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Twelfth Federal Reserve District
FedViews
July 8, 2010
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
www.frbsf.org/publications/economics/fedviews/index.html
Mark Spiegel, vice president at the Federal Reserve Bank of San Francisco, states his views on the current economy and
the outlook:

Some recent data have been below expectations, but the overall economic picture remains one of
continued growth at a moderate pace. Some downside risks to the outlook are apparent, including
weakness in consumer confidence, the labor market, and the real estate sector, as well as the
economic situation in Europe.

Real GDP increased at an annual rate of 2.7% in the first quarter of 2010, well below the 5.6% rate
recorded in the fourth quarter of 2009. The reduced first-quarter figure primarily reflects a slowdown
in inventory investment. At the same time, exports decelerated, residential housing investment turned
down, and the robust rate of growth in business investment in equipment and software slowed.

The Institute for Supply Management (ISM) indexes for both manufacturing and services dropped in
June, but remained at levels indicative of expansion. The ISM index for manufacturing fell to 56.2
from 59.7 in May, while the ISM index for nonmanufacturing activity fell to 53.8 from 55.4.

We expect continued moderate real GDP growth of 3.5% in the second quarter, but then a slowdown
to 3.0% in the third quarter. The second-quarter bump is attributable to higher-than-expected state
and local spending on construction and business equipment. But weakness in the labor market
suggests a payback in the third quarter. Overall growth in 2010 is expected to average about 3.1%.
Growth is expected to pick up next year to about 3.8%.

Real personal consumption expenditures grew by 0.3% in May after being flat in April. However, a
notable decline in consumer confidence registered in a widely followed survey raised some concern.
The Conference Board Consumer Confidence Index released at the end of June dropped sharply to
52.9 from 62.7 in May. Still, the University of Michigan Consumer Sentiment Index released a week
earlier came in slightly above expectations, increasing to 76.0 from 73.6 the previous month. Vehicle
sales fell in June to an 11.1 million-per-year pace, down from an 11.6 million-unit pace in May.

Private nonfarm payroll employment in the United States increased by 83,000 in June, modestly
below market expectations. Overall employment levels actually declined by 125,000, but that figure
was primarily attributable to scheduled layoffs of 225,000 government census workers. The
unemployment rate dipped to 9.5%, reflecting the exit of 650,000 people from the labor force.

Home sales dropped sharply in May, suggesting that the first-time home buyer tax credit has assisted
sales even more than previously expected. The program’s discontinuation portends additional
housing sector weakness. Existing home sales fell by 2.2%, while sales of new homes plummeted
33% to a record low. New housing starts fell 10% in May relative to a month earlier.
The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco. They are not
intended to represent the views of others within the Bank or within the Federal Reserve System. FedViews generally appears around the middle
of the month. The next FedViews is scheduled to be released on or before September 13, 2010.

The trade deficit edged up in April to $40.3 billion. Both exports and imports declined. The deficit’s
rise was more than explained by an increase in the bilateral trade gap with China, which accounts for
close to half of the overall U.S. trade deficit. China recently said it was ending the peg of its currency,
the yuan, against the U.S. dollar, which was reinstated in August 2008 in response to the global
financial crisis. To date, however, the yuan’s appreciation has been only modest, about 0.8%.

Analysts generally do not expect the yuan to appreciate much more against the dollar for the
remainder of the year because the broad yuan, measured against a basket of currencies, has already
appreciated substantially due to the dollar’s appreciation relative to the euro. Since October 2009, the
broad yuan is up about 5% against the euro. The weight of the euro in the broad yuan is almost as
high as the weight of the dollar.

European nations have adopted ambitious schedules for deficit reduction. For example, Greece has
announced deficit reductions to levels compliant with the Maastricht Treaty limit of 3% of GDP by
2014. European leaders are facing resistance from both unions and the general public against the
adoption of austerity programs, but many measures have already gone forward. While fiscal
consolidation is desirable in the long term, in the short term it is likely to be a drag on demand for
U.S. exports.

Inflation levels are below those identified by Federal Open Market Committee members as consistent
with their desired longer-run price stability objectives. The headline personal consumption
expenditures (PCE) price index was unchanged in May, while the core PCE price index rose 0.2%.
The core PCE price index is up only 1.3% over the past 12 months. We expect core PCE prices to
increase at a 1.3% annualized rate in the current quarter and by 1.0% for the year as a whole.

Given these low inflation levels, combined with evidence of slack in the economy and the downside
risks discussed above, the June FOMC statement reiterated the conclusion that economic conditions
are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
Still expect continued moderate recovery
Slowdown in consumer spending growth
Real GDP
Real Personal Consumption Expenditures
Percent change at seasonally adjusted annual rate
Percent
8
Billions of 2005$
10000
Seasonally adjusted annual rate
FRBSF
Forecast
May
9500
4
9000
0
Q1
8500
8000
-4
7500
-8
00
01
02
03
04
05
06
07
08
09
10
11
7000
00
01
Employment recovering very slowly
02
03
04
05
06
07
08
09
10
Unemployment remains high
Nonfarm Payroll Employment
Unemployment Rate
Millions of employees; seasonally adjusted
Millions
140
Monthly Changes
Seasonally adjusted
Percent
11
Jun.
10
208 K
313 K
433 K
-125 K
138
From peak -7.5 M
134
7
132
6
130
5
Mar.
Apr.
May
Jun.
9
136
Jun.
8
4
128
00
01
02
03
04
05
06
07
08
09
3
10
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Trade deficit modestly larger
Housing downturn as subsidies expire
Single-Family Home Sales
Seasonally adjusted, Bil.$
Seaso nally ad justed an nual rate
Thousands
-20
Millions
6.5
1400
New homes
(left axis)
1200
Apr.
6.0
N
1000
-30
5.5
-40
5.0
-50
4.5
-60
May
800
Existing homes
(right axis)
600
400
200
4.0
00
01
02
03
04
05
06
07
08
09
10
-70
1/08
6/08
11/08
4/09
9/09
2/10
Thousands
U.S. Trade Balance
China off peg, but little movement so far
Broad yuan already up due to euro
USD/RMB
0.149
End Peg 7/5
8/7/08
0.147
Dollar-Yuan Rate
Begin Peg
8/7/08
Broad Yuan / Euro-Dollar Rate
Oct. 2009 = 100
Index
105
Nominal broad yuan index
100
0.145
0.143
95
0.141
90
USD/EUR exchange rate index
0.139
85
0.137
0.135
1/08
6/08
11/08
4/09
9/09
2/10
80
7/10
10/09 11/09 12/09
Planned Deficit Reductions, as of 2010 and 2013*
10
2013
4/10
5/10
Basis points
1200
7/6
Portugal
8.2
Italy
8
6.9
6.6
3/10
CDS Swap Rates
% of GDP
2010
2/10
Disparity in risk among EMU countries
Announced austerity measures ambitious
8.7
1/10
1000
Ireland
800
Spain
5.5
6
Greece
600
Germany
4
France
1.9
1.4
1.1
400
2
200
0.3
0.1
0
Greece
Portugal
Ireland
Spain
0
Italy
1/08
* Reductions relative to 2009. Final figure for Italy 2012 target.
US Inflation remains well-contained
Three Measures of Underlying Price Inflation
Percent
4
Percent change from twelve months earlier
Median PCE
Trimmed Mean PCE
3
May
2
Core PCE
Price Index
1
0
02
03
04
05
06
07
08
09
10
7/08
1/09
7/09
1/10
7/10