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The
President’s
Report to the
Board of
Directors
November 2, 2006
CURRENT ECONOMIC DEVELOPMENTS - November 2, 2006
Data since your last Directors' meeting show the economy grew in the third quarter,
but at its slowest pace since the first quarter of 2003.
The increase in real GDP in the third quarter was due mainly to positive contributions
from personal consumption expenditures, exports, equipment and software,
nonresidential structures, and state and local government spending. These effects
were partly offset by a negative contribution from residential fixed investment and an
increase in imports.
In October, consumer attitudes improved over their third quarter averages, but auto
and light truck sales declined slightly. Initial claims for unemployment insurance
followed some third quarter easing with further reductions in October. Both the ISM
manufacturing and employment indices continued to fall through the third quarter,
but the employment component improved some in October.
Lower energy prices helped slow overall consumer price growth in the third quarter,
but core inflation advanced at its fastest quarterly pace in ten years. Adding to
inflation concerns, unit labor costs grew at their fastest annual rate in nearly 25
years in the third quarter, and total compensation costs, as measured by the ECI,
increased.
The deceleration in real GDP growth in the third quarter primarily reflected an
acceleration in imports, a downturn in private inventory investment, a larger decrease
in residential fixed investment, and a deceleration in PCE for services that were
partially offset by upturns in PCE for durable goods and equipment and software.
Real Gross Domestic Product
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
03:Q3
04:Q1
Source: Bureau of Economic Analysis.
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Real consumption picked up in the third quarter, aided by an acceleration in
real disposable incomes.
Personal Income
Real Consumption
Annualized Percent Change
Annualized Percent Change
7.0
14.0
Personal Income
12.0
6.0
10.0
5.0
8.0
4.0
6.0
4.0
3.0
2.0
0.0
2.0
-2.0
1.0
Real Disposable
Income
-4.0
-6.0
0.0
03:Q3
04:Q3
04:Q1
05:Q3
05:Q1
06:Q3
03:Q3
04:Q3
04:Q1
06:Q1
05:Q3
05:Q1
06:Q3
06:Q1
Source: Bureau of Economic Analysis.
Growth in business investment nearly doubled in the third quarter, due primarily to a
solid increase 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
03:Q3
04:Q1
Source: Bureau of Economic Analysis.
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
New orders for durable goods rebounded in the third quarter, offsetting some of the
slowdown seen over the first half of the year. Orders of nondefense capital goods,
excluding aircraft, exhibited a similar turnaround.
Durable Goods Orders
Percent Change, year-over-year
Percent Change, year-over-year
16.0
16.0
12.0
12.0
Capital Goods Nondefense,
Excluding Aircraft
8.0
8.0
4.0
4.0
Durable Goods,
New Orders
0.0
0.0
Durable Goods, New Orders
Percent change, previous quarter
-4.0
2005:Q4
2006:Q1
2006:Q2
2006:Q3
7.02
-1.47
1.50
2.14
-8.0
-4.0
-8.0
03:Q3
04:Q1
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Source: U.S. Census Bureau.
Residential investment decreased further in the third quarter, suffering its sharpest
drop since the first quarter of 1991. The drop reduced overall GDP by 1.12
percentage points.
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
Residential Investment
Contribution to % Change in Real GDP
-10.0
-10.0
-15.0
2005:Q4
2006:Q1
2006:Q2
2006:Q3
-0.06
-0.02
-0.72
-1.12
-15.0
-20.0
-20.0
03:Q3
04:Q1
Source: U.S. Census Bureau.
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Home sales continued to slow in the third quarter, as sales of both new and existing
homes fell to their lowest levels in over three years.
New and Existing Home Sales
Thousands of Units,
Annualized
Thousands of Units,
Annualized
1400
7500
Existing Home Sales
New Home Sales
1300
7000
1200
6500
1100
6000
1000
5500
900
5000
03:Q3
04:Q1
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Source: U.S. Census Bureau.
Government spending accelerated in the third quarter.
Government Spending
Annualized Percent Change
Annualized Percent Change
6.0
6.0
4.0
4.0
2.0
2.0
0.0
0.0
-2.0
-2.0
-4.0
-4.0
03:Q3
04:Q1
Source: Bureau of Economic Analysis.
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Export growth picked up a bit in the third quarter, but imports accelerated and grew
at a faster pace.
Exports and Imports
Annualized Percent Change
Annualized Percent Change
25.0
25.0
20.0
20.0
Exports
Imports
15.0
15.0
10.0
10.0
5.0
5.0
0.0
0.0
-5.0
-5.0
03:Q3
04:Q1
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Source: Bureau of Economic Analysis.
Consumer attitudes underwent some mixed, and relatively minor, changes in the
third quarter, as confidence eased a bit and sentiment was unchanged. October
saw attitudes improving, especially as measured by the Michigan survey.
Consumer Confidence and Expectations
Index, 1985 = 100
Index, 1985 = 100
120
120
Confidence
110
110
100
100
90
90
80
80
70
Expectations
70
60
60
03:Q3 03:Q4 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 Oct-06
Index, 1966:Q1=100
Consumer Sentiment and Expectations
Index, 1966:Q1=100
110
110
100
Sentiment
100
90
90
80
80
70
Expectations
70
60
60
03:Q3 03:Q4 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 Oct-06
Source: The Conference Board (confidence) and University of Michigan (sentiment).
Total auto and light truck sales were down a bit in October, after increasing slightly
during the third quarter.
Total Auto and Light Truck Sales
Millions of Units, Annualized
20.0
18.0
16.0
14.0
12.0
10.0
03:Q3 03:Q4
04:Q1 04:Q2
04:Q3 04:Q4
05:Q1 05:Q2
05:Q3 05:Q4
06:Q1 06:Q2
06:Q3 Oct-06
Source: Bureau of Economic Analysis
Initial claims for unemployment insurance eased slightly in the third quarter, and
continued to decrease in October.
Initial Claims
Thousands of Units at Annual Rates
Thousands of Units at Annual Rates
425
425
400
400
375
375
350
350
325
325
300
300
275
275
03:Q3
04:Q1
03:Q4
04:Q3
04:Q2
05:Q1
04:Q4
05:Q3
05:Q2
Source: Department of Labor, Employment and Training Administration.
06:Q1
05:Q4
06:Q3
06:Q2
Oct-06
Both the ISM manufacturing and employment indices decreased in the third quarter,
much as they had in the first two quarters of the year. The ISM index slipped further
in October, but the employment index improved slightly on its September estimate.
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
03:Q3
04:Q1
03:Q4
04:Q3
04:Q2
05:Q1
04:Q4
05:Q3
05:Q2
06:Q1
05:Q4
06:Q3
06:Q2
Oct-06
Source: Institute for Supply Management.
During the third quarter, core consumer prices accelerated for the second consecutive
quarter while total prices eased. Producer prices, both core and overall, slowed after
holding steady in the second quarter.
Consumer Price Index
Percent Change, Year-Over-Year
Percent Change, Year-Over-Year
5.0
5.0
4.0
Consumer Price Index
Consumer Price Index,
excluding food and energy
4.0
3.0
3.0
2.0
2.0
1.0
1.0
0.0
0.0
03:Q3
04:Q1
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Producer Price Index
Percent Change, Year-Over-Year
Percent Change, Year-Over-Year
8.0
6.0
8.0
Producer Price Index
Producer Price Index,
excluding food and energy
6.0
4.0
4.0
2.0
2.0
0.0
0.0
-2.0
-2.0
03:Q3
04:Q1
Source: Bureau of Labor Statistics.
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Productivity was unchanged in the third quarter, and compensation per hour slowed.
Unit labor costs also slowed on a quarterly basis, but their year-over-year growth was
the fastest since 1982.
Productivity and Costs
Percent Change, Previous Quarter
Percent Change, Previous Quarter
15.0
15.0
Unit Labor Costs
Percent change, year-over-year
12.0
9.0
Compensation
Per Hour
2005:Q4
2006:Q1
2006:Q2
2006:Q3
1.55
3.60
5.13
5.26
12.0
9.0
6.0
6.0
3.0
3.0
0.0
0.0
Output Per Hour
-3.0
-3.0
Unit Labor Costs
-6.0
03:Q3
04:Q1
04:Q3
05:Q1
05:Q3
06:Q1
-6.0
06:Q3
Source: Bureau of Labor Statistics.
In the third quarter, employment costs accelerated as an increase in wages and
salaries more than offset a minor slowdown in benefit costs.
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
03:Q3
04:Q1
Source: Bureau of Labor Statistics.
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
Oil prices decreased late in the third quarter, and continued to fall in October.
Past Five Months
Domestic Spot Oil Price
Dollars per Barrel
Dollars per Barrel
80.0
80.0
70.0
75.0
60.0
70.0
50.0
65.0
40.0
60.0
30.0
55.0
20.0
03:Q3
04:Q2
05:Q1
05:Q4
06:Q3
Jun-06
Aug-06
Oct-06
Source: Wall Street Journal (oil prices).
Overall, the economy grew in the third quarter, but at its slowest pace since the first
quarter of 2003. Consumption is strong and incomes are rising, but the cooling
housing market and inflation concerns will play large rolls in how the economy
performs throughout the rest of the year.
Percent
Short-Term Interest Rates
6.0
Discount Window
Primary Credit
5.0
4.0
3.0
2.0
7.00
6.50
6.00
5.50
5.00
4.50
4.00
5.90
6.25
6.25
5.43
Federal Funds Rate
(effective rate)
4.97
4.43
05:Q3
05:Q4
06:Q1
06:Q2
06:Q3 Oct-06
1.0
0.0
03:Q3 03:Q4
04:Q1 04:Q2
04:Q3 04:Q4
05:Q1 05:Q2
05:Q3 05:Q4
06:Q1 06:Q2
Source: Federal Reserve Board of Governors.
06:Q3 Oct-06
PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS,
FEDERAL RESERVE BANK OF BOSTON
November 9, 2006
Current Economic Developments - Addendum: Data released in the past week
In October, nonfarm payrolls added 92,000 jobs and the unemployment rate fell
two-tenths of a percentage point to 4.4%, its lowest level since May 2001.
September payrolls, originally estimated as adding 51,000 jobs, were revised to
show an increase of 148,000 jobs, and August payrolls were revised from a
previously estimated gain of 188,000 jobs to a gain of 230,000.
Redbook sales increased 0.3% in the first week of November, compared to October.
Sales were 3.4% higher than during the same period last year.
Oil prices decreased a bit over the past week, averaging 58.9 dollars per barrel
compared to last week's average of 59.7.
In October, payroll employment posted its smallest monthly gain in a year, but job
increases in the previous two months were revised sharply upward. Despite the
smaller gain in October, the unemployment rate fell to a five-and-a-half year low.
Nonfarm Payroll Employment
Change from Previous Quarter, Monthly Average
Unemployment Rate
Rate
5.6
350
Change from Previous Month
5.4
300
250
Aug-06
Sep-06
Oct-06
230,00
0
148,00
0
92,000
5.2
200
5
150
4.8
100
4.6
50
4.4
4.2
0
04:Q3
05:Q1
05:Q3
06:Q1
06:Q3
04:Q4
05:Q2
05:Q4
06:Q2 Oct-06
Source: Bureau of Labor Statistics.
04:Q3
05:Q1 05:Q3
06:Q1 06:Q3
04:Q4 05:Q2 05:Q4 06:Q2 Oct-06