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Twelfth Federal Reserve District
FedViews
April 14, 2016
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
http://www.frbsf.org/economic-research/publications/fedviews/
Glenn Rudebusch, executive vice president and director of research at the Federal Reserve Bank of San
Francisco, stated his views on the current economy and the outlook as of April 14, 2016.

Given the substantial progress made toward its employment and inflation goals, the Federal Reserve
raised the federal funds rate target last December from the near-zero levels of the prior seven years.
FOMC projections suggest the possibility of further gradual increases in the funds rate. However,
this future path is not a preset course, as policymakers continue to emphasize a data-dependent
approach to setting monetary policy.

Since the policy rate liftoff, longer-term U.S. Treasury yields have fallen largely in response to
developments abroad. Concerns about the prospects for global economic growth have caused
investors to lower their expectations of the future path of the Fed policy rate. In addition, worries
about foreign growth have prompted a shift towards safe U.S. assets, pushing down the risk
premium embedded in Treasury yields.

The price of crude oil has dropped over 60% over the past two years in response to abundant supply
and lower energy demand as growth abroad has slowed.

Global risks have weighed heavily on equity markets. While lower oil prices generally should be a
positive force for the U.S. economy, the Standard & Poor’s (S&P) 500 is in large part a global
index with roughly half of the associated corporate earnings coming from abroad.

The U.S. dollar has appreciated almost 15% over the past two years reflecting in part differences in
the relative performance of U.S. and foreign economies and an accompanying divergence in
monetary policy actions.

Employment growth in the service-providing sector (retail, professional, government, hospitality,
food, travel, etc.) has shown no signs of slowing. In contrast, jobs in the goods-producing sector
(manufacturing, mining, and construction) have flattened out. The stronger dollar makes U.S.
exports more expensive, and lower oil prices have greatly reduced drilling activity and curtailed
upstream oil sector supply manufacturing as well. However, manufacturing and other exportsensitive sectors are a relatively small share of the economy, so overall employment growth has
continued at a robust pace.

A broad range of labor market indicators are consistent with the economy operating at full
employment. Going forward, we anticipate that the unemployment rate will fall a bit below its
current level of 5%, which is our current estimate of the natural or normal rate of unemployment.
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 May 16, 2016.

Real GDP grew a respectable 2% over the four quarters of 2015. We expect continued moderate
growth as consumer spending is supported by a strong labor market, improving personal income,
low gas prices, and elevated household net worth. Quarterly readings on GDP can be quite volatile.
We expect first-quarter real GDP to show little if any increase. However, if history is any guide,
inadequate seasonal adjustment could hold down that first-quarter estimate by as much as 1¾%.
(See FRBSF Economic Letter 2015-16, “The Puzzle of Weak First-Quarter GDP Growth,” and
FRBSF Economic Letter 2015-27, “Residual Seasonality and Monetary Policy.”)

Inflation was restrained in 2015 by the drop in crude oil prices and the rise in the dollar. With those
factors appearing to stabilize, inflation has made notable progress in moving up toward the Fed’s
2% inflation target recently. Excluding food and energy, personal consumption expenditures (PCE)
prices are 1.7 % higher than a year ago. We anticipate a gradual return of inflation toward the Fed’s
2% objective based on low wage inflation domestically and disinflationary influences from abroad.

A question often asked is: Will the current recovery die of old age? That is, like people, do
recoveries get progressively frailer over time and more likely to end? At 6½ years old, the current
recovery has already lasted longer than most other postwar recoveries. However, statistical analysis
indicates that—based only on age—a 90-month-old expansion is really no more likely to end than a
50-month-old expansion. By contrast, actuarial calculations show increasing mortality rates for
people after 65. (For a full analysis, see FRBSF Economic Letter 2016-03, “Will the Economic
Recovery Die of Old Age?”)

Of course, age is just one factor that could increase the likelihood of death or the demise of an
economic recovery. For people, someone with, say, high blood pressure faces higher probabilities
of death at any age than this actuarial baseline. Similarly, for the economy, we can calculate
recession probabilities that are based not just on age but take into account other factors as well, such
as forward-looking spending indicators (say, durable goods orders) or financial indicators (say,
equity price indexes). For example, the spread between short- and long-term interest rates has been
shown to be particularly useful for forecasting recessions. Based on this yield spread, the
probability of a recession this year has edged up a bit but remains quite low. (See Glenn D.
Rudebusch and John C. Williams (2009), “Forecasting Recessions: The Puzzle of the Enduring
Power of the Yield Curve,” Journal of Business and Economic Statistics 27.)
Fed expects gradual pace of tightening
Interest rates remain low
Federal funds rate
Red line is median FOMC projection for target rate; blue area is the range
%
Interest rates
5
Weekly average
%
8
12/15
7
4
6
FOMC
participants'
projections
3
5
30-year mortgage
4
2
3
2
1
2011
2012
2013
2014
2015
2016
2017
2018
Note: Spans all FOMC participants' projections. Source: SEP, 3/16/16
Federal
funds
rate
0
Longer
2019
run
WTI oil; monthly average
Two-year Treasury
1
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Note: Fed funds target set by FOMC or midpoint of target range. Source: FAME
Crude oil at fire sale prices
Price of crude oil
Ten-year Treasury
Equity markets have been volatile
$/Barrel
160
Stock market index
Index
S&P 500 weekly price
2500
04/08
140
2000
120
100
1500
80
1000
60
Mar.
40
500
20
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
0
Source: FAME
Note: Dashed line based on futures prices. Source: Bloomberg
Limited job losses due to oil and dollar
Dollar remains strong
Employment in service-providing and goods-producing industries
Index Millions
Monthly; seasonally adjusted; nonfarm
Millions
Dollar foreign exchange rate
Monthly; March 1973=100
110
105
128
124
100
120
Mar.
27
124.1
25
Employment in
service-providing industries
(left-hand scale)
23
95
Mar.
116
90
21
112
85
80
75
Employment in
goods-producing industries
(right-hand scale)
19.7
108
104
19
17
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Note: Broad trade-weighted dollar exchange rate, inflation adjusted. Source: FAME
Note: Goods-producing: manufacturing, mining, and construction. Source: BLS
We expect a tighter labor market
Continued moderate economic growth
Unemployment rate
Seasonally adjusted
%
Real GDP
11
Percent change from 4 quarters earlier
%
4
FRBSF
forecast
10
2
9
Q4
1
8
0
7
April 2015
FRBSF
forecast
Current
data
-1
6
-2
5
Current
FRBSF
forecast
-3
4
-4
3
-5
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Source: Bureau of Labor Statistics and FRBSF staff
Source: Bureau of Economic Analysis and FRBSF staff
We expect a gradual return to 2%
Inflation was held down by oil and dollar
Personal consumption expenditures (PCE) price inflation
%
Percent change from 12 months earlier
5
Core PCE price inflation
%
Percent change from four quarters earlier
3
4
Overall PCE
price inflation
3
Trimmed mean PCE
price inflation
Feb.
Core PCE
price inflation
3
Current
data
April 2015
FRBSF
forecast
2.5
2
2
Current
FRBSF
forecast
1
1.5
1
0
0.5
-1
-2
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Source: Bureau of Economic Analysis and FRBSF staff
Source: Bureau of Economic Analysis and FRB Dallas
Probability of recession appears low
Will the current recovery die of old age?
Probability of death and probability of recession
%
Probability of event within next year or month
Probability of a person
dying within next year
(based only on age in years)
Probability of a recession based on yield spread
Probability of a recession two quarters ahead
50
80
40
60
30
40
Probability of a recovery
ending within next month
(based only on age in months)
%
100
20
20
10
0
0
10
20
30
40
50
60
70
80
90 100
Age in years for people or months for recoveries
Source: Social Security Administration, NBER, and author's calculations
110
0
120
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Author's calculations based on Rudebusch and Williams, JBES, 2009.