1

The Economic Outlook Bad, Worse or As Good As It Gets?

Anthony Murphy (anthony.murphy@dal.frb.org)

Federal Reserve Bank of Dallas

NAPAC Conference, Dallas, 20th May 2016

The views expressed are those of the author and do not reflect the views of the Federal Reserve Bank of Dallas or the Federal Reserve System

2

Slow and Uneven Recovery from the Great Recession Output Recovered in 2011 Q2

Employment and Industrial Production Recovered in 2014 Q2

18,000

16,000

14,000

12,000

10,000

8,000

6,0001980 1985 1990 1995 2000 2005 2010 2015

Real GDP (Output)

2011 Q2

Sources BEA. Note: Shaded areas indicate recessions.

3

Recovery from “Great Recession” Slower Than Before

-10

0

10

20

30

40

t-12 t-8 t-4 Trough=t t+4 t+8 t+12 t+16 t+20 t+24

Percent deviation from trough

Average of 5 Previous Recoveries

Current Recovery From 2009 Q2 Trough

Sources: BEA and author’s calculations. Note: The shaded area shows the range of the GDP deviations from the troughs of the five major previous recessions.

4

Much Slower Recovery than in Previous Recessions Many Domestic and External Headwinds/Shocks

5

Consumer Confidence Is Easily Rocked … Expectations Appear To Have Stabilized

20

30

40

50

60

70

80

90

100

110

05 06 07 08 09 10 11 12 13 14 15 16

Index

Conference Board

U. MichiganGovernment ShutdownFiscal

Cliff

Debt Ceiling &Euro Crisis II

EuroCrisis I

EuroCrisis II

Sources: Conference Board and Reuters / U. Michigan future expectations indices

6

Financial Markets Get Fearful & Bond Risk Spreads Rise in Crises Spread is Somewhat Elevated Now

0

1

2

3

4

5

6

7

96 98 00 02 04 06 08 10 12 14 16

2% Ave Spread 1970-2007

BAA Bond - 10 Year T-Note Spread

Sources: Federal Reserve and Moody’s (Haver).

7

Deleveraging Contributed to Anemic Recovery

Households and firms had to reduce their debt Banks had to rebuild their balance sheets

70

80

90

100

110

120

130

140

150

480

520

560

600

640

680

96 98 00 02 04 06 08 10 12 14

Percent Percent

H'hold Debt / Income

H'hold Net Worth / Income

Sources: BEA (Disposable Personal Income) and Board of Governors (Net Worth & Debt).

8

Consumer Spending Has Been Quite Strong Recently Business Fixed Investment and Exports Weak

9

The Current State of the Economy Some Mixed Signals

10

Recent Soft Patch May Be Behind Us … According to Chicago Fed National Activity Index

Source: CBO and Chicago Fed

-5

-4

-3

-2

-1

0

1

2

05 06 07 08 09 10 11 12 13 14 15 16

CFNAI (%)

Above Trend

Below Trend

11

ISM Manufacturing Gauge Back in Expansionary Territory

30

35

40

45

50

55

60

65

70

96 98 00 02 04 06 08 10 12 14 16

Index

Expansion

Contraction

Manufacturing

Non-Manufacturing

Source: Institute of Supply Management.

12

Manufacturing Hit by Weak Global Demand and High Exchange Rate

90

100

110

120

130

140

150

160

1980 1985 1990 1995 2000 2005 2010 2015

Index (Jul 2014 = 100)

DollarExchange Rate

Appreciation

Source: Federal Reserve Board. Note: The exchange rate is a weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners.

13

The Labor Market

14

Trend in Payroll Employment Numbers Strong Although April Number on the Low Side

-800

-600

-400

-200

0

200

400

600

96 98 00 02 04 06 08 10 12 14 16

Nonfarm Private 3-month Moving Average

Payroll Growth (M/M, 000's)

Total Non-Farm Payrolls (000’s,SA,BLS)

Average Monthly 2012 2013 2014 2015 Jan Feb Mar Apr 179 193 251 228 168 233 208 160

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Low Level of Labor Market Slack Headline Unemployment Rate of 5.0% in Jan

Close to Full Employment … Wage Growth Still Quite Low

2

4

6

8

10

12

14

16

18

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

"Broad" U6Unemploymemt Rate

CBO "NAIRU" or Natural Rate

"Headline" U3Unemployment Rate

5.0%

9.7%

Sources: BLS and CBO. Notes: The U-6 unemployment includes discouraged workers, other

marginally attached workers, and those working part time for economic reasons

16

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Headline Inflation Low … Underlying Inflation Higher Expectations Well Anchored, 2% Inflation Likely in Next Two Years

-2

-1

0

1

2

3

4

5

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Headline PCECore PCETrimmed Mean PCE

Percent

2% Target

Note: PCE = Personal Consumption Expenditure. Sources: BEA and Dallas Fed.

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Financial Markets

19

U.S. Financial Market Stress Has Risen … But not to a worrying level

-2

0

2

4

6

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Kansas City Fed Financial Stress Index

Chicago Fed FinancialConditions Index

More Stress

Normal Level

Note: The KC and Chicago Fed financial stress / conditions indices capture the common components in a range of financial variables, including the TED spread, various corporate bond spreads, and the VIX.

20

Stock Markets Are Very Volatile … But the U.S. is ahead of the rest

40

60

80

100

120

140

160

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Eurozone (Eurofirst 300)U.S. (S&P 500)U.K. (FTSE 100)Japan (Nikkei 300)

Index (Jan 2000 = 100)

Source: Haver Analytics. Note: Shaded areas are U.S. Recessions.

21

The Fed Has Kept Interest Rates Low Markets expect gradual rise

(Blue Chip Forecast: 10-year Treasury 700 bps Higher in 2017 Q2)

0

1

2

3

4

5

6

7

8

9

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Fed Funds3-month Treasury1-year Treausry10-year Treasury30-year Mortgage (FRM)

Percent

Source: Federal Reserve Board.

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Low Oil Prices

On Net, Good for U.S. and Global Economy

But a Headwind for Texas and Other Energy States

23

Plunge in Crude Oil Prices From Over $100 a Barrel in Mid-2014

0

20

40

60

80

100

120

140

86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

WTI Spot Price

Dollars/Barrel, Avg

Source: Energy Information Agency. Note: Monthly average WTI spot price.

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Low Real Oil Prices … Déjà Vu

0

20

40

60

80

100

120

140

86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Real WTISpot Price

2009 Dollar/Barrel, Avg

Source: Energy Information Agency and BEA. Note: Monthly average WTI spot price.

25

Plunge in Oil Prices and U.S. Economy

• Strong supply and weak global demand

o Nov 2014 OPEC decision to maintain production

o Nuclear deal with Iran

o Shale oil • For the U.S., a net importer of oil, the main effects are:

o Incomes: real incomes and consumption rise Estimated $400+ gain for typical household in 2016

o Costs & Profits: Sharp fall in oil exploration related investment

(“capex”) Other investment should gradually rise

o Inflation: headline and core inflation fall temporarily

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Uncertain Outlook for Oil Prices Future Prices Suggest Gradual Rise to $50 … But Very Uncertain

20

40

60

80

100

120

140

06 07 08 09 10 11 12 13 14 15 16 17

EIA STEO ForecastNYMEX WTI FuturesNYMEX 95% Confidence Intervals

Actual Forecast

Dollars/Barrel

Brent

WTI

Notes: Confidence interval derived from NYMEX option data for the 5 trading days ending May 13, 2016. Source: Energy Information Administration; Haver; author's calculations.

27

Previous EIA WTI Price Forecasts Often Wrong … But So Were Most Forecasts!

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Global Crude Oil Production and Consumption Supply and Demand Likely To Balance Next Year

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U.S. Oil Rig Count and Crude Oil Production

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U.S. Rig Count and Investment in Mining & Explortation

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U.S. Upstream O&G Bankruptcies and Capex

Notes: The capital spending series is the sum of capital spending for 259 U.S. exploration and production firms with data available on Bloomberg. The bankruptcy series also includes upstream support services. It only includes publicly traded firms, firms with public debt, and major private bankruptcies. The bankruptcy and capex data for 2016 Q2 are for the quarter to May 16 and 18, 2016 respectively. Sources: Bloomberg; New Generation Research; Federal Reserve Bank of Dallas.

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Energy and Other High-Yield (“Junk”) Bond Prices

90

100

110

120

130

140

150

160

170

12 13 14 15 16

Other High Yield BondsAll High Yield BondsEnergy High-Yield Bonds

Bond Price Index

Notes: The Bloomberg USD high yield corporate bond prices are indexed to 100 on 1 Jan 2010. The non-energy bond index is calculated using the energy sector weight on the first day of the month. Sources: Bloomberg; author's calculations.

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Economic Forecasts

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Forecasts Are Hazardous

• Very difficult to forecast GDP (output) growth with any reasonable degree of accuracy: o The economy continually evolves

o Shocks are common, but unpredictable

o Turning points are hard to identify in real time

• It was easier to forecast inflation – somewhat little less so now

• Average or combinations of forecasts may be better than any individual forecast e.g. for the U.S.: o SPF (Survey of Professional Forecasters)

o Blue Chip Economic Indicators

o FOMC (Federal Open Markets Committee)

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Forecasts for the Global Economy

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IMF Global Growth Forecasts, April 2016 Growth Picking Up in Advanced Economies

Slowing Elsewhere

2013 Actual

2014 Actual

2015 Estimate

2016 Forecast

2017 Forecast

Revision Since Oct 2015 (pps) 2015 2016

World Economy 3.3% 3.4% 3.1% 3.2% 3.5% - -0.4

Advanced Economics 1.2% 1.8% 1.9% 1.9% 2.0% -0.1 -0.3

Emerging Market & Developing Economies

4.9% 4.6% 4.0% 4.1% 4.6% - -0.4

Source: IMF World Economic Outlook Update, Apr 2016. http://www.imf.org/external/pubs/ft/weo/2016/01/

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Forecasts for the U.S. Economy

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Median “Blue Chip” Forecast is Moderate U.S. Growth 2% to 2½% Real GDP Growth, Despite Low Q1 Growth

-8

-6

-4

-2

0

2

4

6

8

2000 2002 2004 2006 2008 2010 2012 2014 2016

Blue Chip ForecastsActual GDP Growth

Percent, Q/Q SAAR

Source: BEA and Blue Chip Economic Indicators, May 2016. Recessions are shaded grey.

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Summary of U.S. Economic Outlook

• Moderate growth with continued improvement in the labor market

• Manufacturing facing more challenges than services • Outlook is more uncertain than six months ago • The risks to the outlook are tilted to the downside, but a

recession appears unlikely • Main downside risks are external:

o Further appreciation of the dollar o Recession in China … risk receding but long term

challenges remain o Slow growth in other emerging economies o Possible Brexit

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The Economic Outlook

Not this

More like this

41

Questions?

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Low Oil Prices

A Headwind for Texas and Other Energy States

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Employment Falls in Most Energy Intensive States Due to Job Losses in O&G Industries

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Impact of Low Oil Prices on State Finances

72.4

53.8

39.0

18.5

10.9 8.9 7.5

2.1 0.00

10

20

30

40

50

60

70

80

AK ND WY NM TX LA OK CO CA

Share of Severance Taxes (%)

Percent

Source: Census Bureau, 2014 Annual Survey of State Government Tax Collections.

45

Forecasts for the Global Economy Additional Detail

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Growth In Advanced Economies Picking Up

2013 Actual

2014 Actual

2015 Estimate

2016 Forecast

2017 Forecast

Revision Since Oct 2015 (pps) 2015 2016

Advanced Economics 1.2% 1.8% 1.9% 1.9% 2.0% -0.1 -0.3

United States 1.5% 2.4% 2.4% 2.4% 2.5% -0.2 -0.4 Euro Area -0.3% 0.9% 1.6% 1.5% 1.6% +0.1 -0.1 Japan 1.4% 0.0% 0.5% 0.5% -0.1%% +0.1 -0.5 UK 2.2% 2.9% 2.2% 1.9% 2.2% -0.3 -0.3 Canada 2.0% 2.5% 1.2% 1.5% 1.9% +0.2 -0.2

Source: IMF World Economic Outlook Update, Apr 2016. http://www.imf.org/external/pubs/ft/weo/2016/01/

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Slower Growth in Emerging Market And Developing Economics

2013 Actual

2014 Actual

2015 Estimate

2016 Forecast

2017 Forecast

Revision Since Oct 2015 (pps) 2015 2016

Emerging Market & Developing

4.9% 4.6% 4.0% 4.1% 4.6% - -0.4

Brazil 3.0% 0.1% -3.8% -3.8% 0.0% -0.8 -2.8 China 7.7% 6.8% 6.9% 6.5% 6.2% +0.1 +0.2 India 6.6% 7.2% 7.3% 7.5% 7.5% +0.1 - Russia 1.3% 0.7% -3.7% -1.8% 0.8% -0.1 -1.2 Mexico 1.3% 2.3% 2.5% 2.4% 2.6% +0.2 -0.4 Source: IMF World Economic Outlook Update, Apr 2016. http://www.imf.org/external/pubs/ft/weo/2016/01/

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Forecasts for the U.S. Economy Additional Detail

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Forecasts for Current and Next Two Quarters

Output / GDP Growth (SAAR)

2016 Q1 2016 Q2 2016 Q3 2016 Q4 Blue Chip

0.5% 2.3% 2.4% 2.5%

SPF 2.5% 2.3% 2.5%

Unemployment Rate (Ave) 2016 Q1 2016 Q2 2016 Q3 2016 Q4

Blue Chip 4.9%

4.9% 4.8% 4.7% SPF 4.8% 4.7% 4.6%

Sources: Blue Chip Economic Indicators and Survey of Professional Forecasters (SPF), May 2016.

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Annual Forecasts Economic Indicator

Forecaster Actual 2015

Forecasts 2016 2017 2018 Long Run

Real GDP Growth, Q4/Q4

Fed FOMC 2.4%

2.2%# 2.1%# 2.0%# 2.0% Blue Chip 1.8%# 2.3%# - - SPF 2.1%# 2.4%# 2.7%# 2.3%

Unemployment Rate, Q4 Ave

Fed FOMC 5.0%

4.7%# 4.6%# 4.5%# 4.8% Blue Chip SPF

4.8%# 4.6%# - - 4.8%# 4.6%# 4.6%# 4.9%

PCE Inflation Rate, Q4/Q4

Fed FOMC 0.13%

1.2%# 1.9%# 2.0%#

2.0% SPF 1.3%# 1.9%# 2.0%# FOMC, Core

1.25% 1.6%# 1.8%# 2.0%#

SPF, Core 1.6%# 1.8%# 1.9%# Sources: Federal Open Markets Committee (Mar 2016, median projections), Blue Chip Economic Indicators (May 2016, averages) and Survey of Professional Forecasters (May 2016, medians). # denotes an SPF annual average forecast.