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The President’s Report to the Board of Directors June 1, 2006 CURRENT ECONOMIC DEVEOPMENTS - June 1, 2006 Data released since your last Directors' meeting show the economy is growing at a moderate pace, despite deteriorating consumer attitudes and rising inflation concerns. Current data suggest a slowdown in second quarter growth, which was expected following the robust first quarter. In May, initial claims increased, due in part to a government strike in Puerto Rico. Consumer attitudes weakened, with sentiment, confidence, and expectations all falling. Real consumption expenditures increased for the sixth consecutive month in April, despite a slight decrease in real disposable income. The housing market showed mixed signs in April. Sales of new homes unexpectedly increased, but existing home sales, housing starts and building permits all decreased. In the manufacturing sector, the ISM index decreased a bit in May while industrial production posted a strong gain in April. But, new orders for both durable goods and for nondefense capital goods, excluding aircraft, slowed. Inflation picked up in April, as core consumer prices grew at their fastest pace in over a year. Total consumer and producer prices also accelerated. Oil prices rose in May, adding to the record high set in April. Productivity was revised up slightly in the first quarter, and unit labor costs were revised lower for each of the past two quarters. During the first quarter, real growth was stronger than originally thought. The upward revision primarily reflected upward revisions to private inventory investment and to exports that were partly offset by downward revisions to personal consumption expenditures and equipment and software. Initial claims for unemployment insurance rose for the third consecutive month in May. A government strike in Puerto Rico, however, was partly responsible for the increase. Initial Claims Thousands of Units at Annual Rates Thousands of Units at Annual Rates 450 450 400 400 350 350 300 300 250 250 May-03 Nov-03 May-04 Nov-04 May-05 Nov-05 May-06 Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Source: Department of Labor, Employment and Training Administration. Consumer attitudes deteriorated in May, as a drop in confidence offset the prior two month's gains and sentiment fell to its lowest point since October. Consumers' impressions of current conditions and their future expectations also worsened. Consumer Sentiment Consumer Confidence Index, 1966:Q1 = 100 Index, 1985 = 100 120 150 140 Consumer Expectations Present Situation Consumer Confidence Current Conditions Future Expectations 110 130 Consumer Sentiment 120 100 110 90 100 80 90 80 70 70 60 May-04 Nov-04 May-05 Nov-05 May-06 May-04 Nov-04 May-05 Nov-05 60 May-06 Source: The University of Michigan. Source: The Conference Board. Real consumption increased slightly in April, despite a small reduction in real disposable income. Real Consumption and Real DPI Percent Change, Previous Month Percent Change, Previous Month 5.0 2.0 4.0 Real Consumption 3.0 1.0 2.0 1.0 0.0 0.0 -1.0 -2.0 -1.0 -3.0 Real Disposable Income -4.0 -2.0 Apr-03 Oct-03 Jul-03 Apr-04 Jan-04 Source: Bureau of Economic Analysis. Oct-04 Jul-04 Apr-05 Jan-05 -5.0 Apr-06 Oct-05 Jul-05 Jan-06 New home sales unexpectedly rose for a second straight month in April, enhancing the rebound from the slower sales seen at the beginning of the year. Sales of existing homes eased a bit in April. New and Existing Home Sales Thousands of Units, Annualized Thousands of Units, Annualized 7400 1400 Existing Home Sales 7200 1300 7000 New Home Sales 6800 1200 6600 6400 1100 6200 6000 1000 5800 900 5600 Apr-03 Oct-03 Jul-03 Apr-04 Jan-04 Oct-04 Jul-04 Apr-05 Jan-05 Oct-05 Jul-05 Apr-06 Jan-06 Source: U.S. Census Bureau (new homes sales) and National Association of Realtors (existing home sales). In April, both housing starts and building permits continued to fall, reaching their lowest levels since November of 2004 and February of 2004, respectively. Housing Starts and Building Permits Thousands of Units, Annualized Thousands of Units, Annualized 2300 2300 Building Permits 2200 2200 2100 2100 2000 2000 1900 1900 1800 1800 Housing Starts 1700 1700 1600 1600 Apr-03 Oct-03 Jul-03 Source: U.S. Census Bureau. Apr-04 Jan-04 Oct-04 Jul-04 Apr-05 Jan-05 Oct-05 Jul-05 Apr-06 Jan-06 The ISM manufacturing and employment indices fell in May, offsetting the gains seen in April. The price index rose for the third straight month. ISM Index Index (50+ = Economic Expansion) Index (50+ = Economic Expansion) 90.0 90.0 Price Index 80.0 80.0 70.0 70.0 ISM Index 60.0 60.0 50.0 50.0 Employment Index 40.0 40.0 May-03 Nov-03 Aug-03 May-04 Feb-04 Nov-04 Aug-04 May-05 Feb-05 Nov-05 Aug-05 May-06 Feb-06 Source: Institute for Supply Management. Industrial production continued to increase in April, while capacity utilization reached its highest point in nearly six years. Industrial Production and Capacity Utilization Percent Change, Previous Month Percent of Capacity 82.0 1.5 Industrial Production 1.0 80.0 0.5 78.0 0.0 76.0 -0.5 74.0 -1.0 Capacity Utilization (manufacturing) -1.5 Apr-03 72.0 Oct-03 Jul-03 Apr-04 Jan-04 Source: Federal Reserve Board of Governors. Oct-04 Jul-04 Apr-05 Jan-05 Oct-05 Jul-05 Apr-06 Jan-06 Growth of new orders for durable goods slowed in April, following a strong March. Orders for nondefense capital goods, excluding aircraft, also slowed. New Orders Percent Change, Year-Over-Year Percent Change, Year-Over-Year 24.0 24.0 Capital Goods Nondefense, Excluding Aircraft 20.0 20.0 16.0 12.0 16.0 Durable Goods, New Orders 12.0 8.0 8.0 4.0 4.0 0.0 0.0 -4.0 Durable Goods, New Orders Percent change, month-over-month -8.0 -12.0 -16.0 Apr-03 Oct-03 Jul-03 Apr-04 Jan-04 Jan-06 Feb-06 Mar-06 Apr-06 -7.57 3.63 6.58 -4.76 Oct-04 Jul-04 Apr-05 Jan-05 -8.0 -12.0 -16.0 Apr-06 Oct-05 Jul-05 -4.0 Jan-06 Source: U.S. Census Bureau. Inflation picked up in April, as growth in both overall and core consumer prices accelerated. However, at the wholesale level, total prices increased, while core prices eased slightly. Consumer Price Index Percent Change, Year-Over-Year Percent Change, Year-Over-Year 5.0 5.0 4.0 4.0 Consumer Price Index 3.0 3.0 2.0 2.0 Consumer Price Index, excluding food and energy 1.0 0.0 Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Dec-04 Apr-05 Producer Price Index Percent Change, Year-Over-Year 1.0 Aug-05 Dec-05 0.0 Apr-06 Percent Change, Year-Over-Year 8.0 8.0 Producer Price Index 6.0 6.0 4.0 4.0 2.0 2.0 Producer Price Index, excluding food and energy 0.0 -2.0 Apr-03 Aug-03 Dec-03 Source: Bureau of Labor Statistics. Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 0.0 Dec-05 -2.0 Apr-06 Oil prices continued to rise in May, averaging greater than $70 per barrel for the first time. Domestic Spot Oil Price Dollars per Barrel Dollasr per Barrel 80.0 80.0 70.0 70.0 60.0 60.0 50.0 50.0 40.0 40.0 30.0 30.0 20.0 20.0 May-03 Nov-03 Aug-03 May-04 Feb-04 Nov-04 Aug-04 May-05 Feb-05 Nov-05 Aug-05 May-06 Feb-06 Source: Wall Street Journal. Productivity increased in the first quarter, helping to offset a strong quarterly gain in hourly compensation. Unit labor costs, however, were revised downward for both the first quarter of 2006 and the fourth quarter of 2005. Productivity and Costs Percent Change, Previous Quarter Percent Change, Previous Quarter 12.0 12.0 Output Per Hour Compensation 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 -6.0 03:Q1 03:Q3 03:Q2 04:Q1 03:Q4 Source: Bureau of Labor Statistics. 04:Q3 04:Q2 05:Q1 04:Q4 05:Q3 05:Q2 06:Q1 05:Q4 Real GDP in the first quarter was stronger than originally thought. The upward revision primarily reflected upward revisions to private inventory investment and to exports that were partly offset by downward revisions to personal consumption expenditures and equipment and software. Revisions to First Quarter Real GDP Description Advanced Preliminary 4.8 5.3 Real GDP Personal Consumption 5.5 5.2 Business Investment 14.3 13.1 16.4 13.8 Residential Investment Equipment and Software 2.6 3.1 Government 3.9 4.3 Exports 12.1 14.7 Imports 13.0 12.8 Final Sales 5.4 5.5 Real GDP 8.0 6.0 4.0 2.0 0.0 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 Source: Bureau of Economic Analysis. Overall, data released since your last Directors' meeting show the economy is growing at a moderate pace, despite deteriorating consumer attitudes and rising inflation concerns. Current data suggest a slowdown in second quarter growth, which was expected following the robust first quarter. Percent Short-Term Interest Rates 6.0 Discount Window Primary Credit 5.0 6.20 5.92 5.75 5.80 5.50 5.40 4.0 5.53 Federal Funds Rate (effective rate) 5.26 5.00 Jan-06 Feb-06 Mar-06 Apr-06 May-06 3.0 2.0 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Source: Federal Reserve Board of Governors. Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS, FEDERAL RESERVE BANK OF BOSTON June 8, 2006 Current Economic Developments - Addendum: Data released in the past week In May, nonfarm payrolls added 75,000 jobs and the unemployment rate decreased to 4.6%. April payrolls were revised to show an increase of 126,000 jobs, 12,000 fewer than the original estimate of a 138,000 job increase, and March payrolls were revised to show an increase of 175,000 jobs, 25,000 less than the previously reported increase of 200,000. Domestic auto and light truck sales decreased in May, to an annualized rate of 12.3 million units. May's sales were the lowest since October's rate of 11.4 million. Total vehicle sales for May were 16.0 million, down from April's estimate of 16.7 million. Manufacturers' orders fell 1.8% in April, after rising 4.0% in March. Total shipments were unchanged in April, while shipments of nondefense capital goods, excluding aircraft, rose 1.0%. Redbook sales increased 1.9% in the first week of June, compared to May. Sales were 3.3% higher than during the same period last year. Oil prices increased slightly during the past week, averaging 71.8 dollars per barrel compared to last week's average of 71.1. Payroll employment posted a modest gain in May, and revisions to the prior two months' estimates resulted in a net reduction of 37,000 jobs. Still, the unemployment rate fell one-tenth of a percentage point in May to 4.6%. Unemployment Rate Nonfarm Payroll Employment Change from Previous Month Rate 400 5.8 350 5.6 300 5.4 250 5.2 200 5 150 4.8 100 4.6 50 0 May-04 Jan-05 Sep-04 Sep-05 May-05 Source: Bureau of Labor Statistics. May-06 Jan-06 May-04 Jan-05 Sep-04 4.4 May-06 Sep-05 May-05 Jan-06 In May, domestic auto and light truck sales fell to their lowest level since October. Domestic Auto and Light Truck Sales Millions of Units, Annualized 18.0 16.0 14.0 12.0 10.0 8.0 May-0 May-04 Aug-04 Aug-04 Nov-04 Nov-04 Source: Bureau of Economic Analysis. Feb-05 Feb-05 May-05 May-05 Aug-05 Aug-05 Nov-05 Nov-05 Feb-06 Feb-06 May-06 May-06