BOMA National Advisory Council Meeting Seaport Hotel, Boston MA May 5, 2017 Jeff Fuhrer, EVP and Senior Policy Advisor Federal Reserve Bank of Boston 1
Raising rates? Raising rates more this year? Next? If so, why? Are there risks to keeping rates too low? 2
2015:Jan 2015:Mar 2015:May 2015:Jul 2015:Sep 2015:Nov 2016:Jan 2016:Mar 2016:May 2016:Jul 2016:Sep 2016:Nov 2017:Jan 2017:Mar Federal funds rate at end of year Is the Fed raising rates? So far, yes Three increases so far. Diversity of opinion about the future 1.0 0.8 0.6 0.4 0.2 0.0 Target funds rate (end of month) FOMC members projections for federal funds rate Medians indicated by red lines Year Source: FRB H.15 release (funds rate), Board of Governors of the Federal Reserve System, Summary of Economic Projections (SEP) 3 of 19
They clearly think so, on average But it will of course depend on conditions But let s look at some background first to understand WHY are they raising rates? How far might they go? How nuanced a decision is this? Source: Board of Governors of the Federal Reserve System, Summary of Economic Projections (SEP) 4 of 19
2015:Dec 2016:Jan 2016:Feb 2016:Mar 2016:Apr 2016:May 2016:Jun 2016:Jul 2016:Aug 2016:Sep 2016:Oct 2016:Nov 2016:Dec 2017:Jan 2017:Feb 2017:Mar 2016:Jan 2016:Feb 2016:Mar 2016:Apr 2016:May 2016:Jun 2016:Jul 2016:Aug 2016:Sep 2016:Oct 2016:Nov 2016:Dec 2017:Jan 2017:Feb 2017:Mar Percent of the labor force Thousands of jobs, 3-month avg. 5.2 5.1 5.0 4.9 4.8 4.7 4.6 4.5 4.4 Our responsibilities The Dual Mandate : low inflation, maximum (sustainable) employment Where are we in achieving these goals? First, employment: Measures of labor market slack Civilian unemployment rate Estimates of long-run sustainable rate "U-6" (broader measure of unemployment (right scale)) 10.0 9.9 9.8 9.7 9.6 9.5 9.4 9.3 9.2 9.1 9.0 300 250 200 150 100 50 0 Employment growth Total Private Sustainable long-run employment growth Wage growth has accelerated: AHE: 2.8% (12-mo. chg.) NFC: 3.0% (4-qtr. chg.) 178 197 178 148 5 of 19
Inflation: What s our goal? 2% How close are we? Pretty darned close Some of these movements are likely temporary Increases, decreases in energy, import prices We are OK with modest deviations on either side of 2% 2.0 1.6 1.2 0.8 0.4 0.0 PCE inflation, 12-mo. % change Fed s inflation goal = 2% Headline PCE Core PCE Sources: Bureau of Economic Analysis, Haver Analytics 6 of 19
Federal funds rate at end of year So we probably need to move from very stimulative to a bit less stimulative How far will they go? What s a normal interest rate to go with a normal economy? Hard question Here s what the FOMC members say: About 3 percent Committee members projections for federal funds rate Sources: Board of Governors of the FRS, SEP Year 7 of 19
No, we can do this gradually Compare the SEP chart to previous episodes: Note: Much slower Much lower But gradual does not mean 1x per year, at Christmas 7 6 5 4 3 2 1 0 Federal funds rate during previous tightening cycles 1994 2004 Current 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 Month after tightening starts Sources: FRB H.15 release, Haver Analytics 8 of 19
They lead to economic instability A very low unemployment rate has always been followed by a very high one They may lead to financial instability Many talk about reaching for yield The idea is that when low-risk yields are low, folks look for higher yields, which necessarily entails taking on higher risk Signs of this today? 9 of 19
1949:Q1 1952:Q4 1956:Q3 1960:Q2 1964:Q1 1967:Q4 1971:Q3 1975:Q2 1979:Q1 1982:Q4 1986:Q3 1990:Q2 1994:Q1 1997:Q4 2001:Q3 2005:Q2 2009:Q1 2012:Q4 2016:Q3 This chart almost speaks for itself In every episode post World War II, unemployment slipping too far below normal leads to a recession We d prefer a stable, sustained recovery 6.00 4.00 2.00 0.00-2.00-4.00-6.00 Difference between unemployment rate and natural rate 6 5 4 3 2 1 0 10 of 19 Sources: Bureau of Labor Statistics (unemployment rate), Congressional Budget Office (natural rate of unemployment), Haver Analytics
1995:Jan 1996:Sep 1998:May 2000:Jan 2001:Sep 2003:May 2005:Jan 2006:Sep 2008:May 2010:Jan 2011:Sep 2013:May 2015:Jan 2016:Sep Where do we see risks High stock prices? Low price of risk in bonds? High commercial real estate prices/low cap rates? 35 30 25 20 Some potential risks in financial markets S&P 500 price to operating earnings ratio 15-year avg. PE ratio Risk spread 13.0 11.0 9.0 7.0 5.0 15 3.0 10 1.0 Sources:,Standard and Poor s (stock price, PE ratio, BB+ bond yields),frb H.15 release (10-year Treasury yield), Haver Analytics 11 of 19
Cap rates ratio of income from property to its purchase price Pretty low today Partly due to shift into apartments following housing crash Partly due to decreased household formation among 20-30 year olds Also due to low interest rates a fundamental determinant of cap rates But maybe a warning sign, too? 10 8 6 Percent Apartment Capitalization Rate 2001:Q1-2016:Q4 4 2001:Q1 2004:Q1 2007:Q1 2010:Q1 2013:Q1 2016:Q1 Recession Note: The capitalization or cap rate is the ratio of net operating income produced by a property the price paid, calculated at the time of a transaction. Based on properties of $2.5 million or more Source: Real Capital Analytics, NBER, Haver Analytics 12 of 19
2007:Jan 2007:Sep 2008:May 2009:Jan 2009:Sep 2010:May 2011:Jan 2011:Sep 2012:May 2013:Jan 2013:Sep 2014:May 2015:Jan 2015:Sep 2016:May 2017:Jan Has risen over the past four years But not near peak prior to last recession Many CRE loans securitized, not owned by large banks 16 15 14 13 12 11 10 Extension of credit from banks CRE Loans CRE Loans as % of Total Bank Assets Sources: Federal Reserve H.8 release, assets of all commercial banks, Haver Analytics 13
Financial instabilities may become a problem Most worrisome is pushing the economy too far, well past full employment History shows that does not end well Why/how it ends badly varies widely 14
2011:Q1 2011:Q3 2012:Q1 2012:Q3 2013:Q1 2013:Q3 2014:Q1 2014:Q3 2015:Q1 2015:Q3 2016:Q1 2016:Q3 2017:Q1 Index, Jan. 2016=1.0 19.0 Consumer spending 18.5 18.0 17.5 17.0 16.5 16.0 15.5 Vehicle sales (left, millions) Consumer spending (right) 11800.0 11700.0 11600.0 11500.0 11400.0 11300.0 11200.0 11100.0 66000 Capital spending 65000 64000 63000 62000 61000 60000 Orders Shipments Industrial production 104.5 104.0 103.5 103.0 102.5 102.0 101.5 1.15 1.05 0.95 0.85 Housing and construction Permits 1-fam. New home sales 1-fam. Existing home sales 130 120 110 100 90 International trade Contrib. to GDP growth from trade (right) Exchange rate 2.0 1.0 0.0-1.0-2.0 Sources: Survey Research Center (sentiment), Census Bureau (retail sales, orders, shipments, permits, new home sales), NAR (existing home sales), Federal Reserve Board (industrial production, trade-weighted broad exchange rate), Macroeconomic Advisors (2017:Q1-Q2 forecast of net export contribution), Haver Analytics 15
A bit weaker growth than expected in the first quarter Inventories subtracted almost one percentage point Consumer spending grew by less than 0.5% Warm weather, delayed tax refunds, poor seasonal adjustment But underlying supports income, wealth, sentiment are good So we expect a rebound for the rest of the year, to an average of greater than 2% 2.5 1.5 0.5-0.5-1.5-2.5 2016:Q1 GDP growth and contributions from components Average, 2016 GDP Inventories Consumption spending Investment Net exports 2017:Q1 Sources: Bureau of Economic Analysis (GDP and its components), Haver Analytics 16
Strong employment growth to date Above-2% GDP growth will likely lead to further declines in unemployment Less of a decline if labor force participation increases At some point, employment growth will slow towards its sustainable rate of 70-100k/month Sources: Bureau of Labor Statistics (unemployment), Haver Analytics 5.2 5.0 4.8 4.6 4.4 4.2 4.0 Labor market outlook Unemp. rate SEP forecast (Median) Range of forecasts 17 of 19
1985:Q1 1987:Q1 1989:Q1 1991:Q1 1993:Q1 1995:Q1 1997:Q1 1999:Q1 2001:Q1 2003:Q1 2005:Q1 2007:Q1 2009:Q1 2011:Q1 2013:Q1 2015:Q1 1985:Q1 1987:Q1 1989:Q1 1991:Q1 1993:Q1 1995:Q1 1997:Q1 1999:Q1 2001:Q1 2003:Q1 2005:Q1 2007:Q1 2009:Q1 2011:Q1 2013:Q1 2015:Q1 Two factors contribute to sustainable growth Increase in number of workers Increase in their efficiency Recently Slow labor force growth (<1%?) (demographics) Slow productivity growth (0.5%?) 3 2 1 0-1 7 6 5 4 3 2-1 01 Labor force growth 4-qtr. Growth 12-qtr. Growth 5-yr. growth Nonfarm productivity growth 4-qtr. Growth 12-qtr. Growth 5-yr. growth Sources: Bureau of Labor Statistics, Haver analytics, author s calculations 18 of 19
Percent Fiscal stimulus could be stronger than our baseline Adds to GDP, lowers unemployment, raises inflation Trade restrictions could weaken growth Effects in 2017? Immigration restrictions could weaken growth of the labor force 20 18 16 14 12 10 8 6 4 2 0 Foreign-born share of labor force and population Share of population Share of labor force 1970 1980 1990 2000 2010 2015 Source: Audrey Singer, Brookings Institution (2012), American Community Survey (2015) 19 of 19
We have a $4.5T balance sheet $1.75T of mortgage-backed securities $2.5T of Treasury securities The result of our QE programs Treasuries mature (on a predictable schedule) MBS prepay (in a way that depends on market conditions and propensity to refinance, sell, etc.) We have been re-investing issues that mature/prepay for the last several years Thus maintaining the size of our balance sheet A huge balance sheet changes the way we control interest rates! 20
2008:Jan 2008:May 2008:Sep 2009:Jan 2009:May 2009:Sep 2010:Jan 2010:May 2010:Sep 2011:Jan 2011:May 2011:Sep 2012:Jan 2012:May 2012:Sep 2013:Jan 2013:May 2013:Sep 2014:Jan 2014:May 2014:Sep 2015:Jan 2015:May 2015:Sep 2016:Jan 2016:May 2016:Sep 4500000 4000000 3500000 Agency and MBS Treasuries Federal Reserve Assets (partial) 3000000 2500000 2000000 1500000 1000000 500000 0 Sources: Federal Reserve H.4.1 release, Haver Analytics 21
2006:Jan 2006:Jun 2006:Nov 2007:Apr 2007:Sep 2008:Feb 2008:Jul 2008:Dec 2009:May 2009:Oct 2010:Mar 2010:Aug 2011:Jan 2011:Jun 2011:Nov 2012:Apr 2012:Sep 2013:Feb 2013:Jul 2013:Dec 2014:May 2014:Oct 2015:Mar 2015:Aug 2016:Jan 2016:Jun 2016:Nov 4500000 Federal Reserve Liabilities (partial) 4000000 3500000 3000000 2500000 2000000 Currency Reserve Balances 1500000 1000000 Reserve composition Type Normal Now 500000 Required 96% 5% 0 Excess 4% 95% Sources: Federal Reserve H.4.1 release, Haver Analytics 22
Our holdings of securities are still exerting downward pressure on long-term rates As part of normalization, reduce this pressure May also wish to have balance sheet capacity in the event of another recession The likelihood of hitting the ZLB has increased Due to low inflation, and low equilibrium real rate No plan at present to return to an era of reserves scarcity (i.e. peg the funds rate by small open market operations) With so much money in the banking system, how to raise rates? 23
Two interest rates that we now use Interest on reserves set by Board, not FOMC Overnight reverse repurchase rate (ONRRP) ONRRPs: What are they? Counterparty lends the Fed money with securities as collateral The Fed can set that interest rate unilaterally We have plenty of assets to sell can affect rates Could be a decision of the FOMC (not the Board) Many counterparties: MMMFs, Banks, GSEs, primary dealers broader effects than IOR Does this rate influence other interest rates? Somewhat like the IOR can be used to put a floor on rates why lend out at a lower rate? So we move IOR and RRP together Both affect prevailing funds rate as well Reverse Repo Fed Bank Reserves+ $ (defines interest rate) Day 1 Day 2 Reserves Note: Repo market $2T vs. normal fed funds = $50-100B 24
Interest rate 1.6 1.5 1.4 1.3 1.2 1.1 1 0.9 0.8 0.7 0.6 PC rate IOR ONRRP Normal range of interest rates Borrowing: Fed sets primary credit rate at 1.5% - No one will borrow above PC rate - Normally, won t lend below IOR - To be extra sure, use reverse repo rate another lending rate to firm up floor on interest rates Lending: Fed sets reserves rate at 1% Fed sets ON repo rate at 0.75% 25
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Federal Reserve Board turnover Congressional legislation to change the Fed The CHOICE Act What s the equilibrium real funds rate today? Going forward? Monetary policy in a low-inflation, low-equilibrium rate environment Optimal inflation rate Overshooting, price-level targeting, etc. ff Y Y * t 2 t 1 0.5( t 2) 0.5( t t ) 27