09 12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 -9.0 Apr-10 Source: Bureau of Labor Statistics / Haver Analytics. Oil prices underwent a sustained and dramatic fall throughout most of May. After starting the month at over $80 per barrel, prices fell consistently to an eight month low of $66.9 on May 24th. Prices did rebound, however, into the mid-$70s in the last few days of the month Domestic Spot Oil Price Dollars per Barrel Dollasr per Barrel 160.0 160.0 140.0 140.0 120.0 120.0 100.0 100.0 80.0 80.0 60.0 60.0 40.0 40.0 20.0 20.0 May-07 Nov-07 Aug-07 May-08 Feb-08 Source: Wall Street Journal / Haver Analytics. Nov-08 Aug-08 May-09 Feb-09 Nov-09 Aug-09 May-10 Feb-10 Productivity growth was revised lower in the first quarter, reflecting lower output and greater hours than previously estimated. Most notable in the revisions was a 1.9% decrease in compensation during the fourth quarter, previously reported as a 0.4% gain. The result was a record drop in unit labor costs in the fourth quarter. Productivity and Costs Percent Change, Previous Quarter Percent Change, Previous Quarter 12.0 9.0 12.0 Compensation Per Hour Output Per Hour 9.0 6.0 6.0 3.0 3.0 0.0 0.0 -3.0 -3.0 Unit Labor Costs -6.0 -9.0 07:Q1 07:Q3 08:Q1 -6.0 08:Q3 09:Q1 -9.0 10:Q1 09:Q3 Source: Bureau of Labor Statistics / Haver Analytics. First quarter GDP growth was revised down slightly in the second estimate. The slower rate primarily reflected a downward adjustment to consumption and an upward adjustment to exports. Those effects were partially offset by an unpward revision to imports. Business investment was also revised lower, but its contribution to GDP was essentially unchanged. Revisions to First Quarter Real GDP Description Advance Estimate 2nd Estimate 3.2 3.0 Personal Consumption 3.6 3.5 Business Investment 4.1 3.1 13.4 12.7 Residential Investment -10.9 -10.7 Government -1.8 -1.9 Exports 5.8 7.2 Imports 8.9 10.4 Final Sales 1.6 1.4 Real GDP Equipment and Software Real GDP 8.0 4.0 0.0 -4.0 -8.0 07:Q1 07:Q3 08:Q1 Source: Bureau of Economic Analysis / Haver Analytics. 08:Q3 09:Q1 09:Q3 10:Q1 Data released since your last Directors' meeting are consistent with an economy that is slowly recovering. Manufacturing output and investment continued to improve while the stimulus rebate boosted home sales. Downside risks remaing though as job opportunities are scarce, especially when compared to the number of people laid off during the recession. In addition, the housing market must now stand on its own, and jitters over the European debt crisis continue to effect domestic and global financial markets. Percent Short-Term Interest Rates 0.4 0.3 Federal Funds Rate (effective rate) Discount Window Primary Credit 1.50 1.00 0.2 0.50 0.50 0.59 0.75 0.75 0.75 0.00 Jan-10 Feb-10 Mar-10 Apr-10 May-10 0.1 0.0 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Source: Federal Reserve Board of Governors / Haver Analytics. Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS, FEDERAL RESERVE BANK OF BOSTON June 10, 2010 Current Economic Developments - Addendum: Data released in the past week Nonfarm payrolls posted their largest single-month gain in ten years in May, but the increase was due almost entirely to the hiring of temporary Census 2010 workers. Over the past three months, however, private employment has increased by an average of nearly 139,000 per month. The unemployment rate fell two-tenths of a percentage point in May to 9.7%, mainly reflecting a decline in labor force participation. The debt crisis in Europe continues to present a downside risk to the U.S. economy. The three primary affects the crisis could have are direct losses on the balance sheets of U.S. banks, an atmosphere of uncertainty and risk aversion leading to tighter lending, and a reduction in trade. Should the crisis remain contained in peripheral European nations Greece, Portugal, Spain, Ireland and Italy - the above risks are much smaller than if it were to spread more broadly. Redbook sales inched up 0.1% through the first week of June, compared to May, and were up 3.6% from the same period last year. Oil prices eased a bit further in early June, averaging $72.5 per barrel in the week ending June 8th, compared to $73.2 per barrel in the previous week. Payroll employment rose by 431,000 jobs in May, but most of the increase was due to the hiring of temporary workers for the Census as only 41,000 jobs were added in the private sector. Both average hours worked and average hourly earnings rose, however, providing an income boost to those who have jobs. Also in May, the unemployment rate fell two-tenths of a percentage point to 9.7 percent. Nonfarm Payroll Employment Unemployment Rate Change from Previous Month Rate 500 11.0 250 10.0 9.0 0 8.0 -250 7.0 -500 6.0 -750 5.0 -1000 May-08 Jan-09 Sep-08 Sep-09 May-09 Source: Bureau of Labor Statistics. May-10 Jan-10 4.0 May-08 Jan-09 Sep-09 May-10 Sep-08 May-09 Jan-10 Global stock market jitters were initially alleviated by the bailout plan announcement, but index values have since fallen back to (and in many cases below) where they stood beforehand. Stock Price Index Changes Index (Jan 4, 2010 = 100) Index (Jan 4, 2010 = 100) 120.0 115.0 110.0 120.0 NASDAQ Composite Wilshire 5000 S&P 500 Financial Times Euro 300 (FTSE) 115.0 110.0 105.0 105.0 100.0 100.0 95.0 95.0 90.0 90.0 85.0 85.0 May 10, 2010: First day markets open following EU/IMF bailout announcement 80.0 75.0 1/4/10 80.0 75.0 2/1/10 1/18/10 3/1/10 2/15/10 3/29/10 3/15/10 4/26/10 4/12/10 5/24/10 5/10/10 6/7/10 Sources: Wall Street Journal (NASDAQ), Dow Jones (Wilshire), New York Times (S&P), Financial Times (FTSE) / Haver Analytics. The dollar also continues to strengthen against the Euro amid the crisis, leading to a four-year high in the exchange rate on June 7th. The dollar has been more steady since the bailout announcement when weighed against all major currencies, with its weekly average up less than 1.5%. Going back to mid-April however, the index is up over 5.5%. Exchange Rates Index (Jan 4, 2010 = 100) Index (Jan 4, 2010 = 100) 130.0 130.0 125.0 125.0 120.0 120.0 115.0 115.0 Euro/US$ 110.0 110.0 105.0 105.0 100.0 100.0 Nominal Major Currency Trade-Weighted Exchange Value of US$ (through June 4) 95.0 90.0 1/4/10 95.0 90.0 2/1/10 1/18/10 3/1/10 2/15/10 3/29/10 3/15/10 4/26/10 4/12/10 5/24/10 5/10/10 Sources: Wall Street Journal (Euro), Federal Reserve Board (Trade-weighted dollar) / Haver Analytics. 6/7/10