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The President’s Report to the Board of Directors May 3, 2007 CURRENT ECONOMIC DEVELOPMENTS - May 3, 2007 Data since your last Directors' meeting show the economy grew in the first quarter at its slowest pace in four years. The housing market continues to be a drag on the economy and inflation remains stubborn, but consistent employment growth has been able to sustain incomes and consumer spending. The increase in real GDP in the first quarter was due primarily to positive contributions from personal consumption expenditures and state and local government spending. Those effects were partly offset by negative contributions from residential fixed investment, private inventory investment, and federal government spending and an increase in imports. In April, consumer attitudes weakened after exhibiting little change in the first quarter, and initial claims for unemployment insurance increased a bit but remain relatively low. Both the ISM manufacturing and employment indices increased in April following a flat first quarter. Inflation continued to be of some concern in the first quarter. Little change was seen in core prices, but headline inflation accelerated. Unit labor costs slowed in the first quarter, while total compensation costs, as measured by the ECI, accelerated slightly. Oil prices rose steadily through the first quarter and into April, and threaten to climb higher as demand rises entering the summer months. The deceleration of real GDP in the first quarter primarily reflected a downturn in exports, an upturn in imports, a deceleration in PCE for nondurable goods, and a downturn in federal government spending which were partially offset by smaller decreases in inventory and residential investment, an upturn in equipment and software, and an acceleration in PCE for durable goods. Annualized Percent Change Real Gross Domestic Product Annualized Percent Change 8.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 04:Q1 04:Q3 Source: Bureau of Economic Analysis. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 In the first quarter, personal income grew at nearly twice the rate as seen in the fourth quarter. Real disposable income eased a bit, but consumption still posted another solid gain. Personal Income Real Consumption Annualized Percent Change Annualized Percent Change 6.0 14.0 12.0 Personal Income 10.0 8.0 4.0 6.0 4.0 2.0 2.0 0.0 -2.0 -4.0 Real Disposable Income -6.0 0.0 04:Q1 05:Q1 04:Q3 06:Q1 05:Q3 07:Q1 06:Q3 04:Q1 05:Q1 04:Q3 06:Q1 05:Q3 07:Q1 06:Q3 Source: Bureau of Economic Analysis. Auto sales eased in April, following a first quarter rise. Total Auto and Light Truck Sales Millions of Units, Annualized 19.0 18.0 17.0 16.0 15.0 14.0 13.0 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 Apr-07 Source: Bureau of Economic Analysis Business investment rebounded in the first quarter, aided by a similar rebound in equipment and software investment. Business Investment Annualized Percent Change Annualized Percent Change 20.0 20.0 Equipment and Software 16.0 16.0 12.0 12.0 8.0 8.0 4.0 4.0 0.0 0.0 Business Investment -4.0 -4.0 -8.0 -8.0 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Source: Bureau of Economic Analysis. In the first quarter, new orders for durable goods were essentially unchanged from a year ago and orders of nondefense capital goods, excluding aircraft, fell. Durable Goods Orders Percent Change, year-over-year Percent Change, year-over-year 16.0 16.0 Capital Goods Nondefense, Excluding Aircraft 12.0 12.0 8.0 8.0 4.0 4.0 Durable Goods, New Orders 0.0 0.0 -4.0 -4.0 04:Q1 04:Q3 Source: U.S. Census Bureau. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Residential investment continued to fall in the first quarter, albeit at a slightly less dramatic pace. Residential Investment Annualized Percent Change Annualized Percent Change 25.0 25.0 20.0 20.0 15.0 15.0 10.0 10.0 5.0 5.0 0.0 0.0 -5.0 -5.0 -10.0 -10.0 -15.0 -15.0 -20.0 -20.0 -25.0 -25.0 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Source: U.S. Census Bureau. The housing market was mixed in the first quarter. Sales of existing homes sold at a faster pace than seen the previous quarter, but new home sales slowed significantly, to their lowest quarterly pace in nearly seven years. New and Existing Home Sales Thousands of Units, Annualized Thousands of Units, Annualized 1400 7500 New Home Sales 1300 Existing Home Sales 7000 1200 1100 6500 1000 900 6000 800 700 5500 04:Q1 04:Q3 Source: U.S. Census Bureau. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Government spending decelerated in the first quarter. Government Spending Annualized Percent Change Annualized Percent Change 8.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 -4.0 -4.0 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Source: Bureau of Economic Analysis. Exports fell in the first quarter for the first time in nearly four years. Imports were on the rise again in the first quarter, after falling in the fourth quarter. Exports and Imports Annualized Percent Change Annualized Percent Change 25.0 25.0 20.0 20.0 Exports 15.0 15.0 10.0 10.0 5.0 5.0 0.0 0.0 Imports -5.0 -5.0 -10.0 -10.0 04:Q1 04:Q3 Source: Bureau of Economic Analysis. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Consumer attitudes exhibited only minor changes in the first quarter, but worsened slightly in April. Consumer Confidence and Expectations Index, 1985 = 100 Index, 1985 = 100 120 120 Confidence 110 110 100 100 90 90 80 80 Expectations 70 70 60 60 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 Apr-07 Consumer Sentiment and Expectations Index, 1966:Q1=100 Index, 1966:Q1=100 110 110 100 100 Sentiment 90 90 80 80 70 70 Expectations 60 60 50 50 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 Apr-07 Source: The Conference Board (confidence) and University of Michigan (sentiment). Initial claims for unemployment insurance inched up in the first quarter, and continued to rise 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 04:Q1 04:Q3 04:Q2 05:Q1 04:Q4 05:Q3 05:Q2 06:Q1 05:Q4 Source: Department of Labor, Employment and Training Administration. 06:Q3 06:Q2 07:Q1 06:Q4 Apr-07 In April, both the ISM and employment indices improved, following a relatively flat first quarter. ISM Index Index (50+ = Economic Expansion) Index (50+ = Economic Expansion) 70.0 70.0 65.0 65.0 ISM Index 60.0 60.0 55.0 55.0 50.0 50.0 45.0 45.0 Employment Index 40.0 40.0 35.0 35.0 30.0 30.0 04:Q1 04:Q3 04:Q2 05:Q1 04:Q4 05:Q3 05:Q2 06:Q1 05:Q4 06:Q3 06:Q2 07:Q1 06:Q4 Apr-07 Source: Institute for Supply Management. Core inflation showed little change in the third quarter, but headline inflation accelerated for both consumers and producers. Consumer Price Index Percent Change, Year-Over-Year Percent Change, Year-Over-Year 5.0 5.0 4.0 Consumer Price Index, excluding food and energy Consumer Price Index 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Producer Price Index Percent Change, Year-Over-Year Percent Change, Year-Over-Year 8.0 6.0 8.0 Producer Price Index, excluding food and energy Producer Price Index 6.0 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 04:Q1 04:Q3 Source: Bureau of Labor Statistics. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Productivity growth eased slightly in the first quarter, but hourly compensation and unit labor costs both slowed dramatically. Productivity and Costs Percent Change, Previous Quarter Percent Change, Previous Quarter 15.0 15.0 12.0 12.0 Compensation Per Hour Output Per Hour 9.0 9.0 6.0 6.0 3.0 3.0 0.0 0.0 -3.0 -3.0 Unit Labor Costs -6.0 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 -6.0 07:Q1 Source: Bureau of Labor Statistics. In the first quarter, total employment costs increased a bit as an acceleration in wages and salaries more than offset a benefit cost deceleration. Employment Cost Index Annualized Percent Change Annualized Percent Change 8.0 8.0 7.0 7.0 Benefit Costs 6.0 6.0 5.0 5.0 Total Compensation 4.0 4.0 3.0 3.0 2.0 2.0 Wages and Salaries 1.0 1.0 0.0 0.0 04:Q1 04:Q3 Source: Bureau of Labor Statistics. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 Oil prices eased overall in the first quarter due to a January fall, but rose throughout the rest of the quarter and continued to rise in April. Past Five Months Domestic Spot Oil Price Dollars per Barrel Dollars per Barrel 70.0 80.0 70.0 65.0 60.0 60.0 50.0 55.0 40.0 30.0 04:Q1 04:Q4 05:Q3 06:Q2 07:Q1 Dec-06 Feb-07 50.0 Apr-07 Source: Wall Street Journal (oil prices). . Overall, data since your last Directors' meeting show the economy grew in the first quarter at its slowest pace in four years. The housing market continues to be a drag on the economy and inflation remains stubborn, but consistent employment growth has been able to sustain incomes and consumer spending. Percent Short-Term Interest Rates 7.0 6.0 Discount Window Primary Credit 5.0 6.25 6.25 6.25 6.25 5.90 4.0 5.43 3.0 06:Q1 7.00 6.50 6.00 Federal Funds Rate (effective rate) 5.50 5.00 06:Q2 06:Q3 06:Q4 07:Q1 Apr-07 2.0 1.0 0.0 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 06:Q4 Source: Federal Reserve Board of Governors. 07:Q1 Apr-07 PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS, FEDERAL RESERVE BANK OF BOSTON May 10, 2007 Current Economic Developments - Addendum: Data released in the past week In April, nonfarm payrolls added 88,000 jobs and the unemployment rate rose a tenth of a percentage point to 4.5%. April's increase in payrolls was the smallest since November 2004. March payrolls were revised to show an increase of 177,000 jobs, 3,000 fewer than the original estimate, and February payrolls were also revised downward, to 90,000 from 113,000. Wholesale inventories grew 0.3% in March, following a revised increase of 0.4% in February. February inventories were orignally seen rising 0.5%. Wholesale sales increased 1.8 in March, after rising 1.0% the previous month. Sales were initally reported as rising 1.2% in February. Redbook sales finished April down 4.1%, compared to March. Sales were 0.1% higher than during the same period last year. Oil prices decreased during the past week, averaging 62.5 dollars per barrel, compared to last week's average of 65.4. Payroll employment posted a modest gain in April, but revisions to the prior two months' estimates resulted in a net loss of 26,000 jobs. The unemployment rate held at it's first quarter average of 4.5% in April. Nonfarm Payroll Employment Change from Previous Quarter, Monthly Average Unemployment Rate Rate 5.6 400 Change from Previous Month 350 300 Feb-07 Mar-07 Apr-07 5.4 90,000 177,00 0 88,000 5.2 250 5 200 4.8 150 4.6 100 4.4 50 4.2 0 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 05:Q2 05:Q4 06:Q2 06:Q4 Apr-07 Source: Bureau of Labor Statistics. 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 05:Q2 05:Q4 06:Q2 06:Q4 Apr-07