Economic Outlook. William Strauss Senior Economist and Economic Advisor Federal Reserve Bank of Chicago

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1 Economic Outlook CRF Credit & A/R Forum & EXPO Salt Lake City, UT October 23, 218 William Strauss Senior Economist and Economic Advisor Federal Reserve Bank of Chicago

2 What I said In August The outlook is for the U.S. economy to expand at a above trend in 218 and 219 and close to trend in 22 Employment is expected to rise moderately with the unemployment rate remaining very low Inflation is forecast rise to the Fed s Inflation target this year Housing is predicted to improve at a modest pace Vehicle sales are anticipated to edge lower this year and in 219 Manufacturing output is expected to increase at a rate above trend in 218

3 GDP expanded by 2.9% over the past year Real gross domestic product percent Percent change from a year earlier Quarterly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11'12'13'14'15'16'17'18

4 The Chicago Fed National Activity Index 3-month average has been above trend this year Chicago Fed National Activity Index Three month average Monthly 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1 '11 '12 '13 '14 '15 '16 '17 '18

5 The real value of the stock market is very high Index: 199 = Real S&P 5 stock index 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

6 The Federal Open Market Committee (FOMC) expects GDP to grow above trend this year and in 219; and around trend in 22 and 221 Real gross domestic product percent change from a year earlier FOMC Central Tendency (September 218) Longer run FOMC 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18'19'2'21

7 The probability of recession in the next quarter has eased percent Probablility of a recession one quarters ahead (Survey of Professional Forecasters) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

8 The same is true for the chances of a recession over the next two quarters percent Probablility of a recession two quarters ahead (Survey of Professional Forecasters) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

9 The index of leading indicators continues to rise Index (216=1) Composite Index of 1 Leading Indicators 196 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

10 Employment increased by over 2.5 million jobs over the past 12 months Total employment percent Percent change from a year earlier Quarterly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18

11 The unemployment rate has fallen to 3.7% percent Unemployment rate 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

12 Unemployment rates by race are at or near record lows Unemployment rate percent 25 2 Black 15 1 Hispanic 5 White Asian 197 '75 '8 '85 '9 '95 ' '5 '1 '15

13 Unemployment rates by race are at or near record lows percent Unemployment rate Hispanic Black White Asian 2 '5 '1 '15

14 The FOMC forecasts that the unemployment rate will be well below the natural rate through 221 percent Unemployment rate FOMC Central Tendency (September 218) Longer run FOMC 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19 '2 '21

15 Wages and benefit costs continue to increase at a moderate rate, although it may finally be picking up some its pace Employment cost index percent change from year ago 8 7 benefit costs wages and salaries 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1 '11 '12 '13 '14 '15 '16 '17 '18

16 There is a very strong correlation between 9-month lead NFIB: planning to raise compensation and Employment Cost Index: wages and salaries 2 15 Empolyment cost index wages and salaries and NFIB: Companies planning to raise wages and salaries % of frims 25 ECI: wages and salaries (private industry workers) right scale % y/y NFIB: Companies planning to raise worker compensation (9 month lead) left scale Correlation = '88 '9 '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '

17 Slow productivity growth over the past nine years helps explain why relatively strong employment growth has not translated into higher wages percent change (2 qtr ra te) Productivty 195 '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

18 A large part of the weakness in productivity growth has been the weak pace of investment, although it has been increasing at a strong pace beginning in Real private nonresidential fixed investment percent 1 1 Percent change from a year earlier 2 3 Quarterly change (saar) 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

19 This may help explain the productivity growth improvement over the past year Productivty percent change from a year earlier '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

20 Improving productivity growth is helping to keep unit labor cost growth down even with compensation rising percent Unit labor cost Percent change from a year earlier Quarterly change (saar) 195 '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

21 Corporate profits continue to improve percent Nonfinancial corporate profits Quarterly change (saar) Percent change from a year earlier 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

22 Inflation has moved above the Fed target of 2% Personal consumption expenditure chain price index percent change from a year earlier '91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

23 In large part inflation has been following the pattern of energy prices dollars per barrel,217 dollars Real West Texas Intermediate oil price 197 '75 '8 '85 '9 '95 ' '5 '1 '15

24 Natural gas prices have increased but remains low dollars per mmbtu, 217 dollars Real natural gas price 1994'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

25 Low energy prices have occurred in part due to technology that now allows access to reserves that have been known for quite a few years

26 Imports of oil has been sharply reduced thousand of barrels per day 15, 14, 13, 12, 11, 1, 9, 8, 7, 6, Imports of crude and petroleum products 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

27 Exports of oil has surged over the past decade Exports of crude and petroleum products thousand of barrels per day 8, 7, 6, 5, 4, 3, 2, 1, 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

28 Net imports of oil has been cut by around 6% Net imports of crude and petroleum products thousand of barrels per day 14, 12, 1, 8, 6, 4, 2, 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

29 The rig count has been moving higher 2,5 U.S. rig count 2, 1,5 1, 5 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

30 The U.S. has become less dependent on energy to drive its economy Primary energy consumption per dollar of GDP thousandbtu per chained (29) dollar '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

31 Expenditures on energy remain well below the historical average Energy goods and services expenditures as a share of total consumption percent s 7s 8s s s 1s '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

32 Removing the volatile food and energy components from the PCE, core inflation is at 2% Personal consumption expenditure less food and energy percent change from a year earlier chain price index '91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

33 The FOMC anticipates that PCE inflation will be around its two percent target through 221 Personal consumption expenditure chain price index percent change from a year earlier FOMC Central Tendency (September 218) Longer run '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '18 '2 FOMC

34 The FOMC anticipates that core PCE inflation will get to also remain around two percent through 221 Personal consumption expenditure less food and energy percent change from a year earlier chain price index 5 FOMC Central Tendency (September 218) FOMC '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '18 '2

35 Blue Chip International Consensus Forecasts Inflation Exchange Rate Real GDP % change Against Interest Rates % change Annual US Dollar 3 Month Annual Consumer Prices End of Year End of Year United States Canada Mexico Japan South Korea ,121 1, United Kingdom Germany France Euro Zone Brazil Russia China India Blue Chip Economic Indicators Forecast October 1, 218

36 More open countries have had better growth

37 U.S. trade has been growing percent of GDP Exports and imports Imports Exports 195 '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

38 But U.S. runs a sizeable trade deficit 2 U.S. trade share percent of GDP Imports 15 1 Exports 5 5 Net exports '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

39 U.S. tariffs used to be much higher

40 Other countries have also reduced tariffs

41 Tariffs: U.S. versus other countries

42 Manufacturing output is increasing at a solid pace Industrial production manufacturing percent 15 1 Percent change from a year earlier Quarterly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

43 Capacity utilization has been moving higher over the past year, but is still below full utilization Capacity utilization manufacturing percent '91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

44 The industrial sector output growth has been strong over the past several months Current 3 Month Moving Average Growth is: Above Trend and Accerating Above Trend and Decelerating Below Trend and Accelerating Below Trend and Decelerating Contracting but Improving Contracting and Deteriorating Manufacturing Industries Activity Chart Growth (3-month moving average) compared with the most recent 5-year trend 5-year Trend Manufacturing.9% Wood Products 3.4% Nonmetallic Mineral Products 2.% Primary Metals -1.1% Fabricated Metal Products.3% Machinery -.5% Computer and Electronic Components 3.% Electrical Eqpt, Appliances & Components 1.1% Motor Vehicles and Parts 3.5% Aerospace & Misc. Transport Equip -.6% Furniture and Related Products.9% Miscellaneous Durable Goods -1.5% Food, Beverages, and Tobacco 1.7% Textile and Product Mills -1.3% Apparel and Leather Goods -4.9% Paper -.7% Printing and Related Support Activities -.2% Chemicals.8% Petroleum and Coal Products.6% Plastics and Rubber Products 1.5%

45 Manufacturing employment increased by 278, workers over the past 12 months Manufacturing employment percent Percent change from a year earlier 15 2 Quarterly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

46 Manufacturers Purchasing Managers Indexes Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Global United States Canada Mexico Eurozone Germany France Italy Spain UK Russia Japan China India Brazil

47 Year-to-date sales for 218 has averaged 17.1 million units (saar),.3% higher than a comparable a year earlier Light vehicle sales mi l lions of units (saar) '91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

48 Year-to-date light truck sales are 8.2% higher, while year-to-date passenger car sales are 13.8% lower mi l lions of units (saar) Passenger car and light truck sales light trucks passenger cars 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

49 Light truck market share set a record high in August percent Light truck share of light vehicle market sales 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

50 Alternative powered vehicles (including hybrids) are a very small fraction of total vehicle sales percent of total sales Power Type Gasoline and Diesel Alternative 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

51 Alternative powered vehicles (including hybrids) market share only recently exceeded 4% Alternative Powered Vehicles percent of total sales '91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

52 Blue Chip Forecasts vehicle sales to edge lower this year and next year Vehicle sales millions of units Blue Chip Light Vehicle Sales Forecast Actual Forecast '85 '9 '95 ' '5 '1 '15

53 The supply managers composite index remains at a very strong level net percent reporting increases Purchasing managers' index composite 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

54 Industrial production is forecast to improve at a pace above its historical rate this year Total industrial production percent 1 5 Percent change from a year earlier 5 Q Quarterly change (saar) Blue Chip IP Forecast Actual Forecast '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19

55 The Blue Chip Forecast calls for a continuation of the very gradual recovery in housing Housing starts thousands 2,5 Blue Chip Housing Starts Forecast (thousands) Actual Forecast ,28 1,277 1,317 2, 1,5 1, '85 '9 '95 ' '5 '1 '15

56 Credit spreads between Corporate High Yield securities and Corporate Aaa securities remains very low

57 The yield curve remains well above zero Yield curve 1 year Treasury note yield minus 3 month Treasury bill yield percent '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1'11'12'13'14'15'16'17'18

58 Blue Chip expects the yield curve to continue to flatten through next year, but not invert 1 year T Note to 3 month T Bill spread percent 4 3 Blue Chip Forecast Q '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19

59 The Federal Reserve increased the Federal Funds rate by 2.% since December 215 percent Fed Funds rate 199'91'92'93'94'95'96'97'98'99''1'2'3'4'5'6'7'8'9'1'11'12'13'14'15'16'17'18

60 The Federal Funds Rate is expected to be at the top of the neutral range by the end of 219 and slightly above neutral in 22 and 221 percent Target Federal Funds Rate FOMC Central Tendency (September 218) Longer run FOMC 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19 '2 '21

61 The Fed s balance sheet had remained flat for several years but the Fed began reducing it in October 217 Billions of dollars 4,5 4, 3,5 3, 2,5 2, 1,5 1, Assets of the Federal Reserve 5 Maiden Lane II & III AIG Support Central Bank Swaps Commercial Paper Facility Maiden Lane Term Auction Credit 27 '8 '9 Term Asset Backed Securities Loan Facility Securities Held Outright '1 '11 '12 '13 '14 '15 '16 '17 '18

62 Summary The outlook is for the U.S. economy to expand at a pace above trend in 218 and 219 and close to trend in 22 and 221 Employment is expected to rise moderately with the unemployment rate remaining very low Inflation is forecast be at the Fed s Inflation target through 221 Housing is predicted to improve at a modest pace Vehicle sales are anticipated to edge lower this year and in 219 Manufacturing output is expected to increase at a rate above trend in 218 and rise at a somewhat slower pace in 219

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