Current Economic Climate Overview The Federal Reserve publishes a report (known as the Beige Book) eight times per year that summarizes current economic conditions throughout the twelve Federal Reserve Districts ( Districts ) in the United States. In the most recent Beige Book publication, it was noted that: 1 Most of the Districts reported modest or moderate economic growth from early April through late May. Consumer spending softened with many Districts reporting little or no change in non-auto retail sales. Auto sales have decreased from last year s record highs in several Districts. Moderate growth in manufacturing and nonfinancial service sectors continued to be reported in a majority of Districts. Construction of new homes and nonresidential structures as well as sales of existing homes continued to grow at modest to moderate rates. A majority of Districts reported firms expressed positive near-term outlooks but optimism decreased in a few districts. Labor markets continued to tighten as a majority of Districts reported labor shortages across a broadening range of occupations and regions. Most Districts reported modest increases in pricing pressures, although rapidly rising costs for lumber, steel, and other commodities were noted and falling prices for groceries, apparel, and automobiles were noted in some Districts. Federal Open Market Committee Monetary Policy The Federal Open Market Committee (FOMC) acts as the monetary policymaking body of the Federal Reserve System and makes all decisions regarding open market operations, which affect the federal funds rate (rate at which depository institutions lend to each other), the size of the Federal Reserve s asset holdings, and public communication regarding the likely course of future monetary policy. 2 Information received by the FOMC since they last met in May indicated that: 3 The labor market has continued to strengthen and economic activity has been expanding at a moderate pace this year. Job gains have moderated but have been solid on average since the beginning of the year and the unemployment rate has declined. 1 Summary of Commentary on Current Economic Conditions By Federal Reserve District, May 31, 2017. Beige Book, Federal Reserve. 2 Structure of the Federal Reserve System, Federal Open Market Committee. Internet: https://www.federalreserve.gov/aboutthefed/structure-federal-open-market-committee.htm 3 Board of Governors of the Federal Reserve System, Press Release. June 14, 2017. Internet: https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm
Household spending has been rising in recent months and business fixed investment has continued to expand. Inflation has declined recently and is currently below 2.0 percent. Market based measures of inflation compensation remain low and survey-based measures of longer-term inflation expectations were little changed and remained higher than market based measures. Moreover, it was noted that the FOMC continues to expect that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. 4 Inflation is expected remain below 2.0 percent in the near term and to rise to 2.0 percent over the medium term. 5 With these expectations in mind, the FOMC decided to raise the target range for the federal funds rate from 1.0 to 1.25 percent. 6 The Committee further noted that it expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. 7 The FOMC s stance on monetary policy remains accommodative to support some further strengthening of labor market conditions and a return to the 2.0 percent inflation target. 8 Current Employment Conditions The Bureau of Labor Statistics (BLS) reported that the unemployment rate was little changed at 4.3 percent in May of 2017. 9 Total nonfarm payroll employment increased by 138,000 in May with employment gains primarily experienced in health care and mining. 10 The following exhibit contains historical unemployment rates for the United States as reported by the BLS, indicating a clear trend of decreasing unemployment rates in recent years and months. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2015 5.7% 5.5% 5.4% 5.4% 5.5% 5.3% 5.2% 5.1% 5.0% 5.0% 5.0% 5.0% 2016 4.9% 4.9% 5.0% 5.0% 4.7% 4.9% 4.9% 4.9% 4.9% 4.8% 4.6% 4.7% 2017 4.8% 4.7% 4.5% 4.4% 4.3% Source: YCharts.com UNITED STATES UNEMPLOYMENT RATE 4 5 6 7 8 9 The Employment Situation May 2017. Bureau of Labor Statistics. News Release, June 2, 2017. 10
Current Interest Rates and Market Implied Inflation Compensation The yields in the following exhibit were reported by the Federal Reserve for constant maturity treasuries (nominal and inflation-indexed) as of June 26, 2017. Taking the difference between nominal and inflation-indexed yields provides a market-based estimate for inflation compensation over each maturity period. As previously, noted, the FOMC perceives current market based measures of inflation as being low. Survey based measures of inflation, as will be discussed in reviewing the forecasts published under the Livingston survey, indicate higher levels of expected inflation. Maturity 5 Year 7 Year 10 Year 20 Year 30 Year Nominal Treasuries 1.77% 1.97% 2.14% 2.22% 2.70% Treasury Inflation Protected Securities 0.16% 0.30% 0.43% 0.70% 0.86% Market Implied Inflation 1.61% 1.67% 1.71% 1.52% 1.84% Source: YCharts.com MARKET IMPLIED INFLATION The following exhibit contains a graph of the treasury yield curve as of June 26, 2017 compared to the yield curve a year ago (June 26, 2016). As can be seen in the exhibit, yields have increased across all maturity levels over the course of the year. However, the change in short-term rates was notably higher than those of longer-term maturities, likely due to the high sensitivity of shortterm treasury yields to changes in the federal funds rate. The moderate upward slope of the yield curve suggests that the long-term outlook for the economy is moderately positive.
Economic Forecast Major Indicators The Livingston Survey, first conducted in 1946, is the oldest continuous survey of economists expectations for major economic indicators. The survey summarizes the forecasts of economists from industry, government, banking, and academia. Unless otherwise noted, all forecasts in this outlook refer to those published under the Livingston Survey. The most recent survey, released on June 16, 2017, noted the following forecasts for major macroeconomic indicators.
LIVINGSTON SURVEY MAJOR MACROECONOMIC FACTORS FORECAST OVERVIEW Annual Growth Indicators (%) 2017 2018 Real Gross Domestic Product 2.2 2.5 Nominal Gross Domestic Product 4.3 4.6 Nonresidential Fixed Investment 4.5 4.1 Corporate Profits After Taxes 3.3 4.9 Industrial Production 2.0 2.7 Producer Prices - Finished Goods 3.3 2.0 Consumer Price Index 2.4 2.3 Average Weekly Earnings in Manufacturing 1.4 3.0 Retail trade 4.4 4.2 Levels of Variables Indicators 2017 2018 Total Private Housing Starts (Annual Rate, Millions) 1.26 1.33 Unemployment Rate (%) 4.50 4.20 Automobile Sales (Incl. Foreign)(Annual Rate, Millions) 6.30 6.30 Financial Indicators (Level at End of Month) Jun-17 Dec-17 Jun-18 Dec-18 Prime Interest Rate 4.25 4.50 4.75 5.25 10-Year Treasury Note Yield 2.40 2.75 3.00 3.30 3-Month Treasury Bill Rate 1.00 1.30 1.60 2.02 Stock Prices (S&P 500 Index) 2,410 2,470 2,550 2,630 Long Term Outlook (Average Annual Growth % for the Next 10 Years) Real GDP 2.20 Consumer Price Index 2.32 Source: Federal Reserve Bank of Philadelphia, Livingston Survey, June 2017 Summary of Major Macroeconomic Indicators Gross Domestic Product (GDP) and Inflation Real and nominal GDP are both expected to increase in 2017 and 2018. Of note, Real GDP growth is expected to increase by more in 2018 than in 2017, while the spread between nominal GDP and real GDP is expected to remain constant, suggesting increasing levels of real growth and relatively stable inflation over the near term. Long-term real GDP growth for the next ten years is expected to average 2.20 percent, representing moderate expected real growth. Market based estimates of inflation, as previously discussed, suggest that long-term (10-year maturity) inflation compensation is approximately 1.7 percent. Comparatively, the Livingston Survey s estimate of inflation as measured by growth in the Consumer Price Index (CPI) is expected to be 2.32 percent over the next ten years. As previously noted, the Federal Open Market Committee believes that current market-based measures of inflation (such as those implied by the spread in non-inflation and inflation indexed securities) are low. In consideration of both the market based and survey based estimates of inflation, it would appear reasonable to conclude that long-term (10-year) growth in nominal GDP is expected to be on average, within the realm of roughly 3.9 to 4.5 percent.
Industrial Production and Manufacturing The Institute for Supply Management s (ISM) Purchasing Managers Index (PMI) can be used as an indication as to whether or not the manufacturing sector of the economy is expanding or contracting. A PMI above 50.0 percent indicates that the manufacturing economy is generally expanding while a reading below 50.0 percent indicates that it is generally contracting. The PMI rose slightly to 54.9 percent in May of 2017, indicating growth in the manufacturing economy for the ninth consecutive month. The average PMI over the last twelve months has been 53.9 percent, with a reading above 50.0 percent for eleven out of the trailing twelve months, indicating healthy activity in the manufacturing sector. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2015 53.5 52.9 51.5 51.5 52.8 53.5 52.7 51.1 50.2 50.1 48.6 48.0 2016 48.2 49.5 51.8 50.8 51.3 53.2 52.6 49.4 51.5 51.9 53.2 54.5 2017 56.0 57.7 57.2 54.8 54.9 Source: YCharts.com Forecasts, as published under the Livingston Survey, indicate that Industrial production (manufacturing, mining, and electric and gas utilities) is expected to grow by 2.0 percent in 2017 and 2.7 percent in 2018. Moreover, average weekly earnings in manufacturing are expected to grow by 1.4 percent and 3.0 percent in 2017 and 2018, respectively. Consumer Confidence ISM PURCHASING MANAGERS INDEX (%) The backbone of the United States economy is its consumer base. Consumers influence the outlook for the United States economy immensely through their spending and savings decisions. As such, measures of consumer confidence and sentiment may provide valuable information in discerning the expected outlook of the economy. The University of Michigan s June 2017 Surveys of Consumers reported the following results: UNIVERSITY OF MICHIGAN SURVEYS OF CONSUMERS Jun-17 May-17 Jun-16 M-M Change Y-Y Change Index of Consumer Sentiment 95.1 97.1 93.5-2.1% 1.7% Current Economic Conditions Index 112.5 111.7 110.8 0.7% 1.5% Index of Consumer Expectations 83.9 87.7 82.4-4.3% 1.8% Source: University of Michigan, Surveys of Consumers, Final Results for June 2017. In his commentary, Surveys of Consumers chief economist, Richard Curtin, noted the following key points: 11 Consumer confidence slipped to its lowest level since Donald Trump was elected as President, but overall the level of consumer confidence remains favorable. 11 University of Michigan, Surveys of Consumers, Final Results, June 2017. Internet: http://www.sca.isr.umich.edu/
The average level of the Sentiment Index during the first half of 2017 was the best halfyear average since the second half of 2000. The partisan gap in the Sentiment Index between Democrats and Republicans was 39 index points, little changed from the 38 point partisan gap in February. The optimism among Republicans and Independents has resisted declines in the past several months despite a lower likelihood that President Trump s agenda will be passed in 2017. Increasing uncertainty about future prospects for the United States Economy has been offset by a revival in consumers personal financial situations. While the combination of continuing improvements in personal finances and increasing concerns about the economic outlook are typical around cyclical peaks, the data did not suggest an imminent downturn, nor did the data suggest a resurgence in consumer spending. Personal consumption spending is expected to advance during 2017 by roughly 2.3 percent. Corporate Profits and Retail Trade Corporate profits after taxes are expected to increase by 3.3 percent in 2017, followed by higher expected growth of 4.9 percent in 2018. Retail trade is expected to grow considerably in coming years with expected growth of 4.4 percent and 4.2 percent in 2017 and 2018, respectively. Unemployment The unemployment rate is forecast to be 4.5 percent in 2017 and to improve marginally thereafter to 4.2 percent 2018. These forecasts are consistent with the FOMC s expectations that labor market conditions will strengthen somewhat further. 12 However, it appears that only marginal gains can be expected to be achieved in the unemployment rate as the economy is likely near or approaching full employment. Housing Expectations for private housing starts were revised slightly upward for both 2017 and 2018 compared to the December 2016 Livingston Survey. Private housing starts are expected to grow by 7.1 percent and 5.6 percent and 2017 and 2018, respectively, as illustrated in the following exhibit. 12 Board of Governors of the Federal Reserve System, Press Release. June 14, 2017. Internet: https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm
Financial Markets TOTAL PRIVATE HOUSING STARTS (ANNUAL RATE) Year Previous* Housing Starts Change Forecast Growth 2016A 1,169,000 1,177,000 8,000 2017F 1,256,000 1,260,000 4,000 7.1% 2018F 1,316,000 1,330,000 14,000 5.6% * Livingston Survey, December 2016 Forecasted Results. Source: Federal Reserve Bank of Philadelphia, Livingston Survey, December 2016 & June 2017 The Livingston Survey forecasts that interest rates will rise over the course of 2017 and 2018, noting expected increases in the prime rate, 10-year treasury yield, and 3-month treasury yield. As of June 28, 2017, the prime interest rate is 4.25 percent. 13 The prime rate is posted by a majority of the top 25 (by assets in domestic offices) insured U.S. chartered commercial banks and is one of the several base rates used by banks to price short-term business loans. 14 While the Federal Reserve does not control the prime rate, many banks base their prime rates partly on the target level of the federal funds rate (the rate that banks charge each other for short-term loans) as established by the FOMC. 15 As previously noted, the FOMC expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. 16 Given this commentary and the known relationship between the prime rate and federal funds rate, the forecasted increases in the prime rate appear reasonable. The forecasted increase in the prime rate is indicative of an expected higher cost of borrowing for companies in the United States. Likewise, the expected increase in the 10-year treasury yield and 3-month treasury yield suggest that the risk free rate is expected to increase in coming years. These increases suggest that, all else equal, the cost of capital for companies in the United States will increase. Moreover, a rising interest rate environment should increase the incentive to save as the cost of spending in the current period becomes less attractive to investors due to the availability of higher rates of return. Compared to the December 2016 Livingston Survey forecasts, the June 2017 Livingston Survey forecasts higher levels of the United States stock market (using forecasts for the expected level of the S&P 500 index as a proxy for the United States stock market) as illustrated in the following exhibit. 13 Board of Governors of the Federal Reserve System, Select Interest Rates, Bank Prime Loan. Internet: https://www.federalreserve.gov/releases/h15/ 14 15 What is the prime rate and does the Federal Reserve set the prime rate? Board of Governors of the Federal Reserve System, Current FAQs. Internet: https://www.federalreserve.gov/faqs/credit_12846.htm 16 Board of Governors of the Federal Reserve System, Press Release. June 14, 2017. Internet: https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm
S&P 500 STOCK INDEX ($) Period Ending Date Previous Estimate New Estimate Change June 30, 2017 2,254.8 2,410.0 155.20 December 29, 2017 2,314.5 2,470.0 155.50 June 29, 2017 N/A 2,550.0 N/A December 31, 2018 2,400.0 2,630.0 230.00 Source: Federal Reserve Bank of Philadelphia, Livingston Survey, June 2017. The consistent positive changes across the different period ending dates suggests that in aggregate, economic conditions have evolved in a way that is favorable to United States equity valuations in general. Economic Outlook Summary Current economic conditions and forecasts of major economic indicators for the United States economy suggest that the economy is well positioned for moderate growth in the coming years. Unemployment levels have been trending downward and the economy is likely at or near full employment. Moreover, consumer confidence remains favorable despite declining levels in recent months. While economic uncertainty has increased, personal financial situations are seeing improvement and both the Livingston Survey and consumer sentiment data suggest that an economic downturn is not anticipated in the near-term. A rising interest rate environment should encourage additional savings, and in turn, will likely temper growth in consumer spending.