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The President’s Report to the Board of Directors June 5, 2008 CURRENT ECONOMIC DEVEOPMENTS - June 5, 2008 Data released since your last Directors' meeting show that while first quarter growth was stronger than originally thought, the economy is still restrained. Escalating oil prices and weaker employment conditions are wearing on consumers, and investment data has been mixed. Combined with the prolonged housing slump, these factors are likely to continue to restrict growth through the second quarter and into the second half of the year. In May, initial claims increased and consumer attitudes continued to deteriorate. Lightweight vehicle sales slowed a bit more in May, due in part to rising fuel costs. In April, both real disposable income and real consumption were flat. The sustained weakness in the housing market was still evident in April, but there was some positive movement. New home sales posted a small increase, as did both housing starts and building permits. In the manufacturing sector, the ISM index continued to show contraction in May and industrial production and capacity utilization both decreased in April. New orders for durable goods fell in April, but orders for nondefense capital goods, excluding aircraft, rose for the third time in four months. Headline inflation eased a bit in April, and core prices also slowed for consumers. Oil prices continued to surge in May, reaching new record levels above $130 per barrel. During the first quarter, real growth was stronger than originally thought. The upward revision primarily reflected a downward revision to imports and upward revisions to nonresidential structures and PCE for nondurable goods that were partly offset by downward revisions to private inventory investments, exports, and PCE for services. Initial claims for unemployment insurance rose again in May, offsetting part of the decline seen in April. Initial Claims Thousands of Units at Annual Rates Thousands of Units at Annual Rates 400 400 375 375 350 350 325 325 300 300 275 275 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07 May-08 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Source: Department of Labor, Employment and Training Administration. Consumer attitudes continued to deteriorate in May, as confidence fell to a 16-year low and sentiment dropped to its lowest point in 28 years. Consumers are concerned about rising fuel and food prices, as well as weakening job and business conditions. Consumer Sentiment Consumer Confidence Index, 1966:Q1 = 100 Index, 1985 = 100 120 160 Consumer Expectations Present Situation 140 Future Expectations Current Conditions 110 100 Consumer Sentiment Consumer Confidence 120 90 80 100 70 80 60 60 50 40 May-06 Nov-06 May-07 Nov-07 May-08 May-06 Nov-06 May-07 Nov-07 40 May-08 Source: The University of Michigan. Source: The Conference Board. Total auto and light truck sales slipped lower in May, led by a dramatic decline in truck sales as consumers avoided poor fuel economy vehicles. Domestic auto sales picked up in May, and outsold domestic trucks for the first time in almost 10 years. Total Auto and Light Truck Sales Millions of Units, Annualized Millions of Units, Annualized 24.0 24.0 Domestic Light Vehicle Sales Millions of units, annualized 22.0 20.0 22.0 Feb-08 Mar-08 Apr-08 May-08 Auto 5.04 4.95 4.89 5.33 Truck 6.63 6.20 5.67 5.11 20.0 18.0 18.0 16.0 16.0 14.0 14.0 12.0 12.0 10.0 10.0 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07 May-08 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Source: Bureau of Economic Analysis. In April, real disposable income was flat for the second straight month. Real consumption was also unchanged in April, after posting only a minor gain in March. Real DPI and Consumption Percent Change, Previous Month Percent Change, Previous Month 3.0 3.0 2.0 2.0 Real Consumption 1.0 1.0 0.0 0.0 -1.0 -1.0 -2.0 -2.0 Real Disposable Income -3.0 Apr-05 Oct-05 Jul-05 Apr-06 Jan-06 Oct-06 Jul-06 Apr-07 Jan-07 -3.0 Apr-08 Oct-07 Jul-07 Jan-08 Source: Bureau of Economic Analysis. The weakness in the real estate market continued in April. Existing home sales fell for the second consecutive month, erasing the gain seen in February. Sales of new homes increased in April, but that was due primarily to a significant downward revision to sales in March. New and Existing Home Sales Thousands of Units, Annualized Thousands of Units, Annualized 1600 8000 New Home Sales 7500 1400 Existing Home Sales 7000 1200 6500 1000 6000 800 5500 600 5000 400 4500 Apr-05 Oct-05 Jul-05 Apr-06 Jan-06 Oct-06 Jul-06 Apr-07 Jan-07 Oct-07 Jul-07 Source: U.S. Census Bureau (new homes sales) and National Association of Realtors (existing home sales). Apr-08 Jan-08 In April, housing starts rose and building permits enjoyed their largest one-month gain since December 2006. Housing Starts and Building Permits Thousands of Units, Annualized Thousands of Units, Annualized 2400 2400 2200 2200 Building Permits 2000 2000 1800 1800 1600 1600 Housing Starts 1400 1400 1200 1200 1000 1000 800 800 Apr-05 Oct-05 Jul-05 Apr-06 Jan-06 Oct-06 Jul-06 Apr-07 Jan-07 Oct-07 Jul-07 Apr-08 Jan-08 Source: U.S. Census Bureau. The ISM manufacturing index was below 50 for the fourth consecutive month in May, but did show improvement. The employment component of the index was essentially unchanged in May following the steep drop seen in April. ISM Index Index (50+ = Economic Expansion) Index (50+ = Economic Expansion) 60.0 60.0 ISM Index 55.0 55.0 50.0 50.0 Employment Index 45.0 45.0 40.0 40.0 May-05 Nov-05 Aug-05 May-06 Nov-06 May-07 Nov-07 May-08 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Source: Institute of Supply Management. Industrial production experienced its second sharp drop in three months in April, and capacity utilization fell to its lowest point since November 2004. Industrial Production and Capacity Utilization Percent Change, Previous Month Percent of Capacity 82.0 2.0 Industrial Production 81.0 1.0 80.0 0.0 79.0 78.0 -1.0 Capacity Utilization (manufacturing) -2.0 Apr-05 77.0 76.0 Oct-05 Jul-05 Apr-06 Jan-06 Oct-06 Jul-06 Apr-07 Jan-07 Oct-07 Jul-07 Apr-08 Jan-08 Source: Federal Reserve Board of Governors. Durable goods orders fell for the second straight month in April, while orders of nondefense capital goods excluding aircraft rose. New Orders Percent Change, Year-Over-Year Percent Change, Year-Over-Year 20.0 20.0 Capital Goods Nondefense, Excluding Aircraft 15.0 15.0 New Orders, Durable Goods 10.0 10.0 5.0 5.0 0.0 0.0 Durable Goods, New Orders Percent change, month-over-month -5.0 Jan-08 Feb-08 Mar-08 Apr-08 -4.66 1.13 -0.22 -0.55 -10.0 Apr-05 Oct-05 Jul-05 Source: U.S. Census Bureau. Apr-06 Jan-06 -5.0 Oct-06 Jul-06 Apr-07 Jan-07 -10.0 Apr-08 Oct-07 Jul-07 Jan-08 Consumer prices slowed a bit in April, although headline inflation remains elevated at nearly 4.0%. Total prices for producers also eased, but core inflation sped up for the fourth consecutive month. Consumer Price Index Percent Change, Year-Over-Year Percent Change, Year-Over-Year 6.0 6.0 5.0 5.0 Consumer Price Index 4.0 4.0 3.0 3.0 2.0 2.0 Consumer Price Index, excluding food and energy 1.0 0.0 Apr-05 Aug-05 Dec-05 Apr-06 Percent Change, Year-Over-Year 1.0 Aug-06 Dec-06 Apr-07 Producer Price Index 10.0 8.0 6.0 4.0 2.0 0.0 Producer Price Index, -2.0 excluding food and energy -4.0 Apr-05 Aug-05 Dec-05 Apr-06 Aug-07 Dec-07 Percent Change, Year-Over-Year Producer Price Index Aug-06 Dec-06 0.0 Apr-08 Apr-07 Aug-07 Dec-07 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 Apr-08 Source: Bureau of Labor Statistics. Oil prices continued their rapid ascent in May. The average price for a barrel of oil has risen $30 since February, and nearly doubled over the past year. A new single-day record of $132.78 was set on May 21st. Domestic Spot Oil Price Dollars per Barrel Dollasr per Barrel 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-05 Nov-05 Aug-05 Source: Wall Street Journal. May-06 Feb-06 Nov-06 Aug-06 May-07 Feb-07 Nov-07 Aug-07 May-08 Feb-08 Productivity increased in the first quarter, while compensation and unit labor costs slowed. Productivity and Costs Percent Change, Previous Quarter Percent Change, Previous Quarter 15.0 15.0 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 Unit Labor Costs -6.0 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 -6.0 08:Q1 07:Q3 Source: Bureau of Labor Statistics. Real GDP growth in the first quarter was stronger than originally thought. The upward revision primarily reflected a downward adjustment to imports and upward revisions to nonresidential structures and PCE for nondurable goods. These positive changes were partly offset by downward revisions to private inventory investment, exports, and PCE for services. Revisions to First Quarter Real GDP Description Real GDP Personal Consumption Nondurable Goods Services Business Investment Equipment and Software Residential Investment Advanced Preliminary 0.6 0.9 1.0 1.0 -1.3 -0.3 3.4 3.0 -2.5 -0.2 -0.7 -0.9 -26.7 -25.5 Exports 5.5 2.8 Imports 2.5 -2.6 Final Sales -0.2 0.7 Real GDP 6.0 5.0 4.0 3.0 2.0 1.0 0.0 05:Q1 05:Q3 Source: Bureau of Economic Analysis. 06:Q1 06:Q3 07:Q1 07:Q3 08:Q1 Overall, data released since your last Directors' meeting show that while first quarter growth was stronger than originally thought, the economy is still restrained. Escalating oil prices and weaker employment conditions are wearing on consumers, and investment data has been mixed. Combined with the prolonged housing slump, these factors are likely to continue to restrict growth through the second quarter and into the second half of the year. Percent Short-Term Interest Rates 10.0 9.0 8.0 7.0 Federal Funds Rate (effective rate) 6.00 5.00 4.00 3.00 2.00 1.00 6.0 5.0 4.0 Discount Window Primary Credit 4.48 3.50 3.04 2.49 2.25 Jan-08 Feb-08 Mar-08 Apr-08 May-08 3.0 2.0 1.0 0.0 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Source: Federal Reserve Board of Governors. Mar-08 May-08 PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS, FEDERAL RESERVE BANK OF BOSTON June 11, 2007 Current Economic Developments - Addendum: Data released in the past week In May, nonfarm payrolls posted their fifth straight monthly decline and the unemployment rate rose to its highest level in over three-and-a-half years. Nonfarm payrolls were reduced by 49,000 jobs in May, bringing the total number of jobs lost this year to 324,000. The unemployment rate rose to 5.5%, last matched in October 2004. The U.S. international trade deficit widened in April, due primarily to higher oil prices. Both imports and exports grew in April, building on their previously set record highs. Wholesale inventories and sales both rose in April, the rise in inventories led by an increase in petroleum stocks. Both measures had also risen in March. Redbook sales fell 1.0% through the first week of June, compared to May. Year-overyear, sales rose 2.1%. Oil prices continued to rise in early June, averaging $130.86 per barrel in the week ending June 10, compared to $127.42 per barrel the week before. A new record high was set on June 6 at $138.55. Payroll employment fell by 49,000 jobs in May, and estimates for the previous two months were revised downward by a total of 15,000 jobs. The unemployment rate increased by half of a percentage point to 5.5%, the largest single-month increase in 22 years. Nonfarm Payroll Employment Change from Previous Month Unemployment Rate Rate 300 5.75 250 5.5 200 5.25 150 5 100 4.75 50 4.5 0 4.25 -50 -100 May-06 Jan-07 Sep-06 Sep-07 May-07 Source: Bureau of Labor Statistics. May-08 Jan-08 4 May-06 Jan-07 Sep-07 May-08 Sep-06 May-07 Jan-08