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Twelfth Federal Reserve District
FedViews
May 13, 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
John C. Williams, executive vice president and director of research at the Federal Reserve Bank of San Francisco, states
his views on the current economy and the outlook:
•
As the Greek debt crisis intensified and panic began spreading to other parts of the European
periphery, the European Union (EU), the International Monetary Fund (IMF), and the European
Central Bank (ECB) took aggressive steps to provide support for Greece and to protect against
contagion to other countries. These actions included $140 billion of loans to Greece and the
establishment of a nearly $1 trillion fund to support Greece and other EU countries as necessary.
Moreover, the ECB has started to purchase private and public debt in dysfunctional markets. As a
result of these bold actions, interest rates on government debt of the affected countries fell
dramatically.
•
The crisis in Europe spilled over to stock markets across the globe. Stock prices tumbled on May 6
and 7, but recovered somewhat after the policy announcements on the following weekend. Over the
past month, broad measures of U.S. stock prices have declined by about 2 percent, while measures of
European stock prices fell by about 7 percent. Over the same period, the value of the euro fell by 7
percent against the dollar.
•
The European debt crisis also led to the emergence of stress in dollar-denominated term funding
markets in Europe. The spread between the three-month Libor rate and overnight rates rose to about
20 basis points. Note that stress in this market pales in comparison to the financial crisis of 2007 and
2008. In response to signs of strain in short-term funding markets in Europe, the Federal Open
Market Committee (FOMC) announced on May 9 that it had authorized reestablishing temporary
U.S. dollar swap arrangements with the Bank of Canada, the Bank of England, the European Central
Bank, and the Swiss National Bank. On the next day, reestablishment of temporary swap lines with
the Bank of Japan was also announced. These swap lines, which take the same form as those that
expired in February, are authorized through January 2011.
•
Despite the turmoil afflicting Europe, interest rates in the United States remain very low. Indeed,
concerns about fiscal imbalances in some European countries led to a flight to safety into U.S.
Treasuries and other high-quality dollar-denominated securities. Longer-term Treasury yields have
declined by about 30 basis points over the past month, and rates on higher-quality corporate bonds
and mortgages have also moved down, but by lesser amounts.
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 June 14, 2010.
•
The Federal Reserve’s Senior Loan Officer Opinion Survey showed that U.S. banks eased standards a
bit in April following severe tightening of standards in 2008 and 2009. These improved credit
conditions should help support consumer and business spending during the recovery.
•
Our forecast for economic growth hasn’t changed much in the past month. Real GDP increased at a
3.2 percent annual rate in the first quarter of this year, generally in line with our expectations.
Consumer spending and business purchases of equipment and software were big contributors to firstquarter growth, while the construction sector was a drag on growth. Looking ahead, we expect real
GDP growth of about 3¾ percent this year for 2010 as a whole and about 4¼ percent next year.
Improvements in financial conditions, increased consumer and business confidence levels, and solid
growth in the global economy, especially in Asia, should foster moderate growth this year and next.
•
The labor market is turning around. Nonfarm payrolls have increased by over 570,000 jobs over the
first four months of this year, with broad-based job gains in April. Nonetheless, the labor market still
has a long way to go to get back to full strength. About 8.4 million jobs were lost over 2007–2009.
The unemployment rate stood at 9.9 percent in April. Given our forecast for economic growth, we
expect the unemployment rate to end the year at around 9¼ percent and to end next year at about 8¼
percent, well above most estimates of “full employment.”
•
The weak labor market has restrained growth in labor compensation, which has helped reduce
inflation pressures. Broad measures of labor compensation rose by between 1¾ and 2¼ percent over
the past year, but remained well below levels seen just prior to the recession. Core measures of price
inflation have been subdued as well, with the price index for personal consumption expenditures
(PCE) excluding food and energy rising 1.3 percent in the past year.
•
Our forecast is for core and total measures of PCE price inflation to dip to about 1 percent this year
and remain at about that level for the next two years owing to continued slack in labor markets.
However, this inflation forecast is fraught with uncertainty. The chart shows forecast confidence
regions corresponding to 1 and 2 standard deviation forecast errors based on the historical accuracy
of forecasts. The dashed lines illustrate two possible paths for core inflation based on alternative
assumptions about the behavior of inflation expectations. In the case of “well-anchored
expectations,” the core inflation rate would rise to its average level of about 2 percent over recent
history by the end of next year. In the case of “unanchored expectations,” the very low inflation rate
of the past year would cause inflation expectations to drop lower. The combination of high
unemployment and lower inflation expectations would result in deflation by 2012.
European Sovereign Debt Crisis
Ten-Year Government Bond Yields
Stock Market Recovery Stalls
Percent
13
5/12
12
Stock Market Indices
January 2, 2008 = 100
110
11
Greece
100
10
U.S. S&P 500
90
5/12
9
80
8
Spain
70
7
Portugal
6
Ireland
Italy
Europe DJ STOXX
Broad Price Index
4
US
11/09
60
5
12/09
1/10
2/10
3/10
4/10
3
5/10
Interbank Lending Stress
50
40
Jan Apr
2008
Jul
Oct
Jan Apr
2009
Jul
Oct
Jan Apr
2010
But, U.S. Interest Rates Remain Low
Three-Month Money Market Interest Rate Spread
Interest Rates
LIBOR over three-month overnight index swap rate
Weekly average
Basis Points
400
Percent
10
BAA Corporate Bond
350
9
8
300
30-yr Mortgage Rate
5/6
250
6
200
5
10-yr Treasury
4
150
3
100
5/12
2007
2008
2009
Federal Funds Rate
2
50
0
2010
1
0
2004
Credit Supply Tight, but Improving
2005
2006
2007
2008
2009
2010
Recovery on Solid Footing
FRB Senior Loan Officer Opinion Survey
Real GDP
Net Percent of Banks Tightening Standards for C&I Loans
Percent
100
Percent change at seasonally adjusted annual rate
Percent
10
FRBSF
Forecast
80
4
40
Q2
01
02
03
04
05
06
07
08
09
Note: Average of net percent of banks tightening standards for
large/middle-market and small firms
8
6
Q2
60
00
7
2
20
0
0
-2
-20
-4
-40
-6
10
-8
00
01
02
03
04
05
06
07
08
09
10
11
Manufacturing Sector Soars
Other Sectors Right Behind
Manufacturing Sector
Non-Manufacturing Sector
Percent
30
Index
80
Apr.
Mar.
ISM New
Orders Index*
(right axis)
20
Apr.
0
50
Manufacturing
Production**
(left axis)
-30
20
03
04
05
06
07
50
New orders*
45
40
30
02
55
40
-20
01
65
60
60
00
Index
70
70
10
-10
Institute for Supply Management Survey
08
09
10
35
30
00
*Index above 50 means new orders are increasing
**Annualized percent change from three months earlier
01
02
03
04
05
06
07
08
09
10
* Index above 50 means orders/prices are increasing
Labor Market Turning Around
But, Unemployment Stubbornly High
Unemployment Rate
Change in Nonfarm Payroll Employment
Monthly change in payrolls
Thousands
400
Seasonally adjusted
Percent
11
Apr.
Apr.
10
200
9
0
Change
January
+14K
February
+39K
March
+230K
April
+290K
Dec. 2007Dec. 2009
8
7
-200
6
-400
5
-8.4M
-600
First 4 months
of 2010
+0.6M
FRBSF
Forecast
4
3
-800
2006
2007
2008
2009
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
2010
Compensation Growth Muted
Inflation Subdued, but Highly Uncertain
Compensation Growth
Core PCE Price Inflation
Percent change from same period one-year earlier
Percent
9
Percent change from four quarters earlier
Well-anchored
expectations
8
7
Compensation
per hour
Percent
3
2.5
2
Q1
6
1.5
5
1
4
ECI Total
Compensation
Avg. Hourly
Earnings
Mar.
3
Q1
2
Q1
0.5
FRBSF
Forecast
0
-0.5
Unanchored
expectations
1
0
00
01
02
03
04
05
06
07
08
09
10
-1
00
01
02
03
04
05
06
07
08
09
10
11
12