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Twelfth Federal Reserve District
FedViews
February 11, 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/
Kevin J. Lansing, research advisor at the Federal Reserve Bank of San Francisco, stated his views on the current
economy and the outlook as of February 11, 2016.

Real GDP growth slowed in the fourth quarter of 2015 to less than 1% at an annual rate. Declines in
business investment, inventories, and net exports were offset by solid increases in personal
consumption expenditures and residential investment. For 2015 as a whole, real GDP growth was
1.8%, slightly below the average annual growth rate of 2.1% observed since the Great Recession
ended.

We expect real GDP growth to pick up in 2016 and then ease to trend by the end of 2017. Downside
risks to the U.S. growth outlook include possible spillovers from economic slowdowns in foreign
markets and a continued strengthening of the U.S. dollar which would pose a headwind for net
exports.

Payroll employment increased by 151,000 jobs in January, signaling continued improvements in the
labor market. The six-month moving average remains above 200,000 new jobs per month. The
unemployment rate dipped to 4.9% in January, which is slightly below the level that we judge to be
the natural rate of unemployment.

Inflation as measured by the four-quarter change in the personal consumption expenditures (PCE)
price index has remained below the Federal Open Market Committee’s (FOMC) 2% target since
mid-2012. Absent further declines in energy prices or a further strengthening of the U.S. dollar, we
would expect PCE inflation to rise gradually towards 2% as economic slack continues to dissipate.

Treasury yields have declined recently reflecting a “flight-to-safety” in response to investor concerns
about economic slowdowns in foreign economies and the prospect that such events could have
negative spillovers for U.S. growth. Since May 2015, the yield spread between Baa-rated corporate
bonds and 10-year Treasury bonds has widened by nearly 100 basis points, indicating that corporate
bondholders are demanding more compensation for exposure to credit risk.

Recent declines in the Standard & Poor’s (S&P) 500 have caused the index to dip below levels that
prevailed one year ago. Over the same time frame, oil prices have dropped precipitously to levels last
observed in 2002. Historically, U.S. recessions have often been associated with oil price spikes, but
not sharp declines. The recent contemporaneous drop in stock prices suggests that equity market
investors are interpreting lower oil prices as a signal of slowing global growth—a development that
would have negative consequences for future corporate profits.
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 March 18, 2016.

The Federal Reserve Board’s index of industrial production has recorded three consecutive monthly
declines, mainly reflecting production slowdowns in the energy sector. Still, the December 2015
reading is only about 1% below the prior peak recorded in September 2015.

The Chicago Fed National Activity Index (CFNAI) has proved useful as an early indicator of
recessions. It is distilled from 85 monthly series drawn from four broad data categories: consumption
and housing; employment, unemployment, and hours worked; sales, orders, and inventories; and
production and income. The index is constructed to have an average value of zero, with a positive
reading indicating growth above trend and a negative reading indicating growth below trend. The
three-month moving average CFNAI is currently at –0.24, well above the threshold of –0.7 that has
typically signaled the onset of a recession. But as a caveat, it should be noted that the index has often
dropped quickly in the months leading up to past downturns. For example, the index stood at –0.2 in
July 2007, only five months before the start of the Great Recession.

Few, if any, past recessions have been successfully predicted by professional forecasters. Forecasting
recessions is difficult because each one tends to differ in important ways from previous episodes.
Past recessions have been triggered by upward spiking oil prices, increases in policy interest rates
designed to bring down high inflation, and bursting asset price bubbles. None of these scenarios
would seem to fit the present circumstances.
Moderate growth likely to continue
Solid employment growth continues
Real GDP
%
Percent change from 4 quarters earlier
Nonfarm payroll employment
Thousands
Seasonally adjusted, monthly change
4
FRBSF
forecast
500
3
400
2
Q4
1
Monthly
change
6-month moving
average
300
0
-1
Jan
151,000
-2
200
100
-3
-4
-5
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2013
2014
2015
0
2016
Source: Bureau of Labor Statistics
Source: Bureau of Economic Analysis and FRBSF staff
Inflation expected to increase gradually
Unemployment dips below natural rate
Unemployment rate and forecast
Sesaonally adjusted monthly observations, forecast is quarterly average
%
12
PCE price inflation
%
Percent change from 4 quarters earlier
5
4
10
Overall PCE
price inflation
3
8
FRBSF
forecast
Target
2
Q4
6
1
Jan
4.9
Core PCE
price inflation
4
0
FRBSF
forecasts
2
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
0
2008
2009
2010
2011
2012
2013
2014
2015
2016
-1
-2
2017
Source: Bureau of Economic Analysis and FRBSF staff
Source: Bureau of Labor Statistics and FRBSF staff
Credit spreads have widened
Equity and oil prices signal slowdown
Interest rates
%
Weekly average
10
S&P 500 and West Texas Intermediate (WTI) oil price
%
Percent change from one year earlier
150
9
8
100
7
Baa corporate bond yield
6
S&P 500
50
5
2/11
30-year mortgage
Two-year Treasury
2009
2010
Source: FAME, FRED
2011
0
Jan
3
2
Ten-year Treasury
2008
4
2012
2013
2014
2015
Federal 1
funds
rate
0
2016
-50
Oil (WTI)
1985
1990
1995
2000
2005
2010
2015
Source: Standard & Poor's, Energy Information Administration, Dow Jones & Co.
-100
Industrial production slipping
Recent data indicate below trend growth
Industrial production
Index
Seasonally adjusted index, 100 = 2012
120
Chicago Fed National Activity Index
Index
3-month moving average
2.0
110
1.0
Dec 100
0.0
Dec
90
1985
1990
1995
2000
Source: Federal Reserve Board of Governors
2005
2010
2015
-1.0
Recession threshold
−0.7
80
-2.0
70
-3.0
60
-4.0
50
1985
1990
1995
2000
Source: Federal Reserve Bank of Chicago
2005
2010
2015
-5.0