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The President’s Report to the Board of Directors June 2, 2011 CURRENT ECONOMIC DEVELOPMENTS - June 2, 2011 Data released since your last Directors' meeting has come in mostly below expectations but show that the economy continues to recover, albeit at a slow pace. The housing market remains weak, contributions from manufacturing have slowed, and downside risks remain in foreign debt issues, domestic budget constraints, and the effects of the recent spate of natural disasters. Despite the recent downturn in data, economic growth is expected to pick up a bit in the coming months. Initial claims for unemployment insurance eased a bit in May, but remain uncomfortably high. Consumer attitudes were mixed in May as measures of future expectations moved in opposite directions, but feelings towards current conditions were little changed. Auto sales fell in May to their lowest level in eight months, due primarily to higher prices. Incomes were flat in April and have shown little growth over the past year, and along with higher energy prices have restrained consumption, which managed only another very small gain in April. The housing market remained subdued in April. New home sales increased but remain near historical lows, while sales of existing homes eased a bit. Housing starts and building permits also declined in April and are little changed from where they stood two years ago. In the manufacturing sector, the ISM index fell sharply in May but did continue to signal expansion in the economy. In April, industrial production was flat while new orders for durable goods fell. Price indices continued to accelerate in April, due to higher energy and commodity prices. While core price measures have also been rising, those increases are expected to be transitory. Oil prices fell sharply in the first few days of May and then held mostly steady through the rest of the month. Initial claims for unemployment insurance fell slightly in May, following the sharp increase seen in April. After dropping to a three-year low of 375,000 at the end of February, claims have been above 400,000 for eight consecutive weeks, a level well above what would be considered indicative of a healthy labor market. 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-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Source: Department of Labor, Employment and Training Administration / Haver Analytics. Measures of consumer attitudes were mixed in May, as sentiment improved but confidence fell, due primarily to disparate views on near-term future conditions. The Conference Board survey found respondents to be much more apprehensive about future business and labor market conditions, while the Michgan survey was boosted by increasing reports of job gains and easing inflation concerns. Consumer Confidence Consumer Sentiment Index, 1966:Q1 = 100 Index, 1985 = 100 100 100 Consumer Expectations Current Conditions 90 75 80 70 50 Present Situation 60 Future Expectations 25 50 Consumer Sentiment Consumer Confidence 0 May-09 Nov-09 May-10 Nov-10 Source: The Conference Board / Haver Analytics. May-11 May-09 Nov-09 May-10 Nov-10 40 May-11 Source: The University of Michigan / Haver Analytics. Total lightweight vehicle sales fell in May to their lowest level in eight months, due to a variety of factors including higher prices, tsunami-related supply shortages from Japan, and general concerns among consumers about the state of the economy. Even as oil prices fell during the month, consumers continued to gravitate towards smaller, more fuel-efficient vehicles. 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 2.0 2.0 0.0 0.0 May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Source: Bureau of Economic Analysis / Haver Analytics. Real disposable incomes were unchanged again in April, and have grown by only 0.3% over the past six months. The stagnant incomes are restricting consumption, which edged up only 0.1% in April. Equally small increases were also seen in three of the previous four months. 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-08 Oct-08 Jul-08 Apr-09 Jan-09 Oct-09 Jul-09 Apr-10 Jan-10 -4.0 Apr-11 Oct-10 Jul-10 Jan-11 Source: Bureau of Economic Analysis / Haver Analytics. Housing data was mixed in April and remain historically weak, despite improving a bit from the record lows established in the last few months. New home sales unexpectedly rose in April and are up 16.2% over the past two months, while sales of existing homes eased slightly in April and matched their six-month average. New and Existing Home Sales Thousands of Units, Annualized Thousands of Units, Annualized 800 7000 700 6500 Existing Home Sales New Home Sales 600 6000 500 5500 400 5000 300 4500 200 4000 100 3500 0 3000 Apr-08 Oct-08 Jul-08 Apr-09 Jan-09 Oct-09 Jul-09 Apr-10 Jan-10 Oct-10 Jul-10 Apr-11 Jan-11 Source: U.S. Census Bureau (new homes sales) and National Association of Realtors (existing home sales) / Haver Analytics. Housing starts fell in April, erasing most of the gain seen in March. Building permits also fell slightly during the month and are little changed from where they stood two years ago. Housing Starts and Building Permits Thousands of Units, Annualized Thousands of Units, Annualized 1400 1400 1200 1200 1000 1000 Building Permits 800 800 600 600 400 400 Housing Starts 200 200 0 0 Apr-08 Oct-08 Jul-08 Apr-09 Jan-09 Oct-09 Jul-09 Apr-10 Jan-10 Oct-10 Jul-10 Apr-11 Jan-11 Source: U.S. Census Bureau / Haver Analytics. The ISM manufacturing index fell sharply in May, dropping to its lowest level since September 2009. The index was still above 50, though, signalling continued economic expansion. The employment component of the index also fell in May but remains quite high compared to its recent history. ISM Index Index (50+ = Economic Expansion) Index (50+ = Economic Expansion) 70.0 70.0 ISM Index 60.0 60.0 50.0 50.0 40.0 40.0 Employment Index 30.0 30.0 20.0 20.0 May-08 Nov-08 Aug-08 May-09 Nov-09 May-10 Nov-10 May-11 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Source: Institute of Supply Management / Haver Analytics. Industrial production was flat in April, following a solid gain seen in the previous month. Capacity utilization eased a bit in April, the first decline in the series in nearly two years. Industrial Production and Capacity Utilization Percent Change, Previous Month Percent of Capacity 3.0 80.0 Industrial Production 2.0 75.0 1.0 0.0 70.0 -1.0 -2.0 -3.0 65.0 Capacity Utilization (manufacturing) -4.0 -5.0 Apr-08 Oct-08 Jul-08 Apr-09 Jan-09 Oct-09 Jul-09 Apr-10 Jan-10 60.0 Apr-11 Oct-10 Jul-10 Jan-11 Source: Federal Reserve Board of Governors / Haver Analytics. New orders for durable goods fell in April and posted the smallest year-over-year gain since late 2009. Orders of nondefense capital goods, excluding aircraft, also declined in April, the third decrease in four months. Year-over-year increases in that series have also been steadily declining over the past eight months. New Orders Percent Change, Year-Over-Year Percent Change, Year-Over-Year 30.0 30.0 Percent change, month-over-month Jan-11 Feb-11 Mar-11 Apr-11 Dur. 4.01 -1.06 4.58 -3.59 Cap. -4.81 -0.13 5.41 -2.31 20.0 10.0 20.0 10.0 0.0 0.0 Capital Goods Nondefense, Excluding Aircraft -10.0 -20.0 -10.0 -20.0 -30.0 -30.0 Durable Goods -40.0 Apr-08 Oct-08 Jul-08 Apr-09 Jan-09 Source: U.S. Census Bureau / Haver Analytics. Oct-09 Jul-09 Apr-10 Jan-10 -40.0 Apr-11 Oct-10 Jul-10 Jan-11 Headline consumer prices continued to accelerate in April, growing at their fastest pace since October 2008. The core index also picked up to reach a 14-month high. Producer price measures told a similar story, with the total index growing at its fastest rate since September 2008 and the core index reaching a 21-month high. Consumer Price Index Percent Change, Year-Over-Year Percent Change, Year-Over-Year 8.0 8.0 6.0 6.0 Consumer Price Index, excluding food and energy 4.0 Consumer Price Index 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 -4.0 Apr-08 Aug-08 Dec-08 Apr-09 Dec-09 Apr-10 Aug-10 Producer Price Index Percent Change, Year-Over-Year 12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 -9.0 Apr-08 Aug-09 Dec-08 Apr-09 Producer Price Index Aug-09 Dec-09 -4.0 Apr-11 Percent Change, Year-Over-Year Producer Price Index, excluding food and energy Aug-08 Dec-10 Apr-10 Aug-10 Dec-10 12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 -9.0 Apr-11 Source: Bureau of Labor Statistics / Haver Analytics. Oil prices fell sharply in the first few days of May, and then spent the rest of the month hovering around $100 per barrel. The lower prices helped reduce the cost of gas by about $0.25 per gallon, welcome news to consumers with the summer driving season now underway. Domestic Spot Oil Price Dollars per Barrel Dollasr per Barrel 150.0 150.0 125.0 125.0 100.0 100.0 75.0 75.0 50.0 50.0 25.0 25.0 0.0 0.0 May-08 Nov-08 Aug-08 May-09 Feb-09 Source: Wall Street Journal / Haver Analytics. Nov-09 Aug-09 May-10 Feb-10 Nov-10 Aug-10 May-11 Feb-11 Productivity growth was revised slightly higher in the first quarter, reflecting stronger output than previously estimated but no change in hours worked. Most notable in the revisions was a 0.1% increase in compensation during the fourth quarter, previously reported as a 1.9% gain. Unit labor costs were also revised downward in the fourth quarter, to a drop of 2.8% from the previous estimate of a 1.0% decline. Productivity and Costs Percent Change, Previous Quarter Percent Change, Previous Quarter 12.0 12.0 Compensation Per Hour 9.0 Output Per Hour 9.0 6.0 6.0 3.0 3.0 0.0 0.0 -3.0 -3.0 -6.0 -6.0 Unit Labor Costs -9.0 08:Q1 08:Q3 09:Q1 09:Q3 10:Q1 -9.0 11:Q1 10:Q3 Source: Bureau of Labor Statistics / Haver Analytics. First quarter GDP growth was unrevised in the second estimate, as upward adjustments to nonresidential fixed investment, inventory investment and exports were offset by a downward revision to consumption and an upward revision to imports. GDP growth was expected to undergo a small upward revision, but fell short due mostly to the larger-then-expected downward adjustment to PCE. Revisions to First Quarter Real GDP Description Advance Estimate 2nd Estimate 1.8 1.8 Personal Consumption (PCE) 2.7 2.2 Business Investment 1.8 3.4 Residential Investment -4.1 -3.3 Government -5.2 -5.1 Exports 4.9 9.2 Imports 4.4 7.5 Final Sales 0.8 0.6 Change in Nonfarm Inv. ($2005 Bil.) 30.7 39.8 Real GDP Real GDP 8.0 4.0 0.0 -4.0 -8.0 08:Q1 08:Q3 09:Q1 Source: Bureau of Economic Analysis / Haver Analytics. 09:Q3 10:Q1 10:Q3 11:Q1 Corporate profits posted their weakest quarter of the recovery in the first quarter, with after tax profits falling for the first time in over two years. All of the decrease came from domestic firms, as profits rose for overseas operations. The decreases were due primarily to slower productivity growth (from increased hiring) and the higher cost of imported materials. Corporate Profits Percent Change, Annual Rate Percent Change, Annual Rate 150 150 Total Profits, After Tax (w/ IVA and CCAdj.) 100 100 Total Profits, Before Tax (w/ IVA and CCAdj.) 50 50 0 0 Corporate Profits, % Change, Annual Rate -50 -100 08:Q1 08:Q3 08:Q2 09:Q1 08:Q4 Domestic 2010:Q 3 11.95 2010:Q 4 16.02 2011:Q 1 -7.39 Foreign -8.79 -9.48 60.45 09:Q3 09:Q2 10:Q1 09:Q4 10:Q3 10:Q2 -50 -100 11:Q1 10:Q4 Source: Bureau of Economic Analysis / Haver Analytics. Data released since your last Directors' meeting has come in mostly below expectations but show that the economy continues to recover, albeit at a slow pace. The housing market remains weak, contributions from manufacturing have slowed, and downside risks remain in foreign debt issues, domestic budget constraints, and the effects of the recent spate of natural disasters. Despite the recent downturn in data, economic growth is expected to pick up a bit in the coming months. Percent Short-Term Interest Rates 0.4 0.3 Federal Funds Rate (effective rate) 1.50 1.00 0.2 Discount Window Primary Credit 0.75 0.75 0.75 0.75 0.75 0.50 0.00 Jan-11 Feb-11 Mar-11 Apr-11 May-11 0.1 0.0 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Source: Federal Reserve Board of Governors / Haver Analytics. Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS, FEDERAL RESERVE BANK OF BOSTON June 9, 2011 Current Economic Developments - Addendum: Data released in the past week Nonfarm payrolls posted their smallest single-month gain in eight months in May, far below expectations and more evidence of a soft patch in the economy. The weakness in the jobs report was widespread, with losses seen in manufacturing, motor vehicles and parts, retail sales, nonresidential construction and government. Health services and food and drinking places were the strongest gainers. There were some positive aspects to the data as well. The hours worked index ticked up a bit and average hourly earnings posted a second consecutive 0.3% gain. Also, the labor force grew as some previously discouraged workers returned to the labor market with the belief that jobs were more readily available. The ISM nonmanufacturing index unexpectedly rose in May, signifying further expansion of the services sector. The employment sub-index also rose in May, implying that the servicerelated job gains seen in April continued into the following month. Redbook sales rose 1.3% through the first week of June, compared to May, and were up 4.2% from the same period last year. Oil prices eased a bit further in early June, averaging $99.8 per barrel in the week ending June 7th, compared to $101.2 per barrel in the previous week. Payroll employment rose by only 54,000 jobs in May, and payroll additions were revised downward by 39,000 for the previous two months. Also in May, the unemployment rate rose one-tenth of a percentage point to 9.1 percent, as a small gain in civilian employment was outpaced by a larger increase in the labor force. Nonfarm Payroll Employment Unemployment Rate Rate Change from Previous Month 750 10.5 500 10.0 250 0 9.5 -250 9.0 -500 -750 May-09 Jan-10 Sep-09 Sep-10 May-10 May-11 Jan-11 Source: Bureau of Labor Statistics / Haver Analytics. 8.5 May-09 Jan-10 Sep-10 May-11 Sep-09 May-10 Jan-11