Monetary Policy Report

For use at 10:00 a.m., EDT June 21, 2016 M P r onetary olicy ePort June 21, 2016 Board of Governors of the Federal Reserve System L t etter of ransmittaL Board of Governors of the Federal Reserve System Washington, D.C., June 21, 2016 The President of the Senate The Speaker of the House of Representatives The Board of Governors is pleased to submit its Monetary Policy Report pursuant to section 2B of the Federal Reserve Act. Sincerely, Janet L. Yellen, Chair S L -r g m P S tatement on onger un oaLS and onetary oLicy trategy Adopted effective January 24, 2012; as amended effective January 26, 2016 The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society. Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee’s policy decisions reflect its longer-run goals, its medium- term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee’s goals. The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances. The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee’s policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants’ estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC’s Summary of Economic Projections. For example, in the most recent projections, the median of FOMC participants’ estimates of the longer-run normal rate of unemployment was 4.9 percent. In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee’s assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January. C ontents Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 Part 1: Recent Economic and Financial Developments . . . . . . . . . . . . . . . . . . . 3 Domestic Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Part 2: Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37 List of Boxes Have the Gains of the Economic Expansion Been Widely Shared? . . . . . . . . . . . . . . . . 6 Developments Related to Financial Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Note: Unless stated otherwise, the time series in the figures extend through, for daily data, June 16, 2016; for monthly data, May 2016; and, for quarterly data, 2016:Q1. In bar charts, except as noted, the change for a given period is measured to its final quarter from the final quarter of the preceding period. For figures 14, 32, and 35, note that the S&P/Case-Shiller Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by the Board. Copyright © 2016 S&P Dow Jones Indices LLC, a subsidiary of the McGraw Hill Financial Inc., and/or its affiliates. All rights reserved. Redistribution, reproduction and/or photocopying in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. 1 s ummary Labor market conditions clearly continued Although real gross domestic product is to strengthen during the early months of this reported to have increased at a sluggish rate year: Payrolls expanded at a solid pace of in the first quarter of 2016, the available data almost 200,000 per month in the first quarter, for the second quarter point to a noticeable and while the unemployment rate flattened step-up in the pace of growth. On average, out at close to 5 percent, the labor force consumer spending so far this year appears to participation rate moved up strongly. More be expanding at a moderate pace, supported recently, the signals regarding labor market by solid income gains and the ongoing effects improvement have become more mixed: of the increases in wealth and the declines in Payroll gains are reported to have slowed to oil prices of the past two years. The housing an average of 80,000 per month in April and market continues its gradual recovery, and May (or about 100,000 after adjustment for fiscal policy at all levels of government is now the effects of a strike). The unemployment modestly boosting economic activity after rate dropped in May to 4.7 percent, its lowest exerting a considerable drag in recent years. level since late 2007; however, the labor force One area of concern, however, is the softening participation rate fell back again and was in business fixed investment in recent quarters little changed from its year-ago level. All told, even beyond those sectors most directly the latest readings suggest that labor markets affected by the plunge in energy prices. In are tighter than they were at the end of last addition, the weakness of exports—following year but that the pace of improvement has the significant appreciation of the dollar over slowed. Whether those signs of slowing will the past two years and the subdued pace of be confirmed by subsequent data, and how foreign economic growth—continues to hold persistent any such slowing will be, remains to back overall output growth. be seen. On balance, household and business credit Consumer price inflation has continued to conditions in the United States have remained be held down by lower prices for energy and accommodative so far this year. Following imports, and the price index for personal a period of heightened global financial consumption expenditures (PCE) increased market volatility earlier this year in which only about 1 percent over the 12 months risk spreads for U.S. corporate bonds rose, ending in April. Changes in the PCE price financial conditions have eased somewhat in index excluding food and energy items, which recent months, and corporate bond yields have provide a better indication than the headline returned to historically low levels. Mortgage figure of where overall inflation will be in the rates once again have approached their all- future, also remained modest; this index, time lows, and mortgage credit appears which rose 1½ percent over the 12 months widely available to borrowers with solid credit ending in April, was partly restrained by profiles, though less so to would-be borrowers lower prices for non-oil imported goods. with imperfect credit histories. Student and However, both the headline and core auto loans are broadly available, including inflation measures have picked up somewhat to borrowers with nonprime credit scores, from a year earlier. Meanwhile, some survey- and the availability of credit card loans for based measures of longer-run inflation such borrowers appears to have expanded expectations have remained relatively stable, somewhat over the past several quarters. Broad while others have moved down; market-based measures of U.S. equity prices have increased measures of inflation compensation also are at slightly, on net, since the beginning of the low levels. year. Meanwhile, foreign financial markets 2 SUMMARy appear to have stabilized following the period improvement in the labor market had slowed, of volatility earlier this year, with foreign while growth in economic activity appeared to equity prices higher and risk spreads lower. have picked up. In addition, the Committee’s That said, the potential remains for spillovers policy stance so far this year reflected its to the U.S. economy from shocks to foreign expectation that inflation would remain low in economic activity and financial markets, the near term, in part due to earlier declines including possible reverberations from the in energy prices and in the prices of non- U.K. referendum this week on membership in energy imports. The Committee stated that its the European Union. accommodative stance of policy is intended to support further improvements in labor market Turning to the stability of the U.S. financial conditions and a return to 2 percent inflation. system, financial vulnerabilities have remained at a moderate level this year. Domestic The Committee continued to emphasize financial institutions and markets functioned that, in determining the timing and size of well during the period of heightened volatility future adjustments to the target range for early in the year. Large banking firms have the federal funds rate, it will assess realized kept their capital and liquidity ratios at and expected economic conditions relative to high levels relative to historical standards, its objectives of maximum employment and capital at other financial firms also appears 2 percent inflation. These judgments will take to be elevated, and financial firms’ use of into account a wide range of information, short-term wholesale funding remains including measures of labor market conditions, subdued. Debt growth in the household indicators of inflation pressures and inflation sector has been modest. However, leverage expectations, and readings on financial and of nonfinancial corporations is elevated by international developments. The Committee historical standards, and lower-rated firms are expects that economic conditions will evolve in potentially vulnerable to adverse developments. a manner that will warrant only gradual future In particular, the performance of firms in increases in the federal funds rate, and that the the energy sector has been especially weak federal funds rate will likely remain, for some due to the prolonged period of low oil time, below levels that are expected to prevail prices. In equity markets, valuation pressures in the longer run. Consistent with this outlook, have increased somewhat as expectations in the most recent Summary of Economic for corporate earnings have been revised Projections (SEP), which was compiled at downward; valuation pressures have remained the time of the June meeting of the Federal notable in the commercial real estate sector, Open Market Committee (FOMC), FOMC to which some small banks have substantial participants projected that the appropriate exposures. level of the federal funds rate would be below its longer-run level through 2018. (The June After having raised the target range for the SEP is discussed in more detail in Part 3 of federal funds rate to between ¼ and ½ percent this report.) last December, the Committee maintained that target range over the first half of the The Federal Reserve continued to use interest year. The Committee’s decisions to leave the paid on reserve balances and employ an stance of policy unchanged were supported overnight reverse repurchase agreement by its assessments earlier in the year that facility to manage the federal funds rate, global economic and financial developments and these tools were effective in keeping the posed risks to the economic outlook and that federal funds rate within its target range. growth in economic activity appeared to have The Federal Reserve also continued to test slowed. In June, the Committee noted that the operational readiness of other policy recent information indicated that the pace of implementation tools. 3 P 1 art r e f d eCent ConomiC and inanCiaL eveLoPments Labor market conditions have improved this year, though recent data suggest there has been a loss of momentum. Payroll gains averaged about 200,000 per month in the first quarter but then only 80,000 per month in April and May. The unemployment rate has edged down to 4¾ percent, a level that is near the midpoint of the Federal Open Market Committee (FOMC) participants’ estimates of its longer-run rate. That said, a few indicators suggest that some slack in the labor market remains. Despite persistently weak productivity growth, measures of labor compensation show some tentative signs of acceleration. Overall consumer price inflation has continued to be held down by lower prices for energy and imports, but both overall inflation and inflation excluding food and energy items, a useful gauge of where overall inflation will be in the future, have picked up a bit over the past year. Some survey-based measures of longer-run inflation expectations have moved down; market-based measures of inflation compensation have declined noticeably since last summer. Real gross domestic product (GDP) is estimated to have increased at a sluggish rate in the first quarter, but more recent data point to a noticeable step-up in the pace of growth in the second quarter. Consumer spending appears to be expanding at a moderate pace so far this year, while the housing market continues its gradual recovery, and fiscal policy at all levels of government is now modestly boosting economic activity after exerting a considerable drag in recent years. An area of concern, however, is the softening in business fixed investment in recent quarters, even beyond those sectors most directly affected by the plunge in energy prices. In addition, weak exports are providing little boost to overall output growth. Heightened global financial market volatility early this year damped confidence both domestically and abroad, but financial conditions have generally eased somewhat in recent months; in the United States, credit conditions for both households and businesses have remained generally accommodative. Domestic Developments 1. Net change in payroll employment Early this year, the labor market 3-month moving averages Thousands of jobs continued to improve . . . 400 The labor market continued to improve in Private the first few months of this year. Payrolls 200 + expanded at an average rate of around 200,000 _0 per month from January through March, Total nonfarm 200 modestly below the average of 230,000 jobs 400 per month last year but still well above the number needed to absorb the trend number of 600 new entrants into the workforce (figure 1). The 800 unemployment rate held at about 5 percent, where it had been since the fall, but both labor 2009 2010 2011 2012 2013 2014 2015 2016 force participation and the employment-to- SOURCE: Department of Labor, Bureau of Labor Statistics. 4 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 2. Labor force participation rate and population ratio rose noticeably (figure 2). The employment-to-population ratio rise in the labor force participation rate was encouraging because it seemed to suggest that Monthly Percent labor supply was responding significantly to the strengthening labor market. 68 66 . . . but recently there may have been a loss of momentum . . . 64 Labor force The data for April and May, however, suggest participation rate 62 that the pace of labor market improvement 60 has slowed. Payroll growth is reported to have averaged a pace of only 80,000 per 58 Employment-to-population ratio month (about 100,000 after adjustment for the effects of a strike).1 And although the 2002 2004 2006 2008 2010 2012 2014 2016 unemployment rate fell to 4.7 percent in NOTE: Both series are a percent of the population aged 16 and over. SOURCE: Department of Labor, Bureau of Labor Statistics. May, that decline occurred as both labor force participation and the employment-to- population ratio fell back somewhat from their levels in March. On net, the participation rate in May was little changed from a year earlier (a position that should nonetheless be viewed as a strengthening relative to a trend that is probably declining because of demographic changes, especially the aging of the baby- boom generation). Despite these disappointing data, other labor market indicators are consistent with a job market that has continued to strengthen. In particular, initial claims for unemployment insurance, now available through early June, remain very low—and therefore at odds with the weaker tenor of the recent payroll figures. In addition, according to the Job Openings and Labor Turnover Survey, the rate of job openings as a share of private employment remains at a very high level; the quits rate has continued to trend up and is now fairly high, the latter measure indicating that workers feel increasingly confident about their employment opportunities. 1. According to the Labor Department, payroll employment in May was reduced by about 35,000 because of workers on strike at Verizon. These employees have returned to work and are expected to be included in payroll figures for June. MoNETARy PoLICy REPoRT: JUNE 2016 5 3. Measures of labor underutilization Monthly Percent 18 U-6 16 U-4 14 U-5 12 10 8 Unemployment rate 6 4 2004 2006 2008 2010 2012 2014 2016 NOTE: U-4 measures total unemployed plus discouraged workers, as a percent of the labor force plus discouraged workers. Discouraged workers are a subset of marginally attached workers who are not currently looking for work because they believe no jobs are available for them. U-5 measures total unemployed plus all marginally attached to the labor force, as a percent of the labor force plus persons marginally attached to the labor force. Marginally attached workers are not in the labor force, want and are available for work, and have looked for a job in the past 12 months. U-6 measures total unemployed plus all marginally attached workers plus total employed part time for economic reasons, as a percent of the labor force plus all marginally attached workers. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research. SOURCE: Department of Labor, Bureau of Labor Statistics. . . . and a few signs of labor underutilization remain Although the May level of the unemployment rate is near the midpoint of the FOMC participants’ estimates of its longer-run rate, a few indicators suggest that some slack in labor resource utilization remains. Most notably, the share of workers who are employed part time but would like to work full time is still elevated; accordingly, the more comprehensive U-6 measure of labor underutilization, which includes these underemployed individuals, has remained well above its pre-recession level (figure 3). Meanwhile, jobless rates for African Americans and Hispanics are high relative to the aggregate, though these rates have also improved during the economic recovery (figure 4). (For additional discussion, see the box “Have the Gains of the Economic Expansion Been Widely Shared?”) 6 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS Have the Gains of the Economic Expansion Been Widely Shared? The financial crisis resulted in massive job losses have experienced the largest rebound in employment. and falling income for American households. However, Thus far in 2016, blacks continue to have the lowest not all households suffered to the same extent during prime-age employment rates among these four groups, the downturn, nor have they benefited to the same and the racial differences in employment-to-population extent during the subsequent recovery. This discussion ratios are very similar to pre-recession levels. reviews the labor market situation and household Among the working population, blacks and incomes for Americans of different races and ethnicities Hispanics suffered the greatest losses in full-time during the Great Recession and the ensuing economic employment share during the recession, and, even expansion.1 as overall employment has recovered, the full-time A figure in the main text shows that unemployment share remains significantly depressed for these workers rates for blacks and Hispanics rose more during (figure B). By early 2016, white and Asian prime-age the recession, and have declined more during the workers had nearly returned to their pre-recession rates expansion, than for the nation as a whole (text of full-time work, but the share of full-time employment figure 4).2 Rates for these groups remain higher than among black and Hispanic workers remains several for whites; the differentials among these rates are now percentage points lower than their previous high levels. roughly the same as prior to the recession. A similar Prior to the Great Recession, black workers were the result is true for employment-to-population ratios most likely to report usually working 35 hours per of prime-age individuals (ages 25 to 54).3 Prime- week or more, closely followed by Hispanics. By 2016, age employment rates are lower for blacks and fell Hispanic workers had slightly lower rates of full-time more sharply during the financial crisis, dropping employment than whites, and the full-time share of nearly 8 percentage points between mid-2008 and black workers was slightly lower than that of Asians. the end of 2011, compared with declines of between In the period of sustained high unemployment 4 and 5 percentage points for whites, Asians, and following the financial crisis, household incomes Hispanics (figure A). Since 2011, however, blacks for all groups of Americans fell sharply and did not begin to recover until 2012. The decline in median 1. The employment-to-population ratio and full-time share household income was particularly large for black of employed individuals are calculated using data from the households—16 percent, compared with approximately monthly Current Population Survey (CPS). Median household income and the income composition are calculated using data from the March CPS Annual Social and Economic Supplement of the total labor force. The employment-to-population ratio (ASEC). Monthly data are available through April 2016, while ignores the distinction between those actively seeking work or the most recent ASEC data (March 2015 CPS) are for 2014. not and simply measures the number of employed individuals 2. The Hispanic ethnicity and race categories are not as a share of the total population. We use the prime-age mutually exclusive. Some individuals are, for example, both population because we want to focus on the labor market Hispanic and white, and they are represented in both lines in recovery and do not want income to include Social Security the figures in the box. and other sources of retirement income that are largely 3. The unemployment rate shows the number of independent of economic conditions. unemployed individuals actively looking for work as a share B. Full-time share of all prime-age employed persons, A. Prime-age employment-to-population ratio, by race by race Monthly Percent Monthly Percent 82 Black or African American 92 80 White 78 90 Asian 76 Asian 74 White 88 72 86 Hispanic or Latino 70 Hispanic or Latino 68 84 Black or African American 66 2004 2006 2008 2010 2012 2014 2016 2004 2006 2008 2010 2012 2014 2016 NOTE: The data are 12-month moving averages. Prime age is defined as NOTE: The data are 12-month moving averages. Prime age is defined as those aged 25 to 54. those aged 25 to 54. SOURCE: Department of Labor, Bureau of Labor Statistics. SOURCE: Department of Labor, Bureau of Labor Statistics. MoNETARy PoLICy REPoRT: JUNE 2016 7 8 percent for white, Hispanic, and Asian households substantially below levels experienced prior to the (figure C).4 financial crisis. By 2014 (latest data available), median household Transfer income rose substantially during the incomes of Asian, white, and Hispanic households had recession because of federal economic stimulus improved and were at least 94 percent of pre-recession programs and automatic stabilizers, but the increases levels, but median income for black households only offset a modest portion of the overall decline in remained only 88 percent of the 2007 level. Racial and income.6 Transfer income has receded very slowly since ethnic differences in income were sizable before the 2011, with mean transfers in 2014 remaining above financial crisis and have only grown larger since then, pre-recession levels for all racial and ethnic groups. with the median black household income at $40,000 in 2014, compared with $67,000 for white and $85,000 6. Transfer income includes Social Security income, for Asian households (figure D). welfare, Supplemental Security Income, unemployment benefits, and educational assistance. other income includes Losses in wage income account for the bulk of business income; farm income; income from interest, the decline in income for households during the dividends, rent, alimony, and contributions; retirement downturn. Between 2007 and 2011, mean wage income; trusts; workers’ compensation; veterans’, survivors’, income for households in the middle quintile of the and disability benefits; educational assistance from nongovernment sources; assistance from friends and family; income distribution fell just over $5,000 for white and other sources. households, $4,000 for Hispanic households, $8,000 D. Median prime-age household income, by race for black households, and $7,000 for Asian households (figure E).5 Wages and salaries are the single largest Annual Thousands of inflation-adjusted dollars source of income and have provided most of the increase in total income since 2011. Mean wage 90 Asian income for 2014 had returned to pre-recession levels 85 for Asian households and had made up some of the 80 75 lost ground among white and Hispanic households. Wage income for black households, however, remained White 70 65 4. Percentages are based on an analysis of income data 60 from the March CPS ASEC. Household race was determined 55 by answers to the Hispanic ethnicity question and the first Hispanic or Latino 50 racial category selected by household heads between the ages 45 of 25 and 54. Income of all household members is included. 40 Any household head identifying as Hispanic is coded as Black or African American 35 Hispanic, regardless of race. Incomes for a very small group of households (less than 2 percent in 2014) that are identified 2004 2006 2008 2010 2012 2014 as some other race group are not shown here, as the estimates are somewhat volatile and not very precise. NOTE: Prime-age households are defined as households led by those aged 25 to 54. Race refers to the race of the head of household. The data extend 5. To show changes in the composition of income for through 2014. “typical” households, we switch here to using mean income of SOURCE: U.S. Census Bureau, Current Population Survey, March 2016. households in the middle quintile of the distribution. E. Changing composition of income for middle quintile of C. Indexed median prime-age household income, by race prime-age households, by race group and key year Annual Inflation-adjusted dollars, 2007=100 Thousands of inflation-adjusted dollars Transfer income 105 Wage income 100 Hispanic or Latino Other income Asian 90 100 Asian 80 White White 95 70 90 Black or Hispanic 60 African American or Latino 50 85 40 Black or African American 80 30 2004 2006 2008 2010 2012 2014 07 11 14 07 11 14 07 11 14 07 11 14 NOTE: Prime-age households are defined as households led by those aged NOTE: Prime-age households are defined as households led by those aged 25 to 54. Race refers to the race of the head of household. The data extend 25 to 54. Race refers to the race of the head of household. The data are through 2014. grouped according to key years 2007, 2011, and 2014. SOURCE: U.S. Census Bureau, Current Population Survey, March 2016. SOURCE: U.S. Census Bureau, Current Population Survey, March 2016. 8 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 4. Unemployment by race and ethnicity Monthly Percent 18 Black or African American 16 14 12 Hispanic or Latino 10 White 8 6 Asian 4 2 2004 2006 2008 2010 2012 2014 2016 NOTE: Persons whose ethnicity is identified as Hispanic or Latino may be of any race. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research. SOURCE: Department of Labor, Bureau of Labor Statistics. 5. Measures of change in hourly compensation Compensation growth has shown tentative signs of a pickup . . . Percent change from year earlier By most measures, the growth of labor Compensation per hour, 6 business sector compensation has remained modest, though 5 recently there have been some signs of faster 4 increases. The employment cost index (ECI) 3 for private-industry workers, which includes Employment 2 the cost of employer-provided benefits as well cost index as wages, registered a rise of only 1¾ percent 1 + over the 12 months ending in March (figure 5). _0 Average hourly earnings However, two other prominent measures of 1 labor compensation—average hourly earnings 2004 2006 2008 2010 2012 2014 2016 for all private-sector employees and business- NOTE: The average hourly earnings data series begins in March 2007 and sector compensation per hour—recorded extends through May 2016. The compensation per hour and employment cost larger increases than the ECI over the past index data extend through 2016:Q1. For business-sector compensation, change is over four quarters; for the employment cost index, change is over year, and the increases in both series were the 12 months ending in the last month of each quarter; for average hourly earnings, change is from 12 months earlier. above their corresponding averages over the SOURCE: Department of Labor, Bureau of Labor Statistics. preceding several years. In addition, according to the Federal Reserve Bank of Atlanta’s Wage Growth Tracker, the median of 12-month changes in individuals’ hourly wages (from the monthly survey of households) has been gradually trending higher, reaching 3½ percent in May. MoNETARy PoLICy REPoRT: JUNE 2016 9 . . . amid persistently weak productivity 6. Change in business sector output per hour growth Percent, annual rate The relatively slow gains in labor compensation in recent years have occurred 4 against a backdrop of persistently weak productivity growth. Since 2008, labor 3 productivity gains have averaged around 1 percent per year, far below the pace that 2 prevailed before the recession (figure 6). Indeed, in the past five years, productivity 1 growth has averaged only ½ percent per year. The relatively slow pace of productivity growth is at least in part a consequence of 1948– 1974– 1996– 2001– 2008– 73 95 2000 07 present the sustained weakness in capital investment NOTE: Changes are measured from Q4 of the year immediately preceding over the recession and early recovery period. the period through Q4 of the final year of the period. The final period is Productivity gains may improve in the future measured from 2007:Q4 through 2016:Q1. SOURCE: Department of Labor, Bureau of Labor Statistics. as investment in productivity-enhancing capital equipment and in research and 7. Change in the price index for personal consumption expenditures development strengthens. Monthly 12-month percent change Falling energy prices have held down consumer price inflation 4 Overall consumer price inflation has moved up Total 3 from the lows recorded last year, but it remains 2 well below the FOMC’s longer-run objective 1 of 2 percent. In April, the 12-month change Ex a c n lu d d e i n n e g r g fo y od + in the price index for personal consumption _0 expenditures (PCE) was around 1 percent, 1 higher than the ¼ percent rate recorded in 2 April 2015 (figure 7). The pickup over this period was largely due to a slower rate of 2009 2010 2011 2012 2013 2014 2015 2016 decline in both energy prices and non-energy NOTE: The data extend through April 2016; changes are from one year earlier. import prices. SOURCE: Department of Commerce, Bureau of Economic Analysis. 8. Brent spot and futures prices Low oil prices have reduced global investment in the oil sector and have led to some cutbacks Weekly Dollars per barrel in production, particularly in the United Spot price 120 States. These declines, firming global demand, 110 and some temporary supply disruptions— 100 including in Canada due to wildfires—have 90 recently pushed crude oil prices higher after Dec. 2018 futures contracts 80 they reached a 12-year low in mid-January 70 60 (figure 8). Nonetheless, at a bit below $50 50 per barrel, the spot price of Brent crude oil 40 remains less than half its mid-2014 peak. 30 Moreover, the continued low level of oil 20 futures prices suggests that market participants 2014 2015 2016 expect only a modest increase in oil prices over NOTE: The data are weekly averages of daily data and extend through June 16, 2016. SOURCE: NYMEX via Bloomberg. 10 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS the next couple of years, given the historically high global inventories of crude oil. The large cumulative drop in crude oil prices had mostly passed through to lower retail prices for gasoline and other energy products by early this year; despite some increases thereafter, prices at the pump remain at levels substantially below those of last summer. Similar to the price of crude oil, prices of 9. Non-oil import prices and U.S. dollar exchange rate metals and agricultural goods have moved higher since early this year. The rise in the Monthly 12-month percent change prices of agricultural goods followed several 20 quarters of declines that have held down retail food prices for consumers so far this year. 15 The rise in many nonfuel commodities prices, 10 Broad nominal dollar together with a weaker dollar, helped push 5 non-oil import prices higher in May—the first + _0 increase since 2014 (figure 9). Non-oil import prices 5 Outside of the energy and food 10 categories, inflation has picked up a little bit 2011 2012 2013 2014 2015 2016 SOURCE: Department of Labor, Bureau of Labor Statistics; Federal Reserve Inflation for items other than food and energy Board, Statistical Release H.10, “Foreign Exchange Rates.” (so-called core inflation) has picked up a little. Core PCE prices rose about 1½ percent over the 12 months ending in April, up about ¼ percentage point from its year-earlier pace.2 The increase in the trimmed mean PCE price index, an alternative indicator of underlying inflation, has also picked up a bit over the past year; as is typically the case, this measure has run somewhat above core inflation over this period. Because the slack in labor and product markets appears to have been mostly taken up, and given the recent upward movements in oil prices and non-oil import prices—after months of declines—the downward pressure on inflation from these factors is likely waning. 2. Data from the consumer price index and the producer price index point to a similar reading for the 12-month change in core PCE prices in May. MoNETARy PoLICy REPoRT: JUNE 2016 11 Some survey-based measures of expected 10. Median inflation expectations inflation have drifted downward . . . Percent The FOMC devotes careful attention to indicators of long-run inflation expectations, Michigan survey expectations 4 as these expectations are believed to be for next 5 to 10 years an important factor underlying many 3 wage- and price-setting decisions. The latest readings from surveys of longer-term inflation expectations have sent mixed signals 2 SPF expectations (figure 10). In the Survey of Professional for next 10 years Forecasters, conducted by the Federal Reserve 1 Bank of Philadelphia, the median second- quarter reading on expected annual PCE 2002 2004 2006 2008 2010 2012 2014 2016 price inflation over the next 10 years was NOTE: The Michigan survey data are monthly and extend through June again 2 percent. The distribution of inflation 2016. The SPF data for inflation expectations for personal consumption expenditures are quarterly and extend from 2007:Q1 through 2016:Q2. expectations 5 to 10 years ahead derived from Michigan survey data for June are preliminary. surveys of primary dealers has remained SOURCE: University of Michigan Surveys of Consumers; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters (SPF). similarly stable. But in the University of Michigan Surveys of Consumers, the median reading on inflation expectations over the next 5 to 10 years has drifted down over the past two years and recorded a new low in early June. To the extent that this downward drift is a reaction to energy-driven declines in overall inflation, it could reverse over time as energy prices stop declining. . . . and market-based measures of inflation compensation have remained low 11. 5-to-10-year-forward inflation compensation Market-based measures of longer-term Weekly Percent inflation compensation—derived either from 4.0 differences between yields on nominal Treasury securities and Treasury Inflation-Protected 3.5 Inflation swaps Securities or from inflation swaps—have 3.0 continued to decline and now stand at very 2.5 low levels (figure 11). Deducing the sources TIPS breakevens 2.0 of changes in inflation compensation is challenging because such movements reflect 1.5 not only expected inflation, but also an 1.0 inflation risk premium—the compensation that holders of nominal securities demand 2008 2010 2012 2014 2016 for bearing inflation risk—and other factors. NOTE: The data are weekly averages of daily data and extend through June 17, 2016. TIPS is Treasury Inflation-Protected Securities. Nevertheless, one cannot rule out a decline SOURCE: Federal Reserve Bank of New York; Barclays; Federal Reserve in inflation expectations among market Board staff estimates. participants since last summer. 12 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 12. Change in real gross domestic product and gross Economic activity has been expanding at domestic income a moderate pace Percent, annual rate Real GDP is currently reported to have Gross domestic product increased at an annual rate of just ¾ percent Gross domestic income 5 in the first quarter, but with several signs 4 of faster growth in the current quarter, real 3 GDP appears on track to record a moderate Q1 overall gain in the first half of this year 2 (figure 12).3 Consumer spending is advancing 1 further, and housing activity continues to + _0 strengthen gradually. Meanwhile, government expenditures have maintained momentum. 1 Although inventory investment exerted a 2009 2010 2011 2012 2013 2014 2015 2016 sizable drag on GDP growth in the latter half SOURCE: Department of Commerce, Bureau of Economic Analysis. of last year, it has been less of an influence in the first half of this year. Nevertheless, several of the headwinds that were apparent last year have continued to restrain growth in activity this year. In particular, a substantial appreciation of the dollar over the past couple of years, along with continued sluggish foreign growth, is weighing on the demand for U.S. exports. In addition, the sizable drop in oil prices since 2014—notwithstanding the substantial benefit to households—has led to marked cutbacks in production and investment in the energy sector of our economy. These negative factors have had particularly pronounced effects on activity in the industrial sector. Gains in income and wealth continue to support consumer spending 13. Change in real personal consumption expenditures and disposable personal income Consumption growth was lackluster early in 2016, but data on retail sales and motor Percent, annual rate vehicle sales suggest that spending has picked Personal consumption expenditures up appreciably so far this quarter. Smoothing Disposable personal income 6 through the monthly fluctuations, consumer 4 spending is reported to have increased at H1 an annual rate of nearly 3 percent over the 2 first four months of this year, only a little + _0 slower than the pace in 2015 (figure 13). 2 3. While it appears likely that residual seasonality—a 4 predictable seasonal pattern remaining in data that have already been seasonally adjusted—in some components 2010 2011 2012 2013 2014 2015 2016 of GDP held down measured GDP growth in the first NOTE: The reading for 2016:H1 is the annualized April/Q4 change. quarter, this factor would imply an offsetting boost in SOURCE: Department of Commerce, Bureau of Economic Analysis. measured GDP growth over the remainder of the year. MoNETARy PoLICy REPoRT: JUNE 2016 13 The improvement in the labor market has 14. Prices of existing single-family houses continued to support income growth, and Monthly Percent change from year earlier low energy prices are boosting households’ purchasing power. As a result, real disposable CoreLogic 20 price index personal income—that is, income after taxes S&P/Case-Shiller 15 national index and adjusted for inflation—was reported to 10 have advanced at an annual rate of about 5 + 3¼ percent over the first four months of this _0 year, just a touch below the pace in 2015. 5 Zillow index 10 Ongoing gains in household net worth likely 15 have also supported growth in consumer 20 spending. House prices, which are of 2006 2008 2010 2012 2014 2016 particular importance for the balance sheet NOTE: The data for the S&P/Case-Shiller index extend through March positions of a broad set of households, have 2016. The data for the Zillow and CoreLogic indexes extend through April continued to move higher, with the CoreLogic 2016. For Dow Jones Indices licensing information, see the note on the Contents page. national index showing a rise of about SOURCE: CoreLogic Home Price Index; Zillow; S&P/Case-Shiller U.S. National Home Price Index (“Index”). The S&P/Case-Shiller Index is a 6 percent over the 12 months ending in April product of S&P Dow Jones Indices LLC and/or its affiliates. (figure 14). Elsewhere, although equity prices have only increased slightly, on net, so far this 15. Wealth-to-income ratio year, the prior gains of the past few years have helped improve households’ financial positions. Quarterly Ratio In the first quarter of this year, the ratio of aggregate household net worth to disposable 6.5 income, which had previously returned to its pre-recession highs, ticked down slightly but 6.0 remained far above its long-run historical average (figure 15). 5.5 Consumers are upbeat about their economic prospects . . . 5.0 The solid pace of income growth over the past year has helped households retain fairly upbeat 1996 2000 2004 2008 2012 2016 perceptions about their economic prospects. NOTE: The series is the ratio of household net worth to disposable personal income. The Michigan survey’s composite index of SOURCE: For net worth, Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; for income, Department of consumer sentiment—which incorporates Commerce, Bureau of Economic Analysis. households’ views about their own financial situations as well as economic conditions more broadly—has improved again recently following a moderate deterioration earlier in the year, and the latest readings were near the upper end of the range of values recorded during the previous economic expansion (figure 16). After having lagged behind improvements in headline sentiment earlier in the recovery, the survey measures of households’ expectations for real income changes over the next year or two have also improved noticeably and now stand close to their pre-recession levels. 14 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 16. Indexes of consumer sentiment and income expectations . . . and household credit availability is generally favorable Diffusion index Index Consumer credit has continued to expand 100 110 this year amid stable credit performance Consumer sentiment 100 (figure 17). Auto and student loans remain 90 widely available, even to borrowers with lower 90 80 credit scores, and outstanding balances of 80 these types of loans expanded at a robust pace. 70 70 Credit card borrowing has also accelerated a 60 60 bit, on balance, and the outstanding balance Real income expectations in April was 5½ percent above its level a 50 50 year earlier. Although there have been some 1996 2001 2006 2011 2016 tentative signs of easing overall, credit card standards have remained tight for nonprime NOTE: The data are three-month moving averages and extend through June 2016. June data are preliminary. Consumer sentiment is indexed to 100 in borrowers. 1966. Real income expectations are calculated as the net percent of survey respondents expecting family income to go up more than prices during the next year or two, plus 100. Low interest rates and rising incomes have SOURCE: University of Michigan Surveys of Consumers. enabled many households to lower their debt 17. Changes in household debt payment burdens. The household debt service ratio—that is, the ratio of required principal Billions of dollars, annual rate and interest payments on outstanding Mortgages 1,000 household debt to disposable personal Consumer credit Sum 800 income—has remained at a very low level by 600 historical standards (figure 18). Interest rates Q1 400 on 30-year fixed-rate mortgages are down 200 about ½ percentage point from the level at + _0 the December liftoff date, and rates on auto 200 loans, on net, have been little changed since 400 then. Going forward, the effect of any policy 600 rate tightening on mortgage rates and, in turn, on households’ debt burdens will likely show 2007200820092010201120122013201420152016 through only gradually, as the current stock of SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial household debt is disproportionately held in Accounts of the United States.” loan products with fixed interest rates. 18. Household debt service Residential construction activity has Quarterly Percent of disposable income improved at a gradual pace The recovery in residential construction 14 activity has maintained a moderate pace. 13 Single-family starts continued to edge up slowly over the past year, while multifamily 12 starts receded a little from their elevated levels in the middle of 2015 (figure 19). Looking 11 further back, the rise in multifamily starts over 10 the past five years has been substantial and has far exceeded the percent gain in single- family housing starts. The relative strength in 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 multifamily construction partly reflects a shift NOTE: Debt service payments consist of estimated required payments on outstanding mortgage and consumer debt. SOURCE: Federal Reserve Board, Statistical Release, “Household Debt Service and Financial Obligations Ratios.” MoNETARy PoLICy REPoRT: JUNE 2016 15 in demand away from owner-occupied housing 19. Private housing starts and permits toward rental housing since the recession. Monthly Millions of units, annual rate Elsewhere, outlays for improvements to existing homes increased more than 10 percent Single-family starts 1.8 over the past year, and commissions and fees paid on the sale of residential real estate rose 1.4 moderately, in line with the uptrend in sales of existing homes and contracts for new homes 1.0 (figure 20). In all, residential investment rose Single-family permits almost 10 percent in 2015 and appears on .6 track to maintain a similar pace in the first Multifamily starts .2 half of this year. 2002 2004 2006 2008 2010 2012 2014 2016 Low interest rates and an ongoing easing in mortgage credit standards have continued to SOURCE: Department of Commerce, Bureau of the Census. support the expansions in housing demand 20. New and existing home sales and construction activity. In the April Senior Loan Officer Opinion Survey on Millions, annual rate Millions, annual rate Bank Lending Practices (SLOOS), banks 7.5 1.8 reported having eased lending standards and 7.0 Existing home sales 1.6 experienced stronger demand for most types of 6.5 1.4 residential real estate loans in the first quarter.4 6.0 1.2 Even so, for individuals with relatively low 5.5 1.0 credit scores, mortgages remain difficult to 5.0 .8 obtain. With mortgage interest rates having 4.5 .6 again moved down close to their all-time lows, housing affordability has remained favorable 4.0 .4 despite the moderate growth in house prices 3.5 New home sales .2 over the past year (figure 21). 2004 2006 2008 2010 2012 2014 2016 NOTE: The data extend through April 2016. “Existing home sales” includes Business fixed investment has single-family, condo, townhome, and co-op sales. declined . . . SOURCE: For new single-family home sales, Census Bureau; for existing home sales, National Association of Realtors. A worrisome development in recent quarters 21. Mortgage rates and housing affordability has been the weakening in business fixed Percent Index investment (private nonresidential fixed investment). Over the past year, real outlays Housing affordability index 205 in the nonresidential structures category— 7 185 which constitutes roughly one-fourth of total 6 business fixed investment—have fallen sharply, 165 as investment in oil wells and other drilling 5 145 and mining structures has followed the steep 125 drop in oil prices (figure 22). The decline 4 Mortgage rates in the number of drilling rigs in operation 105 3 has been so pronounced that investment in 85 drilling and mining structures has shrunk to 2008 2010 2012 2014 2016 NOTE: The housing affordability index data are monthly through April 4. The SLOOS is available on the Board’s website at 2016, and the mortgage rate data are weekly through June 15, 2016. At an index value of 100, a median-income family has exactly enough income to www.federalreserve.gov/boarddocs/snloansurvey. qualify for a median-priced home mortgage. Housing affordability is seasonally adjusted by Board staff. SOURCE: For housing affordability index, National Association of Realtors; for mortgage rates, Freddie Mac Primary Mortgage Market Survey. 16 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS less than one-third its peak in 2014, and the 22. Change in real private nonresidential fixed investment ongoing contraction has subtracted nearly Percent, annual rate ½ percentage point from real GDP growth Structures over the past four quarters. Outside of the Equipment and intangible capital 20 energy sector, business outlays for structures 10 recorded relatively modest increases following Q1 + the sizable gains observed in the first half _0 of 2015. Meanwhile, business spending on 10 equipment and intellectual property products moved down in the fourth quarter of last year 20 and the first quarter of 2016, and the available 30 indicators, such as orders and shipments of capital goods and surveys of business 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 conditions, point to continued softness in the SOURCE: Department of Commerce, Bureau of Economic Analysis. current quarter. Although investment spending continues to be supported by low interest rates and generally accommodative financial conditions, spending is likely being restrained by a slowing in actual and expected business output growth. Weak foreign demand and the stronger dollar are already having an adverse effect on domestic businesses, and analysts’ forecasts for year- ahead corporate earnings have been revised down considerably, even outside of the energy sector. Meanwhile, as reported by the Bureau of Economic Analysis, corporate profits recorded only a slight increase in the first quarter after falling sharply at the end of last year, although here, too, the weakness was heavily concentrated in the energy sector. . . . while corporate financing conditions have remained generally accommodative 23. Corporate bond yields, by securities rating Corporate financing conditions remained Daily Percentage points generally accommodative in the first half 20 of this year, although ongoing oil market 18 developments and episodes of global financial 16 stress led to sporadic periods of heightened Triple-B 14 perceptions of risk. In particular, corporate 12 bond markets showed strains early in the High-yield 10 year, especially for those firms most affected 8 6 by the low energy prices. In recent months, 4 however, pressures in bond markets have Double-A 2 eased somewhat, and corporate bond yields 0 overall have returned to historically low 1998 2001 2004 2007 2010 2013 2016 levels (figure 23). In the April SLOOS, banks NOTE: The yields shown are yields on 10-year bonds. indicated that they had tightened their SOURCE: BofA Merrill Lynch Global Research, used with permission. MoNETARy PoLICy REPoRT: JUNE 2016 17 standards on commercial and industrial (C&I) 24. Selected components of net debt financing for nonfinancial businesses loans to large and middle-market firms in the first quarter, but even so, such financing Billions of dollars, monthly rate remained broadly available. For the first Commercial paper quarter as a whole, corporate bond issuance Bonds Q1 80 and the growth of C&I loans on banks’ Bank loans Sum 60 balance sheets were quite strong (figure 24). 40 Firms’ equity issuance was also generally solid, though initial public offerings have been weak. 20 + Meanwhile, the growth of small business loans _0 was subdued. 20 Financing conditions in the commercial 40 real estate (CRE) sector have remained 20062007200820092010201120122013201420152016 accommodative overall, but here, too, there SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial have been some signs of tightening. Growth of Accounts of the United States.” CRE loans at banks remained strong during the first half of the year. However, banks indicated that they had further tightened their lending standards on CRE loans in the first quarter of 2016, according to the April SLOOS. In addition, spreads on interest rates for CRE loans relative to 10-year swap rates and to yields on commercial mortgage-backed securities rose sharply further early this year, and although they have retreated significantly since then, these measures remain well above their historical average levels. Exports and imports have both been weak this year Based on recently released trade prices and the nominal census trade data, it appears that real exports were roughly flat in the first quarter of 2016, held back by slow foreign 25. U.S. trade and current account balances growth and the considerable appreciation of Quarterly Percent of nominal GDP the dollar over the past two years. Despite the + appreciation of the dollar, real imports looked _0 to have declined in the first quarter, with 1 weakness in both capital- and consumer-goods Trade 2 categories. Overall, the net export contribution 3 to GDP growth was about neutral. While 4 the nominal trade deficit narrowed a little in 5 the first quarter, the current account deficit widened a touch to 2.7 percent of nominal 6 Current account GDP (figure 25). The April trade data suggest 7 that net exports will be a small drag on GDP 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 growth in the current quarter, as the trade NOTE: GDP is gross domestic product. deficit increased, with imports rebounding SOURCE: Department of Commerce, Bureau of Economic Analysis. from a very weak March level. 18 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 26. Change in real government expenditures on The drag from federal fiscal policy has consumption and investment ended . . . Percent, annual rate Fiscal policy at the federal level had a roughly Federal neutral influence on GDP growth in 2015, as State and local 9 the substantial contractionary effects of earlier 6 fiscal consolidation have abated. Policy actions Q1 3 had little effect on taxes, while transfers + and federal purchases of goods and services _0 merely edged up (figure 26). Going forward, 3 if the increased spending authority enacted in 6 last year’s budget agreement is fully utilized, 9 federal fiscal policy would likely be mildly supportive of GDP growth over 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016 and 2017. SOURCE: Department of Commerce, Bureau of Economic Analysis. After narrowing significantly over the past several years, the federal unified budget deficit has recently widened slightly. At 18 percent of GDP, receipts have remained high relative 27. Federal receipts and expenditures to the recession and early recovery period Annual PPeerrcceenntt ooff nnoommiinnaall GGDDPP (figure 27). At 21 percent, expenditures as a share of GDP are above the levels that 26 prevailed before the start of the most recent Expenditures 24 recession. Although the ratio of federal debt 22 held by the public to nominal GDP is already Receipts quite elevated, the deficit currently remains 20 small enough to roughly stabilize this ratio at 18 around 75 percent (figure 28). 16 . . . and state and local government 14 expenditures are rising 1996 2000 2004 2008 2012 2016 The expansion of economic activity and NOTE: Through 2015, receipts and expenditures are for fiscal years further gains in house prices continue to (October to September); gross domestic product (GDP) is for the four quarters ending in Q3. For 2016, receipts and expenditures are for the support a gradual improvement in the fiscal 12 months ending in May, and GDP is the average of 2015:Q4 and 2016:Q1. Receipts and expenditures are on a unified-budget basis. position of most state and local governments. SOURCE: Office of Management and Budget. Consistent with their improving finances, states and localities significantly expanded real construction spending in 2015 and in the early part of this year. By contrast, employment growth in the state and local sector was muted last year, but the pace has stepped up somewhat so far in 2016 (figure 29). Financial Developments Financial conditions tightened early in the year but then eased Early in 2016, domestic financial conditions tightened, as uncertainty about the outlook MoNETARy PoLICy REPoRT: JUNE 2016 19 for the Chinese economy, lower oil prices, 28. Federal government debt held by the public and weak data on economic activity in several Quarterly Percent of nominal GDP economies contributed to concerns about the prospects for global economic growth and 80 to a pullback from risky assets. At that time, 70 Treasury yields declined across maturities, equity prices fell steeply, equity price volatility 60 rose, and risk spreads on corporate bonds 50 widened notably. In addition, investors came 40 to expect a more gradual increase in the 30 target range for the federal funds rate than they had previously anticipated. However, 20 investors’ concerns appeared to diminish beginning in mid-February, and since then, 1966 1976 1986 1996 2006 2016 amid mixed U.S. economic data, domestic NOTE: The data for gross domestic product (GDP) are at an annual rate. Federal debt held by the public equals federal debt less Treasury securities financial conditions have generally eased on held in federal employee defined benefit retirement accounts, evaluated at the end of the quarter. balance: Stock prices rose notably, equity SOURCE: For GDP, Department of Commerce, Bureau of Economic price volatility declined, and credit spreads on Analysis; for federal debt, Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.” corporate bonds narrowed. (For a discussion of financial stability developments over this same period, see the box “Developments 29. State and local government employment change Related to Financial Stability.”) Thousands of jobs, monthly average On balance to date this year, the expected path for the federal funds rate 20 over the next several years declined . . . H1 10 The path of the federal funds rate implied + _0 by market quotes on interest rate derivatives flattened, on net, since December. The 10 turbulence in global financial markets early 20 in the year, the FOMC’s communications, and some indications of a slowing in the 30 pace of improvement in the labor market of late contributed to market participants’ 2004 2006 2008 2010 2012 2014 2016 expectation that U.S. monetary policy would NOTE: The value for 2016:H1 is calculated with data extending through May. The value for 2013 is -0.08. be more accommodative than they had SOURCE: Department of Labor, Bureau of Labor Statistics. anticipated late last year. Survey-based measures of the expected path of policy also moved down this year. Respondents to the Survey of Primary Dealers and to the Survey of Market Participants in June expected fewer 25 basis point increases in the FOMC’s target range for the federal funds rate this year than they projected in December. Market-based measures of uncertainty about the policy rate approximately one to two years ahead declined, on balance, from their year- end levels. 20 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS Developments Related to Financial Stability Financial vulnerabilities in the United States Capital positions also have remained relatively overall remain at a moderate level. This assessment is elevated at insurance companies and broker-dealers. In supported by the resilience demonstrated by domestic addition, net secured borrowing by dealers—primarily financial firms and markets during the period of used to finance their own portfolios of securities—has heightened financial volatility near the start of the year. stayed near its lowest levels since 2001. Margin credit Capital and liquidity ratios at large banks have stayed extended by dealers—which funds clients’ positions in at high levels relative to historical standards, and debt traded stocks—has fluctuated within the upper part of growth in the household sector has been modest. its historical range, but margin calls reportedly were However, leverage of nonfinancial corporations met without disruption or a marked increase in disputes continues to be elevated by historical standards, during the heightened market volatility at the start of leaving lower-rated firms potentially vulnerable to the year. adverse developments. Stresses on energy firms The stock of private, short-term, money-like remain high given the low level of oil prices. valuation instruments, which form funding intermediation chains pressures have increased somewhat in equity that are vulnerable to runs, has continued to trend markets as expected profits have been marked down. down relative to gross domestic product (GDP) and Commercial real estate (CRE) prices are near or above total nonfinancial debt, suggesting vulnerabilities from their previous peaks. Even given moderate financial maturity transformation have continued to fall. Assets vulnerabilities, a number of possible external shocks, in money market mutual funds (MMFs) have been including if the United Kingdom chooses to leave the relatively stable this year, though assets in institutional European Union in a pending referendum, could pose prime MMFs have been declining, primarily because risks to financial stability. Securities and Exchange Commission (SEC) reforms Stronger capital positions at domestic banking aimed at mitigating the funds’ susceptibility to investor organizations have substantially contributed to the runs have induced conversions of prime funds into improved resilience of the U.S. financial system government-only funds. Nevertheless, some structural (figure A). The results of the stress tests mandated by vulnerabilities are expected to persist in MMFs even the Dodd-Frank Wall Street Reform and Consumer after SEC reforms go fully into effect in october 2016. Protection Act of 2010 and the accompanying For open-end mutual funds, the Financial Stability Comprehensive Capital Analysis and Review are oversight Council highlighted potential risks to scheduled to be released June 23 and June 29, 2016, financial stability from liquidity transformation respectively.1 In addition, large domestic banks have continued to hold high levels of liquid assets and A. Regulatory capital ratios at the top 25 bank holding have shifted the composition of their liabilities toward companies more-stable funding sources. However, measures of Quarterly Percent profitability, such as return on assets and return on equity, declined noticeably in the first quarter as many banking firms increased provisions for loan losses. 12 The pickup in provisions to date primarily reflects rising delinquencies for loans to energy-related firms. 10 Energy exposures for most banks appear manageable, Common equity tier 1 ratio but some small domestic banks still have significant 8 exposure to the oil sector, and others could be affected by spillovers from the energy sector to other business Leverage ratio 6 lines. A few large domestic banks have material ties to global banks that appear to be more susceptible to 4 low oil prices due to their significant exposures to oil- producing emerging market economies. 2002 2004 2006 2008 2010 2012 2014 2016 NOTE: The common equity tier 1 ratio equals core equity capital divided by 1. The exercise tests the ability of the 34 participating risk-weighted assets, while the leverage ratio equals tier 1 capital divided by bank holding companies to maintain adequate capital ratios average total consolidated assets. Exact calculations for the two regulatory and continue to provide intermediary services in the face capital ratios can be found in schedule HC-R of the Federal Reserve Board's of a hypothetical severe recession. For descriptions of the reporting form FR Y-9C. Before 2014:Q1, the numerator of the common scenarios, see Board of Governors of the Federal Reserve equity tier 1 ratio is tier 1 common capital. Beginning in 2014:Q1 for advanced approaches bank holding companies and in 2015:Q1 for all other System (2016), 2016 Supervisory Scenarios for Annual Stress bank holding companies, the numerator is common equity tier 1 capital. The Tests Required under the Dodd-Frank Act Stress Testing Rules shaded bars indicate periods of business recession as defined by the National and the Capital Plan Rule (Washington: Board of Governors, Bureau of Economic Research. January), https://www.federalreserve.gov/newsevents/press/ SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial bcreg/bcreg20160128a2.pdf. Statements for Bank Holding Companies. MoNETARy PoLICy REPoRT: JUNE 2016 21 through funds that hold less liquid assets and could The Federal Reserve Board has taken several further face elevated redemptions, and the council suggested steps to improve the resilience of financial institutions possible actions to mitigate those risks. and overall financial stability, including three proposals valuation pressures have generally stayed at a that apply only to large banking organizations and moderate level since January, though they rose for increase in stringency with the systemic footprint a few asset classes. Forward price-to-earnings ratios of the organization. First, the Board issued for for equities have increased to a level well above public comment a proposed rule that would impose their median of the past three decades. Although single-counterparty credit limits to help constrain equity valuations do not appear to be rich relative to interconnectedness within the financial system.2 Treasury yields, equity prices are vulnerable to rises Second, the Board and the other federal banking in term premiums to more normal levels, especially if agencies issued for public comment a proposed rule a reversion was not motivated by positive news about that would require large U.S. banking organizations economic growth. In contrast, valuation pressures in to maintain a minimum net stable funding ratio corporate bond markets—which manifest in low yields (NSFR).3 The proposal would require those institutions and credit spreads—were about unchanged. Credit to maintain sufficient levels of stable funding spreads for 10-year investment- and speculative-grade relative to the liquidity of their assets, derivatives, bonds changed little, on balance, and far-term forward and commitments over a one-year period, reducing spreads on speculative-grade corporate bonds have liquidity risk in the banking system. The NSFR proposal risen slightly, suggesting only a small decrease in would also serve as a complement to the liquidity investors’ risk appetite. Although respondents to the coverage ratio rule. Third, the Board issued for public Board’s Senior Credit officer opinion Survey on Dealer comment a proposed rule that would reduce the threat Financing Terms reported some deterioration in market of disorderly liquidation of financial firms by requiring liquidity during the heightened financial volatility near U.S. global systemically important banks (G-SIBs) and the start of the year, standard measures of liquidity the U.S. operations of foreign G-SIBs to restrict the in corporate bond markets decreased only about in ability of counterparties to terminate qualified financial line with what might be expected given historical contracts early if the firm enters bankruptcy or a relationships between liquidity and volatility. resolution process.4 valuations in the CRE sector appear increasingly In addition, the Board and the Federal Deposit vulnerable to negative shocks, as CRE prices have Insurance Corporation announced their determinations continued to outpace rental income and exceed, and provided firm-specific feedback on the 2015 by some measures, their pre-crisis peaks. However, resolution plans of eight U.S. G-SIBs.5 The two leverage in the sector does not appear excessive, and agencies ordered five of the firms to address identified some evidence points to a recent reduction in risk deficiencies in their plans by october 1, 2016, or appetite among CRE investors. overall growth of CRE possibly be subjected to more stringent prudential debt is moderate, and the ratio of debt backed by requirements. nonfarm nonresidential property to GDP is below an 2. See Board of Governors of the Federal Reserve System estimate of its long-run historical trend. In addition, (2016), “Federal Reserve Board Proposes Rule to Address Risk according to the January and April results of the Board’s Associated with Excessive Credit Exposures of Large Banking Senior Loan officer opinion Survey on Bank Lending organizations to a Single Counterparty,” press release, Practices, banks tightened lending standards in the March 4, https://www.federalreserve.gov/newsevents/press/ bcreg/20160304b.htm. fourth quarter of 2015 and first quarter of 2016. 3. See Board of Governors of the Federal Reserve System, The private nonfinancial-sector credit-to-GDP ratio Federal Deposit Insurance Corporation, and office of the has stayed near the levels that prevailed in the mid- Comptroller of the Currency (2016), “Agencies Propose Net 2000s, though it is below conventional estimates of Stable Funding Ratio Rule,” joint press release, May 3, https:// www.federalreserve.gov/newsevents/press/bcreg/20160503a. its long-term upward trend. In addition, debt growth htm. in the household sector remained modest and mostly 4. See Board of Governors of the Federal Reserve System attributable to prime borrowers. In contrast, leverage for (2016), “Federal Reserve Board Proposes Rule to Support U.S. the nonfinancial corporate sector has stayed elevated Financial Stability by Enhancing the Resolvability of very Large and indicators of corporate credit quality, though still and Complex Financial Firms,” press release, May 3, https:// www.federalreserve.gov/newsevents/press/bcreg/20160503b. solid overall, continued to show signs of deterioration htm. for lower-rated firms, especially in the energy sector. 5. See Board of Governors of the Federal Reserve System Even so, the risks posed by the elevated indebtedness and Federal Deposit Insurance Corporation (2016), “Agencies of nonfinancial corporations may be attenuated by Announce Determinations and Provide Feedback on Resolution Plans of Eight Systemically Important, Domestic substantial cash holdings of investment-grade firms, Banking Institutions,” joint press release, April 13, https:// relatively low interest expenses, and limited short- www.federalreserve.gov/newsevents/press/bcreg/20160413a. term debt. htm. 22 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 30. Yields on nominal Treasury securities . . . longer-term nominal Treasury yields decreased . . . Daily Percent Yields on 5-, 10-, and 30-year nominal 7 Treasury securities declined in the first half 6 of the year on balance (figure 30). Treasury 10-year 30-year 5 yields decreased most notably in the early 4 part of the year amid an increase in safe- 3 haven demands and a pullback from risky assets. Yields changed little since then, on 2 5-year net, as risk sentiment generally improved but 1 concerns about longer-term economic growth 0 remained. Consistent with the change in 2000 2002 2004 2006 2008 2010 2012 2014 2016 yields on Treasury securities, yields on 30-year agency mortgage-backed securities (MBS)—an NOTE: The Treasury ceased publication of the 30-year constant maturity series on February 18, 2002, and resumed that series on February 9, 2006. important determinant of mortgage interest SOURCE: Department of the Treasury. rates—decreased, on balance, in the first half 31. Yield and spread on agency mortgage-backed of 2016 (figure 31). securities . . . broad equity price indexes increased Percent Basis points slightly, and those of companies linked to 9 400 energy sectors rose substantially . . . 350 8 Yield After incurring sharp declines early in the year, 300 7 broad equity price indexes rebounded as risk 250 6 sentiment improved, resulting in levels that 200 5 were slightly higher, on net, than at year-end 150 4 (figure 32). In addition, reflecting the rebound 100 Spread in oil prices since the turn of the year, stock 3 50 prices of companies in the energy sector 2 0 outperformed broad equity market indexes 2000 2002 2004 2006 2008 2010 2012 2014 2016 over the first half of 2016. Meanwhile, implied NOTE: The data are daily. Yield shown is for the Fannie Mae 30-year volatility of the S&P 500 index increased current coupon, the coupon rate at which new mortgage-backed securities through mid-February and then declined, would be priced at par, or face, value. Spread shown is to the average of the 5- and 10-year nominal Treasury yields. ending the period above its year-end level. SOURCE: Department of the Treasury; Barclays. . . . while risk spreads on corporate bonds 32. Equity prices narrowed Daily December 31, 2007 = 100 Similar to the movements in equity markets, 160 spreads on corporate bonds over comparable- 140 maturity Treasury securities widened early Dow Jones bank index 120 in the year but later retraced those moves, leaving spreads generally little changed, on 100 net, over the first half of the year. Spreads 80 on the lowest-rated speculative-grade issues 60 declined appreciably. Nonetheless, corporate S&P 500 index 40 bond spreads stayed notably above their 20 historical median levels, consistent with some deterioration in credit quality in the 1995 1998 2001 2004 2007 2010 2013 2016 corporate sector. NOTE: For Dow Jones Indices licensing information, see the note on the Contents page. SOURCE: Standard and Poor’s Dow Jones Indices via Bloomberg. MoNETARy PoLICy REPoRT: JUNE 2016 23 Bank credit continued to expand, but 33. Ratio of total commercial bank credit to nominal gross profitability declined domestic product Aggregate credit provided by commercial Quarterly Percent banks increased at a solid pace through May (figure 33). The expansion in bank credit 75 reflected strong loan growth coupled with 70 a modest increase in banks’ holdings of securities. The growth of loans on banks’ 65 books was generally consistent with banks’ reports in the April SLOOS of stronger 60 demand for most loan categories and easier lending standards for loans to households. 55 Measures of bank profitability remained 2006 2008 2010 2012 2014 2016 below their historical averages and declined in SOURCE: Federal Reserve Board, Statistical Release H.8, “Assets and Liabilities of Commercial Banks in the United States”; Department of the first quarter of 2016, pressured by higher Commerce, Bureau of Economic Analysis. provisioning for losses on loans to borrowers in the oil and gas sectors, reduced trading and 34. Profitability of bank holding companies investment banking revenues, and continued low net interest margins (figure 34). However, Percent, annual rate Percent, annual rate with the exception of C&I loans, loan 2.0 delinquency and charge-off rates continued Return on assets 30 1.5 to decline across most major loan types and 20 1.0 remained near or at their lowest levels since 10 the financial crisis. Stock prices of large bank . + 5 Return on equity + holding companies decreased over the first _0 _0 .5 half of the year, while banks’ credit default 10 1.0 swap spreads increased and stayed above their 20 1.5 average level over the past two years. 30 2.0 Measures of liquidity conditions and 1998 2001 2004 2007 2010 2013 2016 functioning in financing markets were NOTE: The data are quarterly and are seasonally adjusted. generally stable SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Bank Holding Companies. Available indicators of Treasury market functioning have remained broadly stable over the first half of 2016. A variety of liquidity metrics—including bid-asked spreads and bid sizes in secondary markets for Treasury securities—have displayed no notable signs of liquidity pressures over the same period. In addition, Treasury auctions generally continued to be well received by investors. Liquidity conditions in the agency MBS market also appeared to be generally stable. Dollar-roll-implied financing rates for production coupon MBS—an indicator of the scarcity of agency MBS for settlement— 24 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS suggested limited settlement pressures over the first half of 2016. In addition, measures of corporate bond market liquidity, such as gauges of the effect of trades on market prices, stayed at levels comparable with those seen prior to the financial crisis. However, accurately measuring liquidity in fixed-income markets can be challenging, and liquidity conditions may vary in certain segments of the market or during times of stress. Short-term dollar funding markets also continued to function smoothly during the first half of 2016. There were generally no signs of stress in either secured or unsecured money markets, including at March quarter-end. Municipal bond markets functioned smoothly despite recent developments on Puerto Rico’s debt Credit conditions in municipal bond markets continued to be stable even as the situation facing Puerto Rico and its creditors deteriorated further. Gross issuance of municipal bonds remained solid in the first quarter, and yield spreads on general obligation (GO) municipal bonds over comparable-maturity Treasury securities increased a bit on net. Puerto Rico’s Government Development Bank missed a substantial debt payment due in early May, 35. Equity indexes for selected foreign economies and investors remained focused on the next Weekly January 6, 2014 = 100 sizable payment of GO bonds due in July. 135 International Developments United 125 Kingdom 115 Foreign financial market conditions 105 improved after tightening early in the 95 year Euro area Japan 85 Foreign financial market conditions tightened Emerging markets 75 early in the year, with bond spreads rising 65 and equity markets falling in most countries as investor concerns about global economic 2014 2015 2016 growth increased, particularly with regard NOTE: The data are weekly averages of daily data and extend through June 16, 2016. For Dow Jones Indices licensing information, see the note on the to China (figure 35). Since mid-February, Contents page. in response to the release of some positive SOURCE: For Japan, Tokyo Stock Price Index (TOPIX); for the euro area, Dow Jones Euro STOXX Index; for the United Kingdom, FTSE 350 Index; foreign data, reassuring moves by Chinese for emerging markets, Morgan Stanley Emerging Markets MXEF Capital Index; all via Bloomberg. policymakers, and a market perception that MoNETARy PoLICy REPoRT: JUNE 2016 25 U.S. monetary policy would be somewhat 36. 10-year nominal benchmark yields in selected more accommodative than previously advanced economies expected, financial conditions generally Weekly Percent improved. A rebound in oil prices also seemed to reassure investors, possibly by diminishing 3.0 United States financial stability concerns around oil- 2.5 producing firms and oil-exporting economies. 2.0 Bond yields, however, have generally moved United Kingdom 1.5 lower since February, both because of low Germany 1.0 readings on inflation and in response to the Japan .5 U.S. employment report in June (figure 36). + _0 The dollar depreciated early in the year .5 but has risen, on balance, more recently 2014 2015 2016 After increasing more than 20 percent from NOTE: The data are weekly averages of daily data and extend through June 16, 2016. mid-2014 through its recent peak in January of SOURCE: Bloomberg. this year, the broad dollar index—a measure 37. U.S. dollar exchange rate indexes of the trade-weighted value of the dollar against foreign currencies—has declined about Weekly January 6, 2014 = 100 4 percent on balance (figure 37). The exchange value of the dollar fluctuated importantly 130 over the first half of this year in response to 125 Advanced foreign economies shifting views about the path of U.S. monetary 120 policy—falling early on, rising starting in May, 115 and declining again more recently. On net, the dollar declined significantly against currencies Broad 110 of some commodity exporters, including Emerging market economies 105 Canada, as higher oil prices provided support 100 for those currencies. In contrast, the British pound appreciated less against the dollar 2014 2015 2016 than other currencies, likely reflecting investor NOTE: The data, which are in foreign currency units per dollar, are weekly concerns about the upcoming referendum on averages of daily data and extend through June 16, 2016. SOURCE: Federal Reserve Board, Statistical Release H.10, “Foreign whether the United Kingdom should leave the Exchange Rates.” European Union. The Chinese renminbi was 38. Chinese renminbi exchange rate under considerable depreciation pressure late last year and very early in 2016 but stabilized Weekly RMB/USD (inverted scale) as fears that Chinese policymakers would allow 6.0 the renminbi to fall considerably further were allayed by reassuring statements of Chinese 6.1 authorities, positive macroeconomic data, and 6.2 decreased capital outflows (figure 38). 6.3 Economic growth remained modest in 6.4 most advanced foreign economies 6.5 In the euro area, Canada, and Japan, 6.6 economic growth picked up in the first quarter 2014 2015 2016 of 2016 (figure 39). The euro-area economy was supported by the European Central Bank’s NOTE: The data are weekly averages of daily data and extend through June 16, 2016. The line plots the number of Chinese renminbi per U.S. dollar (RMB/USD). Given the inverted scale, the line moving up indicates an appreciation of the renminbi against the dollar. SOURCE: Bloomberg. 26 PART 1: RECENT ECoNoMIC AND FINANCIAL DEvELoPMENTS 39. Real gross domestic product growth in selected highly accommodative monetary policies, and advanced foreign economies the Canadian economy continued to recover from a brief recession in early 2015, with past Percent, annual rate depreciation of the Canadian dollar providing United Kingdom Japan 5 some support. However, GDP growth in Euro area the second quarter is likely to be hampered Canada 4 in Japan (as a result of an earthquake in 3 Q1 April) and in Canada (on account of massive 2 wildfires that have disrupted oil production). 1 In addition, uncertainty related to the + forthcoming U.K. referendum appears to have _0 contributed to a step-down in U.K. growth 1 this year. 2013 2014 2015 2016 Inflation also remained low . . . SOURCE: For the euro area, Eurostat; for Japan, Cabinet Office, Government of Japan; for Canada, Statistics Canada; for the United In most advanced foreign economies (AFEs), Kingdom, Office for National Statistics; all via Haver Analytics. core inflation remained subdued, reflecting continued economic slack in some countries 40. Inflation in selected advanced foreign economies and generally subdued wage growth. As a result, despite the recent rebound in oil prices Monthly 12-month percent change and the inflationary effects of past sizable 4 depreciations of some currencies, headline Japan inflation remained well below central bank 3 targets in Canada, the euro area, Japan, and Canada 2 the United Kingdom (figure 40). 1 . . . leading AFE central banks to maintain + highly accommodative monetary policies _0 United Kingdom Euro area 1 In late January of this year, the Bank of Japan adopted a negative policy rate, and in March, 2014 2015 2016 the European Central Bank reduced its deposit NOTE: The data for Canada and Japan extend through April 2016. rate further into negative territory, increased SOURCE: For the United Kingdom, Office of National Statistics; for Japan, the pace and scope of its asset purchases, Ministry of International Affairs and Communications; for euro area, Statistical Office of the European Communities; for Canada, Statistics and announced a new program of four-year Canada; all via Haver Analytics. loans—potentially at slightly negative rates— to euro-area banks. Meanwhile, the Bank of Canada, the Bank of England, and many other AFE central banks maintained their policy rates at historically low levels. MoNETARy PoLICy REPoRT: JUNE 2016 27 In emerging markets, economic growth 41. Real gross domestic product growth in selected picked up from late last year but remains emerging market economies subpar Percent, annual rate The Chinese economy slowed in the first China Korea 12 quarter (figure 41). However, recent indicators Mexico suggest that more accommodative fiscal Brazil 9 Q1 and monetary policies are providing a lift to 6 economic activity, particularly in the property 3 market, where easier credit conditions have + fueled a sharp turnaround. Elsewhere in _0 emerging Asia, weak external demand from 3 both the advanced economies and China 6 weighed on growth in the first quarter, but exports and manufacturing have improved 2013 2014 2015 2016 more recently. NOTE: The data for China are seasonally adjusted by staff. The data for Mexico, Brazil, and Korea are seasonally adjusted by their respective government agencies. Mexico’s economy was a bright spot in SOURCE: For China, China National Bureau of Statistics; for Korea, Bank of Korea; for Mexico, Instituto Nacional de Estadistica Geografia e Latin America in the first quarter, as GDP Informatica; for Brazil, Instituto Brasileiro de Geografia e Estadistica; all via Haver Analytics. growth picked up despite lackluster exports to the United States; however, it appears economic activity decelerated in the second quarter. In Brazil, the recession continued in the first quarter, reflecting long-standing structural problems, low commodity prices, and a political crisis, subsequently resulting in a change in government. However, the contraction was smaller than in previous quarters, as commodity prices recovered somewhat and the sharp depreciation of the currency last year helped boost exports. Growth was mixed in the rest of South America, with Chilean GDP rebounding sharply while Venezuela’s economy continued to experience a deep recession. 29 P 2 art m P onetary oLiCy Over the first half of the year, monetary policy remained accommodative to support further improvement in labor market conditions and a return to 2 percent inflation. In particular, the Federal Open Market Committee (FOMC) maintained the target range for the federal funds rate at ¼ to ½ percent. This unchanged policy stance was supported, among other factors, by the FOMC’s assessments in the first months of the year that global economic and financial developments posed risks to the economic outlook, and in June that recent information indicated that the pace of improvement in the labor market had slowed. In addition, the Committee’s policy stance reflected its expectation that inflation would remain low in the near term. Looking ahead, the FOMC expects that economic conditions will warrant only gradual increases in the federal funds rate. In determining future adjustments to the federal funds rate, the Committee will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The FOMC maintained the federal funds domestic economic activity appeared to have rate target range at ¼ to ½ percent in the slowed.5 In June, the Committee noted that first half of the year . . . recent information indicated that the pace of improvement in the labor market had slowed, After raising the target range for the federal while growth in domestic economic activity funds rate last December to between ¼ and ½ percent, the Committee has maintained that range over the first half of the year (figure 42). 5. See Board of Governors of the Federal Reserve This unchanged policy stance was supported System (2016), “Federal Reserve Issues FOMC initially by the Committee’s assessment that Statement,” press release, March 16, https://www. global economic and financial developments federalreserve.gov/newsevents/press/monetary/20160316a. htm; and Board of Governors of the Federal Reserve posed risks to the economic outlook, as System (2016), “Federal Reserve Issues FOMC State- expressed in its March 2016 statement, ment,” press release, April 27, https://www.federalreserve. and by its judgment in April that growth in gov/newsevents/press/monetary/20160427a.htm. 42. Selected interest rates Daily Percent 5 10-year Treasury rate 4 3 2 2-year Treasury rate 1 0 Target range for the federal funds rate 2008 2009 2010 2011 2012 2013 2014 2015 2016 NOTE: The 2-year and 10-year Treasury rates are the constant-maturity yields based on the most actively traded securities. SOURCE: Department of the Treasury; Federal Reserve Board. 30 PART 2: MoNETARy PoLICy appeared to have picked up in the spring.6 FOMC meeting, FOMC participants projected The decision to maintain the target range that the appropriate level of the federal funds for the federal funds rate also reflected the rate would be below its longer-run level Committee’s expectation that inflation would through 2018. stay low in the near term, partly because of earlier declines in energy prices and in . . . and stressed that future changes in the prices of non-energy imports, as well the target range for the federal funds rate as recently elevated uncertainty about the will depend on the economic outlook as possible consequences of the U.K. referendum informed by incoming data on European Union membership for the U.S. The FOMC continued to emphasize that, economic outlook. in determining the timing and size of future adjustments to the target range for the federal Over the first half of 2016, the Committee funds rate, the Committee would assess remained particularly attentive to risks to realized and expected economic conditions, the U.S. economic outlook posed by global as informed by incoming data, relative to economic and financial developments. The its objectives of maximum employment and Committee noted earlier in the year that it 2 percent inflation. This assessment would was closely monitoring such developments take into account a wide range of information, and assessing their implications for the labor including measures of labor market market and inflation and for the balance conditions, indicators of inflation pressures of risks to the outlook. The Committee and inflation expectations, and readings on subsequently indicated that these concerns financial and international developments. In had attenuated, but that it would continue to light of the current shortfall of inflation from closely monitor inflation indicators and global 2 percent, the Committee indicated that it economic and financial developments. would carefully monitor actual and expected progress toward its inflation goal. Stronger . . . indicated that the stance of growth or a more rapid increase in inflation monetary policy was likely to remain than the Committee currently anticipates accommodative . . . would likely call for faster increases in the The Committee continued to expect that the federal funds rate; conversely, if conditions federal funds rate was likely to remain, for prove weaker, a lower path of the federal funds some time, below levels that were expected to rate would likely be appropriate. prevail in the longer run, and that with gradual adjustments in the stance of monetary policy, The size of the Federal Reserve’s balance economic activity would expand at a moderate sheet has remained stable pace and labor market indicators would To help maintain accommodative financial continue to strengthen. The Committee also conditions, the Federal Reserve kept its continued to expect inflation to remain low in holdings of longer-term securities at sizable the near term but to rise to 2 percent over the levels over the first half of the year. In medium term as the transitory effects of past particular, the Committee maintained its declines in energy and import prices dissipate existing policy of reinvesting principal and the labor market strengthens further. payments from its holdings of agency debt and agency mortgage-backed securities in agency Consistent with this outlook, in the most mortgage-backed securities and of rolling over recent Summary of Economic Projections, maturing Treasury securities at auction, and it which was compiled at the time of the June anticipates doing so until normalization of the level of the federal funds rate is well under way. 6. See Board of Governors of the Federal Reserve System (2016), “Federal Reserve Issues FOMC With the continuation of the Committee’s Statement,” press release, June 15, https://federalreserve. gov/newsevents/press/monetary/20160615a.htm. reinvestment policy, the Federal Reserve’s total MoNETARy PoLICy REPoRT: JUNE 2016 31 assets have held steady at around $4.5 trillion The Federal Reserve’s remittances to the (figure 43). Holdings of U.S. Treasury Treasury have totaled over $600 billion on a securities in the System Open Market Account cumulative basis since 2008. (SOMA) have remained at $2.5 trillion, and holdings of agency debt and agency The Federal Reserve’s implementation of mortgage-backed securities at approximately monetary policy has continued smoothly $1.8 trillion. Consequently, total liabilities Consistent with the FOMC’s Policy on the Federal Reserve’s balance sheet were Normalization Principles and Plans published mostly unchanged. on September 17, 2014, and augmented with additional operational information at the Interest income on the SOMA portfolio has March 2015 FOMC meeting, the Federal continued to support substantial remittances Reserve continued to use interest paid on to the U.S. Treasury Department. The Federal reserve balances and employ an overnight Reserve provided $117.1 billion of such reverse repurchase agreement (ON RRP) distributions to the Treasury in 2015, which facility to manage the federal funds rate, included a one-time transfer of $19.3 billion and the effective federal funds rate has made in December 2015 to reduce aggregate remained in its target range.8 Specifically, Reserve Bank capital surplus to $10 billion, the Board of Governors left the interest rate as required by the Fixing America’s Surface paid on required and excess reserve balances Transportation Act, and a transfer of unchanged at ½ percent, while the FOMC $24.8 billion during the first quarter of 2016.7 continued to authorize daily ON RRP 7. See Board of Governors of the Federal Reserve 8. See Board of Governors of the Federal Reserve System (2016), “Federal Reserve System Publishes System (2014), “Federal Reserve Issues FOMC Statement Annual Financial Statements,” press release, March 18, on Policy Normalization Principles and Plans,” https://www.federalreserve.gov/newsevents/press/ press release, September 17, www.federalreserve.gov/ other/20160317a.htm; and Board of Governors of newsevents/press/monetary/20140917c.htm; and Board the Federal Reserve System (2016), Quarterly Report of Governors of the Federal Reserve System (2015), on Federal Reserve Balance Sheet Developments “Minutes of the Federal Open Market Committee, (Washington: Board of Governors, May), https://www. March 17–18, 2015,” press release, April 8, www. federalreserve.gov/monetarypolicy/files/quarterly_ federalreserve.gov/newsevents/press/monetary/20150408a. balance_sheet_developments_report_201605.pdf. htm. 43. Federal Reserve assets and liabilities Weekly Trillions of dollars — 4.5 Assets — 4.0 Other assets — 3.5 — 3.0 — 2.5 Agency debt and mortgage-backed securities holdings — 2.0 Credit and liquidity — 1.5 facilities — 1.0 Treasury securities held outright — .5 — 0 Federal Reserve notes in circulation — .5 — 1.0 — 1.5 Deposits of depository institutions — 2.0 — 2.5 — 3.0 Capital and other liabilities — 3.5 Liabilities and capital — 4.0 — 4.5 2008 2009 2010 2011 2012 2013 2014 2015 2016 NOTE: “Credit and liquidity facilities” consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden Lane, Bear Stearns, and AIG; and other credit facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. “Other assets” includes unamortized premiums and discounts on securities held outright. “Capital and other liabilities” includes reverse repurchase agreements, the U.S. Treasury General Account, and the U.S. Treasury Supplementary Financing Account. The data extend through June 15, 2016. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” 32 PART 2: MoNETARy PoLICy operations at an offering rate of ¼ percent. Committee has stated that it intends to phase In addition, the Board of Governors took no out the ON RRP facility when it is no longer action to change the discount rate (the primary needed to help control the federal funds rate. credit rate), which remained at 1 percent. The Federal Reserve also continued to test The FOMC also continued to indicate that the the operational readiness of other policy Federal Reserve’s daily ON RRP operations tools. In particular, two Term Deposit Facility would be undertaken in amounts limited operations were conducted in the first half only by the value of Treasury securities held of 2016; seven-day deposits were offered at outright in the SOMA that are available for both operations at a floating rate of 1 basis such operations and by a per-counterparty point over the interest rate on excess reserves. limit of $30 billion per day. The total take-up at In these operations, term deposit volumes ON RRP operations with the Federal Reserve were broadly in line with those in previous generally decreased in the first half of the year tests with similar parameters. In addition, the and remained at levels below those observed Open Market Desk conducted several small– prior to the increase in the target range for dollar value exercises solely for the purpose of the federal funds rate in December. The maintaining operational readiness. 33 P 3 art s e P ummary of ConomiC rojeCtions In conjunction with the Federal Open under appropriate monetary policy and in the Market Committee (FOMC) meeting held absence of further shocks to the economy. on June 14–15, 2016, meeting participants “Appropriate monetary policy” is defined as submitted their projections of the most the future path of policy that each participant likely outcomes for real output growth, the deems most likely to foster outcomes for unemployment rate, inflation, and the federal economic activity and inflation that best funds rate for each year from 2016 to 2018 satisfy his or her individual interpretation of and over the longer run.9 Each participant’s the Federal Reserve’s objectives of maximum projection was based on information available employment and stable prices. at the time of the meeting, together with his or her assessment of appropriate monetary The median of participants’ projections for policy and assumptions about the factors likely the growth of real gross domestic product to affect economic outcomes. The longer- (GDP) was 2 percent for each year from 2016 run projections represent each participant’s through 2018, in line with the median estimate assessment of the value to which each variable of the longer-run growth rate of real GDP would be expected to converge, over time, (table 1 and figure 1). The median of growth projections in 2016 and 2017 was slightly lower than the median of near-term projections 9. One participant did not submit longer-run projections in conjunction with the June 2016 FOMC made at the time of the March FOMC meeting. meeting. The range of participants’ projections Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assessments of projected appropriate monetary policy, June 2016 Percent Median1 Central tendency2 Range3 Variable Longer Longer Longer 2016 2017 2018 2016 2017 2018 2016 2017 2018 run run run Change in real GDP ......... 2.0 2.0 2.0 2.0 1.9–2.0 1.9–2.2 1.8–2.1 1.8–2.0 1.8–2.2 1.6–2.4 1.5–2.2 1.6–2.4 March projection ........... 2.2 2.1 2.0 2.0 2.1–2.3 2.0–2.3 1.8–2.1 1.8–2.1 1.9–2.5 1.7–2.3 1.8–2.3 1.8–2.4 Unemployment rate .......... 4.7 4.6 4.6 4.8 4.6–4.8 4.5–4.7 4.4–4.8 4.7–5.0 4.5–4.9 4.3–4.8 4.3–5.0 4.6–5.0 March projection ........... 4.7 4.6 4.5 4.8 4.6–4.8 4.5–4.7 4.5–5.0 4.7–5.0 4.5–4.9 4.3–4.9 4.3–5.0 4.7–5.8 PCE inflation .................... 1.4 1.9 2.0 2.0 1.3–1.7 1.7–2.0 1.9–2.0 2.0 1.3–2.0 1.6–2.0 1.8–2.1 2.0 March projection ........... 1.2 1.9 2.0 2.0 1.0–1.6 1.7–2.0 1.9–2.0 2.0 1.0–1.6 1.6–2.0 1.8–2.0 2.0 Core PCE inflation4 .......... 1.7 1.9 2.0 1.6–1.8 1.7–2.0 1.9–2.0 1.3–2.0 1.6–2.0 1.8–2.1 March projection ........... 1.6 1.8 2.0 1.4–1.7 1.7–2.0 1.9–2.0 1.4–2.1 1.6–2.0 1.8–2.0 Memo: Projected appropriate policy path Federal funds rate ............. 0.9 1.6 2.4 3.0 0.6–0.9 1.4–1.9 2.1–2.9 3.0–3.3 0.6–1.4 0.6–2.4 0.6–3.4 2.8–3.8 March projection ........... 0.9 1.9 3.0 3.3 0.9–1.4 1.6–2.4 2.5–3.3 3.0–3.5 0.6–1.4 1.6–2.8 2.1–3.9 3.0–4.0 Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are percent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expendi- tures (PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. The March projections were made in conjunction with the meeting of the Federal Open Market Committee on March 15–16, 2016. One participant did not submit longer-run projections in conjunction with the June 14–15, 2016, meeting. 1. For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. 2. The central tendency excludes the three highest and three lowest projections for each variable in each year. 3. The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year. 4. Longer-run projections for core PCE inflation are not collected. 34 PART 3: SUMMARy oF ECoNoMIC PRoJECTIoNS Figure 1. Medians, central tendencies, and ranges of economic projections, 2016–18 and over the longer run Percent Change in real GDP Median of projections Central tendency of projections 3 Range of projections 2 Actual 1 2011 2012 2013 2014 2015 2016 2017 2018 Longer run Percent Unemployment rate 9 8 7 6 5 4 2011 2012 2013 2014 2015 2016 2017 2018 Longer run Percent PCE inflation 3 2 1 2011 2012 2013 2014 2015 2016 2017 2018 Longer run Note: Definitions of variables and other explanations are in the notes to the projections table. The data for the actual values of the variables are annual. MoNETARy PoLICy REPoRT: JUNE 2016 35 for real GDP growth in 2017, 2018, and over personal consumption expenditures (PCE) in the longer run widened somewhat relative 2016 stands at 1.4 percent, a bit higher than in to March. March; the median rises to 1.9 percent for 2017 and to the Committee’s objective of 2 percent The median of projections for the for 2018 and over the longer run. The medians unemployment rate edges down from of projections for core PCE inflation also rise 4.7 percent at the end of 2016 to 4.6 percent gradually over the next two years. in 2017 and 2018, modestly below the median assessment of the longer-run normal With regard to participants’ projections of unemployment rate of 4.8 percent. The appropriate monetary policy, the median medians and ranges of the unemployment projection for the federal funds rate rises rate projections for 2016 to 2018 were nearly only gradually from ⅞ percent in 2016 to unchanged from March. 1⅝ percent at the end of 2017 and 2⅜ percent by the end of 2018, somewhat below the The median of projections for inflation as 3 percent median of participants’ estimates measured by changes in the price index for of its longer-run normal level (figure 2). Figure 2. FOMC participants’ assessments of appropriate monetary policy: Midpoint of target range or target level for the federal funds rate Percent 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2016 2017 2018 Longer run Note: Each shaded circle indicates the value (rounded to the nearest ⅛ percentage point) of an individual participant’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. One participant did not submit longer-run projections. 36 PART 3: SUMMARy oF ECoNoMIC PRoJECTIoNS Although the median federal funds rate at the inflation, and other factors. However, the end of 2016 is unchanged from the March economic outlook is inherently uncertain; thus, projection, a number of participants revised each participant’s assessment of appropriate down their projections. For 2017 and 2018, the policy is also necessarily uncertain, especially median projections are ¼ percentage point and at longer time horizons, and will change in ⅝ percentage point lower, respectively, than response to changes to the economic outlook in March. The median estimate of the longer- and associated risks. run level of the federal funds rate was revised down ¼ percentage point. These projections A more complete description of the Summary represent participants’ individual assessments of Economic Projections will be released with of appropriate policy consistent with their the minutes of the June 14–15, 2016, FOMC projections of economic growth, employment, meeting on July 6. 37 a bbreviations AFE advanced foreign economy C&I commercial and industrial CRE commercial real estate ECI employment cost index FOMC Federal Open Market Committee; also, the Committee GDP gross domestic product GO general obligation MBS mortgage-backed securities Michigan survey University of Michigan Surveys of Consumers ON RRP overnight reverse repurchase agreement PCE personal consumption expenditures SEP Summary of Economic Projections SLOOS Senior Loan Officer Opinion Survey on Bank Lending Practices SOMA System Open Market Account S&P Standard & Poor’s For use at 8:30 a.m., EDT June 21, 2016 M P r onetary olicy ePort June 21, 2016 Board

Federal Reserve (2016, June 20). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20160621

@misc{wtfs_monetary_policy_report_20160621,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2016},
  month = {Jun},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20160621},
  note = {Retrieved via When the Fed Speaks corpus}
}