FRBSF: The Economic Outlook

John Williams of the San Francisco Fed uses twelve graphs to illustrate and support his view of the current economy and the economic outlook:

FedViews, by John Williams, Economic Outlook, FRBSF: Conditions in money markets continue to improve following the turmoil of August and September.

The spread between the one-month LIBOR rate and the comparable maturity Overnight Indexed Swap (OIS) rate is now about 20 basis points, well below the peak of about 90 basis points reached two months ago.  Similarly, the spread between rates on second-tier A2/P2 nonfinancial commercial paper and AA commercial paper has declined to about 30 basis points.  Still, these spreads remain above the levels seen in July.

Securitization of jumbo loans remains impaired and the spread between so-called “jumbo” and conforming fixed-rate mortgages has come down only modestly since the peaks of August and early September. 

The housing slump has deepened further.  Sales of existing homes fell 8 percent in September and are down 19 percent over the past 12 months.  New-home sales rebounded in September, but are still down 23 percent over the past year.  Inventories of new and existing homes for sale are at high levels, putting downward pressure on house prices and building.

House prices in ten metropolitan areas fell on average about 5 percent in the 12 months through August, according to the Case-Shiller Index.  Futures contracts on this index imply investors expect house prices in these cities to decline about 8 percent over the next 12 months.

With demand soft and supply plentiful, housing starts plummeted 10 percent in September, bringing the year-over-year decline to over 30 percent.  Housing permits likewise are in a deep descent, falling 7 percent in September and down 26 percent over the past year.

Despite the bad news in the housing market and the turmoil in financial markets, consumers continued to spend in September.  More recent data, however, suggest consumers may be tightening their grips on their pocketbooks.  Sales of motor vehicles ticked down in October.  Readings of consumer confidence and sentiment have moved down considerably over the past few months. Moreover, the recent surge in energy prices should damp consumption in coming months.

Growth in the manufacturing sector has slowed, reflecting weakness in the automotive and building sectors.  Manufacturing output rose a modest 0.1 percent in September after declining 0.4 percent in August.  The Institute of Supply Management new orders index has softened in recent months. Indicators of business investment, however, have picked up of late.

The advance estimate showed real GDP grew 3.9 percent in the third quarter. Strength in consumer and business spending and exports outweighed the sharp decline in spending on residential investment.  Data released since the GDP numbers came out suggest that third-quarter growth will be revised up to about 5 percent.  Some of the factors that boosted growth last quarter are unlikely to persist, implying some “payback” effect in the fourth quarter.  In addition, the effects of higher energy prices and a sharper decline in spending on residential investment should both drag GDP growth down to an anemic 1 1/4 percent in the current quarter.

Looking further ahead, weakness in the housing market and the effects of falling house prices on household wealth and spending point to below-trend growth of a little over 2 percent next year.   This forecast is subject to a great deal of uncertainty and depends in particular on the evolution of credit and financial conditions and developments in housing markets.

The labor market remains strong.  Nonfarm payrolls added a solid 166,000 jobs in October, well above the pace of about 100,000 jobs per month of the past few months.

The unemployment rate was unchanged at 4.7 percent and is about equal to conventional estimates of the natural rate of unemployment.  Other indicators of labor market conditions are consistent with this view.

Oil prices reached all-time highs in response to concerns over supply and strong demand.  Prices of futures contracts show oil prices coming back down gradually over the next few years, but remaining over $80 a barrel.  The nominal exchange value of the dollar has fallen about 12 percent over the past year.  Both of these developments pose risks to the outlook for inflation.

Nonetheless, core measures of consumer price inflation have been well contained.  The core personal consumption expenditure (PCE) price index (i.e., excluding food and energy) increased 1.8 percent in the 12 months through September.  A sustained rise in food prices pushed the headline PCE price inflation rate to 2.4 percent over the same period.  The recent rise in energy prices will likely cause headline inflation to pick up in the next few months.  Still, with oil prices expected to come back down, headline inflation should moderate to a level in line with core inflation.

Comments

[calmo]

A nice presentation (you flower arrangers agree?) starting with the most important issues and ending with those energy expectations:Still, with oil prices expected to come back down, headline inflation should moderate to a level in line with core inflation. Whose expectations, I wonder? Not likely Hugo Chavez's or those other nationalizing wuzzes (after all the expertise we supplied and they treat us like that!).
And Q3 GDP growth is "likely to go to 5%"...fuggedabout the Fed thinking there was some slowing that needed to be arrested with 75bp (and some think more on the way). So not only was housing not the driver of the economy, it was the big dump truck and as soon as it was off the road, the economy was rocketing upwards? Housing plunges to decade low starts and "unemployment rate was unchanged at 4.7 percent"...meaning residential construction is not credibly reported. [I wonder if oil went to $200/bl whether one could still assert figures for core inflation with a straight face?]
Some flowers in this bouquet aren't "right"...Q3 GDP @ 3.9 , a real dandelion I make it, you?

[reason]

Calmo,
but you know their models tell them everything returns to trend but is affected by short term trends. And guess what - most of the time it works, so they have no reason to change them. The only problem is sometimes there are big sudden reversals. Now I think anybody with sense knows one is due. But saying WHEN it will happen is bloody hard.

[ndd]

First of all, I appreciate Williams sharing such a detailed outlook.

That being said, he lost me when he said that "the labor market remains strong" by adding 100,000 jobs a month (is there anyone who thinks that even keeps pace with population growth?).

I don't recall what the latest studies show w.r.t. the PCE as predictive of future behavior, but let's assume that like core CPI, it has some value as an indicator of headline inflation 2 to 3 years out. The only way I see that happening is if consumers cut back substantially, which means that in between now and then there is probably a recession.

[ken melvin]

The man shouldn't be operating heavy equipment.

[calmo]

I was expecting the response, reason, to be that the Fed is looking ahead, (turning the steering wheel now, knowing the wheels turn several quarters later) [not that the mission of the FRSF is to provide *this* story, but to treat us like children in need of reassurance] providing good governance...starting with the fear of insolvency of certain IBs and ending with that reassurance that employment is satisfactory. [In that order as Williams illustrates]
Have I tole you before how the headlines on the graphs drive me nuts? How about the one entitled "Job growth still strong"...which I think is a cognitive test --esp with the captionNonfarm payrolls added a solid 166,000 jobs in October, well above the pace of about 100,000 jobs per month of the past few months. See where that 100,000 horizontal line would fall?...see that declining trend since 2005? [Does J Williams see it?]
Not that I can get excited about employment stats anymore with the continuing mystery of how construction employment can be reported as not following plummeting housing starts...[so many more mysteries associated with that 'advance' Q3GDP]
Like I say, the piece is not interested in mysteries...wrong genre. And to the extent that this was prolly vetted by the Fed, neither is the FOMC...now that the herd is restless and short on trust of the banking industry.

[ken melvin]

Some people are too smart to play the game.

[Patricia Shannon]

One of the things that distorts the unemployment figures is that many of the construction jobs were filled by Mexican immigrants. When their jobs end, many go back to Mexico. In my manufactured home park, where almost all the residents are Mexican immigrants, there are several homes for sale. I never see the "for sale" signs taken down, just more going up. A few days ago, I saw a couple on my block. I notice people putting large things out on the curb, possibly thinning out their possessions before they move.

My observation of many years is that to know the true state of the economy, you talk to ordinary people, esp. job seekers. And in recnt polls, half the people believe we're already in recession. As I said in another blog, there are cases of government agencies deliberately us about the state of the economy, always in the direction of saying it's better than it is.

[ken melvin]

Yes Patricia, I've known the SFChron business page to headline a story that was obviously false in the hopes that it would effect the market. AP does it too.

[calmo]

How dare you spend time on other blogs, Patricia!As I said in another blog, there are cases of government agencies deliberately [telling] us about the state of the economy, always in the direction of saying it's better than it is. I suppose we shouldn't expect headlines that tell us NOW IS A GOOD TIME TO TAKE YOUR MONEY OUTA THE BANK.
The actual anomaly of BLS construction jobs diverting from housing starts (ie plunging housing starts yet respectable, ("gravity defying" for all you wylie coyote lovers) --residential construction jobs (all going to commercial and industrial? --spare me your desperation) that should have peeked more than a year ago and fallen (ok, with a quarter or 2 lag) have remained inexplicably high...embarrassingly high...incredibly high.
ken, I know the headlines on those graphs are tellin "some of us" to Beat It...but honest to Pete (even Shaeffer), who do you think bothers to read these FRB missives? Should we offer critiques by suggesting toboggans sliding down some of the delcines on those graphs? pussycats? balloons?
Sadly, tis a small boutique audience...shall we break the news to the SFRB?