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PRESIDENT'S REPORT TO THE BOARD OF DIRECTORS, FEDERAL RESERVE BANK OF BOSTON Current Economic Developments - May 12, 2004 Data since your last Directors' meeting show the economy expanded in the first quarter of 2004. During the first quarter, real GDP posted a gain led by growth in consumption, equipment and software, government spending, exports, and inventory investment. Imports, which are subtracted from GDP, also increased. Non-farm payroll employment increased significantly in April, and the unemployment rate fell one-tenth of a percentage point. Initial claims remained at their three-year low of 350 throughout the month of April. Consumer attitudes saw little change as personal income and consumption increased, but auto sales fell in April. Housing starts declined in the first quarter, while building permits changed only slightly from the fourth quarter. Despite the continuous rise in energy prices, inflation risks remain minimal as core consumer and producer prices showed little change in the first quarter. The ECI saw its biggest increase in a year due to rising pension benefit costs. In the business sector, durable goods and leading indicators continued to increase, and the ISM index has remained above 50 for the last twelve months. However, the U.S. deficit in international trade reached a record level in the first quarter as the average oil price hit its highest peak in over 20 years. Real GDP rose in the first quarter, led by consumer and government spending, business investment, exports, and inventory investment. Real Gross Domestic Product Annualized Percent Change 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 01:Q1 01:Q2 01:Q3 01:Q4 Source: Bureau of Economic Analysis. 02:Q1 02:Q2 02:Q3 02:Q4 03:Q1 03:Q2 03:Q3 03:Q4 04:Q1 Real consumption and real disposable income increased in the first quarter as consumers continued to spend. Personal Income Real Consumption Annualized Percent Change Annualized Percent Change 4.0 8.0 7.0 3.0 6.0 2.0 Personal Income 5.0 1.0 4.0 3.0 0.0 Real Disposable Income 2.0 -1.0 1.0 0.0 01:Q1 01:Q3 02:Q1 02:Q3 03:Q1 03:Q3 04:Q1 01:Q1 02:Q1 01:Q3 -2.0 04:Q1 03:Q1 02:Q3 03:Q3 Source: Bureau of Economic Analysis. Businesses continued to invest in equipment and software, although at a slower pace than the fourth quarter. Residential investment also slowed from its third and fourth quarter pace. Residential Investment Business Investment Annualized Percent Change Annualized Percent Change 25.0 20.0 Equipment and Software 20.0 10.0 15.0 10.0 0.0 Business Investment 5.0 -10.0 0.0 -5.0 -20.0 01:Q1 01:Q4 02:Q3 Source: Bureau of Economic Analysis. 03:Q2 04:Q1 01:Q1 01:Q4 02:Q3 03:Q2 04:Q1 Government spending increased in the first quarter, due in part to a 15.1% increase in national defense spending. Although slower than the fourth quarter, exports and imports rose in the first quarter. Exports and Imports Government Spending Annualized Percent Change Annualized Percent Change 30.0 8.0 Exports 6.0 20.0 4.0 Imports 10.0 2.0 0.0 0.0 Government spending and investment -2.0 -10.0 Contribution to Real GDP -4.0 -6.0 01:Q1 01:Q4 02:Q3 03:Q2 01:Q1 04:Q1 01:Q4 02:Q3 03:Q2 -20.0 04:Q1 Source: Bureau of Economic Analysis. In the labor market, nonfarm payroll employment increased sharply for the second consecutive month in April, and the unemployment rate dropped to 5.6%. Initial claims continued to hover around 350,000. Initial Claims Nonfarm Payroll Employment Percent 6.0 Change from Previous Month Thousands of Units at Annual Rates 300 475 400 6.5 Unemployment Rate 500 200 450 Four-Week Moving Average Ending May 1st, 343,250 100 5.5 0 425 400 5.0 -100 375 -200 4.5 Payroll Employment 4.0 Apr-2001 350 -300 325 -400 Apr-2002 Apr-2003 Apr-2004 Nov-00 Jan-02 Mar-03 May-04 Source: Bureau of Labor Statistics (employment) and the Department of Labor, Employment and Training Administration (claims). Consumer attitudes were mixed in April as concerns about the health of the job market lingered. Consumer Confidence and Expectations Index, 1985 = 100 140 Confidence Expectations 120 100 80 60 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 40 Apr-04 Oct-03 Consumer Sentiment and Expectations Index, 1966:Q1=100 110 Sentiment 100 Expectations 90 80 70 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 Oct-03 60 Apr-04 Source: The Conference Board (confidence) and University of Michigan (sentiment). As consumer attitudes remained mixed, autos sales slowed somewhat in April compared to March. Total Auto and Light Truck Sales Millions of Units, Annualized 21.0 20.0 19.0 18.0 17.0 16.0 15.0 Apr- 1 Aug-01 Dec-01 Apr-02 Source: Federal Reserve, Board of Governors. Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Housing starts fell in the first quarter compared to the fourth, however March's 6.4% increase was its largest gain since May 2003. Building permits saw little change in the first quarter. Housing Starts and Building Permits Thousands of Units, Annualized 2100 Housing Starts 2000 1900 Building Permits 1800 1700 1600 1500 01:Q1 01:Q3 02:Q1 02:Q3 03:Q1 03:Q3 04:Q1 Source: U.S. Census Bureau. At a quarterly frequency, consumer prices saw little change, although the core index increased sharply in March, its largest gain since November 2001. Producer prices fell in the first quarter. Consumer Price Index Percent Change, Year-Over-Year Consumer Price Index, excluding food and energy Consumer Price Index 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 01:Q1 01:Q2 01:Q3 01:Q4 02:Q1 02:Q2 02:Q3 02:Q4 03:Q1 03:Q2 03:Q3 03:Q4 04:Q1 Producer Price Index Percent Change, Year-Over-Year 6.0 Producer Price Index Producer Price Index, excluding food and energy 4.0 2.0 0.0 -2.0 -4.0 01:Q1 01:Q2 01:Q3 01:Q4 02:Q1 02:Q2 02:Q3 02:Q4 03:Q1 03:Q2 03:Q3 03:Q4 04:Q1 Source: Bureau of Labor Statistics. The employment cost index increased 1.1%, the largest gain in a year. The increase was led by a 2.4% rise in contributions to defined benefit plans, its largest increase in 22 years. Employment Cost Index Percent Change, Previous Quarter 2.5 Benefit Costs 2.0 1.5 Total Compensation 1.0 0.5 Wages and Salaries 01:Q1 01:Q2 01:Q3 01:Q4 02:Q1 02:Q2 02:Q3 02:Q4 03:Q1 03:Q2 03:Q3 03:Q4 0.0 04:Q1 Source: Bureau of Labor Statistics. Productivity accelerated in the first quarter, and labor costs continued to fall on a yearly basis. Productivity and Costs Percent Change, Previous Quarter 15.0 Output Per Hour 10.0 Compensation Per Hour 5.0 0.0 -5.0 Unit Labor Costs 01:Q1 01:Q2 01:Q3 01:Q4 Source: Bureau of Labor Statistics. 02:Q1 02:Q2 02:Q3 02:Q4 03:Q1 03:Q2 03:Q3 03:Q4 -10.0 04:Q1 In April, the ISM index remained above 50 and has been for the last twelve months. Both the ISM and employment indices rose to their highest levels in over 15 years. ISM Index Index (50+ = Economic Expansion) 70.0 65.0 ISM Index 60.0 55.0 50.0 45.0 40.0 Employment Index Apr-87 Feb-90 Sep-88 Dec-92 Jul-91 Oct-95 May-94 35.0 Aug-98 Mar-97 30.0 Apr-04 Jun-01 Jan-00 Nov-02 Source: National Association of Purchasing Management. Orders for durable goods remained strong in the first quarter. Orders for these goods have increased three of the last four months. Durable Goods Orders Percent Change, Previous Quarter 6.0 Durable Goods, New Orders 4.0 2.0 0.0 Capital Goods Nondefense, Excluding Aircraft -2.0 -4.0 -6.0 -8.0 01:Q1 01:Q3 Source: U.S. Census Bureau. 02:Q1 02:Q3 03:Q1 03:Q3 -10.0 04:Q1 The index of leading indicators rose in the first quarter, but at a slower pace than the fourth. Index of Leading and Coincident Indicators Percent Change, Previous Quarter 2.0 1.5 Leading Indicators 1.0 0.5 0.0 Coincident Indicators -0.5 01:Q1 01:Q3 02:Q1 02:Q3 03:Q1 03:Q3 04:Q1 Source: The Conference Board. In the first quarter, the trade deficit reached a record level as the average oil price hit its highest level in over 20 years. The trade deficit may cause downward revisions to the first quarter GDP estimate. Trade Balance Domestic Spot Oil Price Dollars/Barrel Quartly Average, Billions of Dollars -28.0 42.0 40.0 -30.0 Week ending May 11th, 39.6 -32.0 38.0 36.0 -34.0 34.0 32.0 -36.0 30.0 -38.0 28.0 -40.0 26.0 24.0 -42.0 22.0 -44.0 01:Q1 01:Q4 02:Q3 Source: Bureau of Economic Analysis. 03:Q2 -46.0 04:Q1 20.0 18.0 Apr-01 Jan-02 Oct-02 Source: West Texas Intermediate Jul-03 Apr-04 Overall, the economy continues to expand. While the business sector gains strength, the labor market and consumer attitudes need to show sustained improvement for extended growth. Percent Short-Term Interest Rates 7.0 6.0 Federal Funds Rate (effective rate) 5.0 Discount Window Primary Credit 4.0 2.20 3.0 2.00 1.80 2.0 03:Q2 1.0 03:Q3 03:Q4 04:Q1 Apr-04 pr -0 4 A 04 :Q 1 03 :Q 4 3 03 :Q 2 4 02 :Q 03 :Q 1 3 03 :Q Source: Federal Reserve Board of Governors. 02 :Q 02 :Q 2 02 :Q 1 3 01 :Q 4 01 :Q 01 :Q 2 01 :Q 1 0.0