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Board of Governors of the Federal Reserve System

For use at 10:00 a.m., EDT

June 21, 2016

MONETARYPOLICYREPORTJune 21, 2016


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LETTEROFTRANSMITTAL

B G F R S

Washington, D.C., June 21, 2016

T P ST S H R

The Board of Governors is pleased to submit its Monetary Policy Report pursuant tosection 2B of the Federal Reserve Act.

Sincerely,

Janet L. Yellen, Chair


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The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutorymandate from the Congress of promoting maximum employment, stable prices, and moderate

long-term interest rates. The Committee seeks to explain its monetary policy decisions to the publicas clearly as possible. Such clarity facilitates well-informed decisionmaking by households andbusinesses, reduces economic and financial uncertainty, increases the effectiveness of monetarypolicy, and enhances transparency and accountability, which are essential in a democratic society.

Inflation, employment, and long-term interest rates fluctuate over time in response to economic andfinancial disturbances. Moreover, monetary policy actions tend to influence economic activity andprices with a lag. Therefore, the Committees policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system thatcould impede the attainment of the Committees goals.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the

Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms itsjudgment that inflation at the rate of 2 percent, as measured by the annual change in the priceindex for personal consumption expenditures, is most consistent over the longer run with theFederal Reserves statutory mandate. The Committee would be concerned if inflation were runningpersistently above or below this objective. Communicating this symmetric inflation goal clearly to thepublic helps keep longer-term inflation expectations firmly anchored, thereby fostering price stabilityand moderate long-term interest rates and enhancing the Committees ability to promote maximumemployment in the face of significant economic disturbances. The maximum level of employmentis largely determined by nonmonetary factors that affect the structure and dynamics of the labormarket.These factors may change over time and may not be directly measurable. Consequently,it would not be appropriate to specify a fixed goal for employment; rather, the Committees policydecisions must be informed by assessments of the maximum level of employment, recognizing that

such assessments are necessarily uncertain and subject to revision. The Committee considers awide range of indicators in making these assessments. Information about Committee participantsestimates of the longer-run normal rates of output growth and unemployment is published fourtimes per year in the FOMCs Summary of Economic Projections. For example, in the mostrecent projections, the median of FOMC participants estimates of the longer-run normal rate ofunemployment was 4.9 percent.

In setting monetary policy, the Committee seeks to mitigate deviations of inflation from itslonger-run goal and deviations of employment from the Committees assessments of its maximumlevel. These objectives are generally complementary. However, under circumstances in which theCommittee judges that the objectives are not complementary, it follows a balanced approach inpromoting them, taking into account the magnitude of the deviations and the potentially differenttime horizons over which employment and inflation are projected to return to levels judgedconsistent with its mandate.

The Committee intends to reaffirm these principles and to make adjustments as appropriate at itsannual organizational meeting each January.

STATEMENTONLONGER-RUNGOALSANDMONETARYPOLICYSTRATEGY

Adopted effective January 24, 2012; as amended effective January 26, 2016


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NOTE:Unless stated otherwise, the time series in the figures extend through, for daily data, June 16, 2016; for monthly data,May 2016; and, for quarterly data, 2016:Q1. In bar charts, except as noted, the change for a given period is measured to its final quarterfrom the final quarter of the preceding period.

For figures 14, 32, and 35, note that the S&P/Case-Shiller Index is a product of S&P Dow Jones Indices LLC and/or its affiliates andhas been licensed for use by the Board. Copyright 2016 S&P Dow Jones Indices LLC, a subsidiary of the McGraw Hill Financial Inc.,and/or its affiliates. All rights reserved. Redistribution, reproduction and/or photocopying in whole or in part are prohibited withoutwritten permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLCs indices please visitwww.spdji.com. S&P is a registered trademark of Standard & Poors Financial Services LLC and Dow Jones is a registered trademarkof Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates northeir third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately representthe asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark HoldingsLLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or thedata included therein.

CONTENTS

Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1Part 1: Recent Economic and Financial Developments. . . . . . . . . . . . . . . . . . . 3

Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Financial Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Part 2:Monetary Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Abbreviations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37List of Boxes

Have the Gains of the Economic Expansion Been Widely Shared?. . . . . . . . . . . . . . . . 6Developments Related to Financial Stability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
http://www.spdji.com/http://www.spdji.com/


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1

SUMMARYLabor market conditions clearly continued

to strengthen during the early months of thisyear: Payrolls expanded at a solid pace ofalmost 200,000 per month in the first quarter,and while the unemployment rate flattenedout at close to 5 percent, the labor forceparticipation rate moved up strongly. Morerecently, the signals regarding labor marketimprovement have become more mixed:Payroll gains are reported to have slowed toan average of 80,000 per month in April andMay (or about 100,000 after adjustment forthe effects of a strike). The unemployment

rate dropped in May to 4.7 percent, its lowestlevel since late 2007; however, the labor forceparticipation rate fell back again and waslittle changed from its year-ago level. All told,the latest readings suggest that labor marketsare tighter than they were at the end of lastyear but that the pace of improvement hasslowed. Whether those signs of slowing willbe confirmed by subsequent data, and howpersistent any such slowing will be, remains tobe seen.

Consumer price inflation has continued tobe held down by lower prices for energy andimports, and the price index for personalconsumption expenditures (PCE) increasedonly about 1 percent over the 12 monthsending in April. Changes in the PCE priceindex excluding food and energy items, whichprovide a better indication than the headlinefigure of where overall inflation will be in thefuture, also remained modest; this index,which rose 1 percent over the 12 monthsending in April, was partly restrained bylower prices for non-oil imported goods.However, both the headline and coreinflation measures have picked up somewhatfrom a year earlier. Meanwhile, some survey-based measures of longer-run inflationexpectations have remained relatively stable,while others have moved down; market-basedmeasures of inflation compensation also are atlow levels.

Although real gross domestic product is

reported to have increased at a sluggish ratein the first quarter of 2016, the available datafor the second quarter point to a noticeablestep-up in the pace of growth. On average,consumer spending so far this year appears tobe expanding at a moderate pace, supportedby solid income gains and the ongoing effectsof the increases in wealth and the declines inoil prices of the past two years. The housingmarket continues its gradual recovery, andfiscal policy at all levels of government is nowmodestly boosting economic activity after

exerting a considerable drag in recent years.One area of concern, however, is the softeningin business fixed investment in recent quarterseven beyond those sectors most directlyaffected by the plunge in energy prices. Inaddition, the weakness of exportsfollowingthe significant appreciation of the dollar overthe past two years and the subdued pace offoreign economic growthcontinues to holdback overall output growth.

On balance, household and business credit

conditions in the United States have remainedaccommodative so far this year. Followinga period of heightened global financialmarket volatility earlier this year in whichrisk spreads for U.S. corporate bonds rose,financial conditions have eased somewhat inrecent months, and corporate bond yields havereturned to historically low levels. Mortgagerates once again have approached their all-time lows, and mortgage credit appearswidely available to borrowers with solid creditprofiles, though less so to would-be borrowerswith imperfect credit histories. Student andauto loans are broadly available, includingto borrowers with nonprime credit scores,and the availability of credit card loans forsuch borrowers appears to have expandedsomewhat over the past several quarters. Broadmeasures of U.S. equity prices have increasedslightly, on net, since the beginning of theyear. Meanwhile, foreign financial markets


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2 SUMMARY

appear to have stabilized following the periodof volatility earlier this year, with foreignequity prices higher and risk spreads lower.That said, the potential remains for spillovers

to the U.S. economy from shocks to foreigneconomic activity and financial markets,including possible reverberations from theU.K. referendum this week on membership inthe European Union.

Turning to the stability of the U.S. financialsystem, financial vulnerabilities have remainedat a moderate level this year. Domesticfinancial institutions and markets functionedwell during the period of heightened volatilityearly in the year. Large banking firms have

kept their capital and liquidity ratios athigh levels relative to historical standards,capital at other financial firms also appearsto be elevated, and financial firms use ofshort-term wholesale funding remainssubdued. Debt growth in the householdsector has been modest. However, leverageof nonfinancial corporations is elevated byhistorical standards, and lower-rated firms arepotentially vulnerable to adverse developments.In particular, the performance of firms inthe energy sector has been especially weak

due to the prolonged period of low oilprices. In equity markets, valuation pressureshave increased somewhat as expectationsfor corporate earnings have been reviseddownward; valuation pressures have remainednotable in the commercial real estate sector,to which some small banks have substantialexposures.

After having raised the target range for thefederal funds rate to between and percentlast December, the Committee maintainedthat target range over the first half of theyear. The Committees decisions to leave thestance of policy unchanged were supportedby its assessments earlier in the year thatglobal economic and financial developmentsposed risks to the economic outlook and thatgrowth in economic activity appeared to haveslowed. In June, the Committee noted thatrecent information indicated that the pace of

improvement in the labor market had slowed,while growth in economic activity appeared tohave picked up. In addition, the Committeespolicy stance so far this year reflected its

expectation that inflation would remain low inthe near term, in part due to earlier declinesin energy prices and in the prices of non-energy imports. The Committee stated that itsaccommodative stance of policy is intended tosupport further improvements in labor marketconditions and a return to 2 percent inflation.

The Committee continued to emphasizethat, in determining the timing and size offuture adjustments to the target range forthe federal funds rate, it will assess realized

and expected economic conditions relative toits objectives of maximum employment and2 percent inflation. These judgments will takeinto account a wide range of information,including measures of labor market conditions,indicators of inflation pressures and inflationexpectations, and readings on financial andinternational developments. The Committeeexpects that economic conditions will evolve ina manner that will warrant only gradual futureincreases in the federal funds rate, and that thefederal funds rate will likely remain, for some

time, below levels that are expected to prevailin the longer run. Consistent with this outlook,in the most recent Summary of EconomicProjections (SEP), which was compiled atthe time of the June meeting of the FederalOpen Market Committee (FOMC), FOMCparticipants projected that the appropriatelevel of the federal funds rate would be belowits longer-run level through 2018. (The JuneSEP is discussed in more detail in Part 3 ofthis report.)

The Federal Reserve continued to use interestpaid on reserve balances and employ anovernight reverse repurchase agreementfacility to manage the federal funds rate,and these tools were effective in keeping thefederal funds rate within its target range.The Federal Reserve also continued to testthe operational readiness of other policyimplementation tools.


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3

PART1RECENTECONOMICANDFINANCIALDEVELOPMENTS

Labor market conditions have improved this year, though recent data suggest there has been aloss of momentum. Payroll gains averaged about 200,000 per month in the first quarter but thenonly 80,000 per month in April and May. The unemployment rate has edged down to 4 percent,a level that is near the midpoint of the Federal Open Market Committee (FOMC) participantsestimates of its longer-run rate. That said, a few indicators suggest that some slack in the labormarket remains. Despite persistently weak productivity growth, measures of labor compensationshow some tentative signs of acceleration. Overall consumer price inflation has continued to beheld down by lower prices for energy and imports, but both overall inflation and inflation excludingfood and energy items, a useful gauge of where overall inflation will be in the future, have pickedup a bit over the past year. Some survey-based measures of longer-run inflation expectations havemoved down; market-based measures of inflation compensation have declined noticeably sincelast summer.

Real gross domestic product (GDP) is estimated to have increased at a sluggish rate in the firstquarter, but more recent data point to a noticeable step-up in the pace of growth in the secondquarter. Consumer spending appears to be expanding at a moderate pace so far this year, whilethe housing market continues its gradual recovery, and fiscal policy at all levels of government isnow modestly boosting economic activity after exerting a considerable drag in recent years. Anarea of concern, however, is the softening in business fixed investment in recent quarters, evenbeyond those sectors most directly affected by the plunge in energy prices. In addition, weakexports are providing little boost to overall output growth. Heightened global financial marketvolatility early this year damped confidence both domestically and abroad, but financial conditionshave generally eased somewhat in recent months; in the United States, credit conditions for bothhouseholds and businesses have remained generally accommodative.

Domestic Developments

Early this year, the labor marketcontinued to improve . . .

The labor market continued to improve inthe first few months of this year. Payrollsexpanded at an average rate of around 200,000per month from January through March,

modestly below the average of 230,000 jobsper month last year but still well above thenumber needed to absorb the trend number ofnew entrants into the workforce (figure 1). Theunemployment rate held at about 5 percent,where it had been since the fall, but both laborforce participation and the employment-to-

Total nonfarm

Private

800

600

400

200

+

_0

200

400

Thousands of jobs

20162015201420132012201120102009

1. Net change in payroll employment

3-month moving averages

SOURCE: Department of Labor, Bureau of Labor Statistics.


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4 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

population ratio rose noticeably (figure 2). Therise in the labor force participation rate wasencouraging because it seemed to suggest thatlabor supply was responding significantly to

the strengthening labor market.

. . . but recently there may have been aloss of momentum . . .

The data for April and May, however, suggestthat the pace of labor market improvementhas slowed. Payroll growth is reported tohave averaged a pace of only 80,000 permonth (about 100,000 after adjustment forthe effects of a strike).1And although theunemployment rate fell to 4.7 percent inMay, that decline occurred as both laborforce participation and the employment-to-population ratio fell back somewhat from theirlevels in March. On net, the participation ratein May was little changed from a year earlier(a position that should nonetheless be viewedas a strengthening relative to a trend that isprobably declining because of demographicchanges, especially the aging of the baby-boom generation).

Despite these disappointing data, other labormarket indicators are consistent with a jobmarket that has continued to strengthen. Inparticular, initial claims for unemploymentinsurance, now available through early June,remain very lowand therefore at odds withthe weaker tenor of the recent payroll figures.In addition, according to the Job Openingsand Labor Turnover Survey, the rate of jobopenings as a share of private employmentremains at a very high level; the quits rate hascontinued to trend up and is now fairly high,the latter measure indicating that workers

feel increasingly confident about theiremployment opportunities.

1. According to the Labor Department, payroll

employment in May was reduced by about 35,000

because of workers on strike at Verizon. These employees

have returned to work and are expected to be included in

payroll figures for June.

Employment-to-population ratio58

60

62

64

66

68

Percent

20162014201220102008200620042002

2. Labor force participation rate andemployment-to-population ratio

Monthly

Labor forceparticipation rate

NOTE: Both series are a percent of the population aged 16 and over.SOURCE: Department of Labor, Bureau of Labor Statistics.


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MONETARY POLICY REPORT: JUNE 2016 5

. . . and a few signs of laborunderutilization remain

Although the May level of the unemploymentrate is near the midpoint of the FOMCparticipants estimates of its longer-run rate, afew indicators suggest that some slack in laborresource utilization remains. Most notably,the share of workers who are employed parttime but would like to work full time is stillelevated; accordingly, the more comprehensiveU-6 measure of labor underutilization, whichincludes these underemployed individuals,has remained well above its pre-recessionlevel (figure 3). Meanwhile, jobless rates for

African Americans and Hispanics are highrelative to the aggregate, though these rateshave also improved during the economicrecovery (figure 4). (For additional discussion,see the box Have the Gains of the EconomicExpansion Been Widely Shared?)

U-5

U-4

U-6

4

6

8

10

12

14

16

18

Percent

2016201420122010200820062004

3. Measures of labor underutilization

Monthly

Unemployment rate

NOTE: U-4 measures total unemployed plus discouraged workers, as a percent of the labor force plus discouraged workers. Discouraged workers are a subset omarginally attached workers who are not currently looking for work because they believe no jobs are available for them. U-5 measures total unemployed plus allmarginally attached to the labor force, as a percent of the labor force plus persons marginally attached to the labor force. Marginally attached workers are not inthe labor force, want and are available for work, and have looked for a job in the past 12 months. U-6 measures total unemployed plus all marginally attachedworkers plus total employed part time for economic reasons, as a percent of the labor force plus all marginally attached workers. The shaded bar indicates aperiod of business recession as defined by the National Bureau of Economic Research.



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have experienced the largest rebound in employment.

Thus far in 2016, blacks continue to have the lowestprime-age employment rates among these four groups,and the racial differences in employment-to-populationratios are very similar to pre-recession levels.

Among the working population, blacks andHispanics suffered the greatest losses in full-timeemployment share during the recession, and, evenas overall employment has recovered, the full-timeshare remains significantly depressed for these workers(figure B). By early 2016, white and Asian prime-ageworkers had nearly returned to their pre-recession ratesof full-time work, but the share of full-time employmentamong black and Hispanic workers remains severalpercentage points lower than their previous high levels.

Prior to the Great Recession, black workers were themost likely to report usually working 35 hours perweek or more, closely followed by Hispanics. By 2016,Hispanic workers had slightly lower rates of full-timeemployment than whites, and the full-time share ofblack workers was slightly lower than that of Asians.

In the period of sustained high unemploymentfollowing the financial crisis, household incomesfor all groups of Americans fell sharply and did notbegin to recover until 2012. The decline in medianhousehold income was particularly large for blackhouseholds16 percent, compared with approximately

The financial crisis resulted in massive job losses

and falling income for American households. However,not all households suffered to the same extent duringthe downturn, nor have they benefited to the sameextent during the subsequent recovery. This discussionreviews the labor market situation and householdincomes for Americans of different races and ethnicitiesduring the Great Recession and the ensuing economicexpansion.1

A figure in the main text shows that unemploymentrates for blacks and Hispanics rose more duringthe recession, and have declined more during theexpansion, than for the nation as a whole (textfigure 4).2Rates for these groups remain higher thanfor whites; the differentials among these rates are now

roughly the same as prior to the recession. A similarresult is true for employment-to-population ratiosof prime-age individuals (ages 25 to 54).3Prime-age employment rates are lower for blacks and fellmore sharply during the financial crisis, droppingnearly 8 percentage points between mid-2008 andthe end of 2011, compared with declines of between4 and 5 percentage points for whites, Asians, andHispanics (figure A). Since 2011, however, blacks

of the total labor force. The employment-to-population ratio

ignores the distinction between those actively seeking work ornot and simply measures the number of employed individualsas a share of the total population. We use the prime-agepopulation because we want to focus on the labor marketrecovery and do not want income to include Social Securityand other sources of retirement income that are largelyindependent of economic conditions.

1. The employment-to-population ratio and full-time shareof employed individuals are calculated using data from themonthly Current Population Survey (CPS). Median householdincome and the income composition are calculated using datafrom the March CPS Annual Social and Economic Supplement

(ASEC). Monthly data are available through April 2016, whilethe most recent ASEC data (March 2015 CPS) are for 2014.2. The Hispanic ethnicity and race categories are not

mutually exclusive. Some individuals are, for example, bothHispanic and white, and they are represented in both lines inthe figures in the box.

3. The unemployment rate shows the number ofunemployed individuals actively looking for work as a share

Have the Gains of the Economic Expansion Been Widely Shared?

Black or African American

Asian

Hispanic or Latino

66

68

70

72

74

76

78

80

82

Percent

2016201420122010200820062004

. r me-age emp oyment-to-popu at on rat o, y race

Monthly

White

NOTE: The data are 12-month moving averages. Prime age is defined ashose aged 25 to 54.



Asian

Hispanic or Latino

84

86

88

90

92

Percent

2016201420122010200820062004

. Full-time share of all prime-age employed persons,by race

Monthly

White

NOTE: The data are 12-month moving averages. Prime age is defined ashose aged 25 to 54.



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substantially below levels experienced prior to thefinancial crisis.

Transfer income rose substantially during the

recession because of federal economic stimulusprograms and automatic stabilizers, but the increasesonly offset a modest portion of the overall decline inincome.6Transfer income has receded very slowly since2011, with mean transfers in 2014 remaining abovepre-recession levels for all racial and ethnic groups.

8 percent for white, Hispanic, and Asian households(figure C).4

By 2014 (latest data available), median household

incomes of Asian, white, and Hispanic households hadimproved and were at least 94 percent of pre-recessionlevels, but median income for black householdsremained only 88 percent of the 2007 level. Racial andethnic differences in income were sizable before thefinancial crisis and have only grown larger since then,with the median black household income at $40,000 in2014, compared with $67,000 for white and $85,000for Asian households (figure D).

Losses in wage income account for the bulk ofthe decline in income for households during thedownturn. Between 2007 and 2011, mean wageincome for households in the middle quintile of theincome distribution fell just over $5,000 for white

households, $4,000 for Hispanic households, $8,000for black households, and $7,000 for Asian households(figure E).5Wages and salaries are the single largestsource of income and have provided most of theincrease in total income since 2011. Mean wageincome for 2014 had returned to pre-recession levelsfor Asian households and had made up some of thelost ground among white and Hispanic households.Wage income for black households, however, remained

4. Percentages are based on an analysis of income datafrom the March CPS ASEC. Household race was determinedby answers to the Hispanic ethnicity question and the firstracial category selected by household heads between the agesof 25 and 54. Income of all household members is included.

Any household head identifying as Hispanic is coded asHispanic, regardless of race. Incomes for a very small groupof households (less than 2 percent in 2014) that are identifiedas some other race group are not shown here, as the estimatesare somewhat volatile and not very precise.

5. To show changes in the composition of income fortypical households, we switch here to using mean income ofhouseholds in the middle quintile of the distribution.

6. Transfer income includes Social Security income,welfare, Supplemental Security Income, unemploymentbenefits, and educational assistance. Other income includesbusiness income; farm income; income from interest,dividends, rent, alimony, and contributions; retirementincome; trusts; workers compensation; veterans, survivors,and disability benefits; educational assistance fromnongovernment sources; assistance from friends and family;and other sources.


Asian

Hispanic or Latino

80

85

90

95

100

105

Inflation-adjusted dollars, 2007=100

201420122010200820062004

. n exe me an pr me-age ouse o ncome, y race

Annual

White

NOTE: Prime-age households are defined as households led by those aged25 to 54. Race refers to the race of the head of household. The data extendhrough 2014.

SOURCE: U.S. Census Bureau, Current Population Survey, March 2016.


Asian

Hispanic or Latino

35

40

45

50

55

60

65

70

75

80

85

90

Thousands of inflation-adjusted dollars

201420122010200820062004

D. Median prime-age household income, by race

Annual

White

NOTE: Prime-age households are defined as households led by those aged25 to 54. Race refers to the race of the head of household. The data extendhrough 2014.


30

40

50

60

70

80

90

100

Thousands of inflation-adjusted dollars

E. Changing composition of income for middle quintile ofprime-age households, by race group and key year

White

Black orAfrican American

Asian

Hispanicor Latino

07 11 14 07 11 14 07 11 14 07 11 14

NOTE: Prime-age households are defined as households led by those aged25 to 54. Race refers to the race of the head of household. The data aregrouped according to key years 2007, 2011, and 2014.


Transfer income

Wage income

Other income


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Compensation growth has showntentative signs of a pickup . . .

By most measures, the growth of laborcompensation has remained modest, thoughrecently there have been some signs of faster

increases. The employment cost index (ECI)for private-industry workers, which includesthe cost of employer-provided benefits as wellas wages, registered a rise of only 1 percentover the 12 months ending in March (figure 5).However, two other prominent measures oflabor compensationaverage hourly earningsfor all private-sector employees and business-sector compensation per hourrecordedlarger increases than the ECI over the pastyear, and the increases in both series wereabove their corresponding averages over the

preceding several years. In addition, accordingto the Federal Reserve Bank of Atlantas WageGrowth Tracker, the median of 12-monthchanges in individuals hourly wages (fromthe monthly survey of households) has beengradually trending higher, reaching 3 percentin May.


Asian

Hispanic or Latino

2

4

6

8

10

12

14

16

18

Percent

2016201420122010200820062004

4. Unemployment by race and ethnicity

Monthly

White

NOTE: Persons whose ethnicity is identified as Hispanic or Latino may be of any race. The shaded bar indicates a period of business recession as defined by theNational Bureau of Economic Research.


Employmentcost index

Average hourly earnings

1

+

_0

1

2

3

4

5

6

Percent change from year earlier

2016201420122010200820062004

5. Measures of change in hourly compensation

Compensation per hour,business sector

NOTE: The average hourly earnings data series begins in March 2007 andextends through May 2016. The compensation per hour and employment costindex data extend through 2016:Q1. For business-sector compensation,change is over four quarters; for the employment cost index, change is overthe 12 months ending in the last month of each quarter; for average hourlyearnings, change is from 12 months earlier.



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. . . amid persistently weak productivitygrowth

The relatively slow gains in laborcompensation in recent years have occurred

against a backdrop of persistently weakproductivity growth. Since 2008, laborproductivity gains have averaged around1 percent per year, far below the pace thatprevailed before the recession (figure 6).Indeed, in the past five years, productivitygrowth has averaged only percent peryear. The relatively slow pace of productivitygrowth is at least in part a consequence ofthe sustained weakness in capital investmentover the recession and early recovery period.Productivity gains may improve in the futureas investment in productivity-enhancingcapital equipment and in research anddevelopment strengthens.

Falling energy prices have held downconsumer price inflation

Overall consumer price inflation has moved upfrom the lows recorded last year, but it remainswell below the FOMCs longer-run objectiveof 2 percent. In April, the 12-month changein the price index for personal consumption

expenditures (PCE) was around 1 percent,higher than the percent rate recorded inApril 2015 (figure 7). The pickup over thisperiod was largely due to a slower rate ofdecline in both energy prices and non-energyimport prices.

Low oil prices have reduced global investmentin the oil sector and have led to some cutbacksin production, particularly in the UnitedStates. These declines, firming global demand,and some temporary supply disruptions

including in Canada due to wildfireshaverecently pushed crude oil prices higher afterthey reached a 12-year low in mid-January(figure 8). Nonetheless, at a bit below $50per barrel, the spot price of Brent crude oilremains less than half its mid-2014 peak.Moreover, the continued low level of oilfutures prices suggests that market participantsexpect only a modest increase in oil prices over

1

2

3

4

Percent, annual rate

6. Change in business sector output per hour

1948 73

1974 95

19962000

2001 07

2008present

NOTE: Changes are measured from Q4 of the year immediately precedingthe period through Q4 of the final year of the period. The final period ismeasured from 2007:Q4 through 2016:Q1.


Excluding foodand energy

2

1

+

_0

1

2

3

4

12-month percent change

20162015201420132012201120102009

7. Change in the price index for personal consumptionexpenditures

Monthly

Total

NOTE: The data extend through April 2016; changes are from one yearearlier.

SOURCE: Department of Commerce, Bureau of Economic Analysis.

Spot price

20

30

40

50

60

70

80

90

100

110

120

Dollars per barrel

2014 2015 2016

8. Brent spot and futures prices

Weekly

Dec. 2018 futures contracts

NOTE: The data are weekly averages of daily data and extend through June16, 2016.

SOURCE: NYMEX via Bloomberg.


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the next couple of years, given the historicallyhigh global inventories of crude oil. Thelarge cumulative drop in crude oil priceshad mostly passed through to lower retail

prices for gasoline and other energy productsby early this year; despite some increasesthereafter, prices at the pump remain at levelssubstantially below those of last summer.

Similar to the price of crude oil, prices ofmetals and agricultural goods have movedhigher since early this year. The rise in theprices of agricultural goods followed severalquarters of declines that have held down retailfood prices for consumers so far this year.The rise in many nonfuel commodities prices,

together with a weaker dollar, helped pushnon-oil import prices higher in Maythe firstincrease since 2014 (figure 9).

Outside of the energy and foodcategories, inflation has picked up alittle bit

Inflation for items other than food and energy(so-called core inflation) has picked up alittle. Core PCE prices rose about 1 percentover the 12 months ending in April, up about percentage point from its year-earlier pace.2The increase in the trimmed mean PCE priceindex, an alternative indicator of underlyinginflation, has also picked up a bit over the pastyear; as is typically the case, this measure hasrun somewhat above core inflation over thisperiod. Because the slack in labor and productmarkets appears to have been mostly takenup, and given the recent upward movementsin oil prices and non-oil import pricesaftermonths of declinesthe downward pressureon inflation from these factors is likely waning.

2. Data from the consumer price index and the

producer price index point to a similar reading for the

12-month change in core PCE prices in May.

Non-oil import prices

10

5

+

_0

5

10

15

20

12-month percent change

201620152014201320122011

9. Non-oil import prices and U.S. dollar exchange rate

Monthly

Broad nominal dollar

SOURCE: Department of Labor, Bureau of Labor Statistics; Federal ReserveBoard, Statistical Release H.10, Foreign Exchange Rates.


16/44


Some survey-based measures of expectedinflation have drifted downward . . .

The FOMC devotes careful attention toindicators of long-run inflation expectations,

as these expectations are believed to bean important factor underlying manywage- and price-setting decisions. Thelatest readings from surveys of longer-terminflation expectations have sent mixed signals(figure 10). In the Survey of ProfessionalForecasters, conducted by the Federal ReserveBank of Philadelphia, the median second-quarter reading on expected annual PCEprice inflation over the next 10 years wasagain 2 percent. The distribution of inflationexpectations 5 to 10 years ahead derived fromsurveys of primary dealers has remainedsimilarly stable. But in the University ofMichigan Surveys of Consumers, the medianreading on inflation expectations over the next5 to 10 years has drifted down over the pasttwo years and recorded a new low in earlyJune. To the extent that this downward drift isa reaction to energy-driven declines in overallinflation, it could reverse over time as energyprices stop declining.

. . . and market-based measures ofinflation compensation have remainedlow

Market-based measuresof longer-terminflation compensationderived either fromdifferences between yields on nominal Treasurysecurities and Treasury Inflation-ProtectedSecurities or from inflation swapshavecontinued to decline and now stand at verylow levels (figure 11). Deducing the sourcesof changes in inflation compensation ischallenging because such movements reflectnot only expected inflation, but also aninflation risk premiumthe compensationthat holders of nominal securities demandfor bearing inflation riskand other factors.Nevertheless, one cannot rule out a declinein inflation expectations among marketparticipants since last summer.

Michigan survey expectationsfor next 5 to 10 years

1

2

3

4

Percent

20162014201220102008200620042002

SPF expectationsfor next 10 years

10. Median inflation expectations

NOTE: The Michigan survey data are monthly and extend through June2016. The SPF data for inflation expectations for personal consumptionexpenditures are quarterly and extend from 2007:Q1 through 2016:Q2.Michigan survey data for June are preliminary.

SOURCE: University of Michigan Surveys of Consumers; Federal ReserveBank of Philadelphia, Survey of Professional Forecasters (SPF).

Inflation swaps

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Percent

20162014201220102008

11. 5-to-10-year-forward inflation compensation

Weekly

TIPS breakevens

NOTE: The data are weekly averages of daily data and extend through June17, 2016. TIPS is Treasury Inflation-Protected Securities.

SOURCE: Federal Reserve Bank of New York; Barclays; Federal ReserveBoard staff estimates.


17/44


Economic activity has been expanding ata moderate pace

Real GDP is currently reported to haveincreased at an annual rate of just percent

in the first quarter, but with several signsof faster growth in the current quarter, realGDP appears on track to record a moderateoverall gain in the first half of this year(figure 12).3Consumer spending is advancingfurther, and housing activity continues tostrengthen gradually. Meanwhile, governmentexpenditures have maintained momentum.Although inventory investment exerted asizable drag on GDP growth in the latter halfof last year, it has been less of an influence inthe first half of this year.

Nevertheless, several of the headwinds thatwere apparent last year have continuedto restrain growth in activity this year. Inparticular, a substantial appreciation of thedollar over the past couple of years, alongwith continued sluggish foreign growth, isweighing on the demand for U.S. exports. Inaddition, the sizable drop in oil prices since2014notwithstanding the substantial benefitto householdshas led to marked cutbacks in

production and investment in the energy sectorof our economy. These negative factors havehad particularly pronounced effects on activityin the industrial sector.

Gains in income and wealth continue tosupport consumer spending

Consumption growth was lackluster earlyin 2016, but data on retail sales and motorvehicle sales suggest that spending has pickedup appreciably so far this quarter. Smoothingthrough the monthly fluctuations, consumer

spending is reported to have increased atan annual rate of nearly 3 percent over thefirst four months of this year, only a littleslower than the pace in 2015 (figure 13).

3. While it appears likely that residual seasonalitya

predictable seasonal pattern remaining in data that have

already been seasonally adjustedin some components

of GDP held down measured GDP growth in the first

quarter, this factor would imply an offsetting boost in

measured GDP growth over the remainder of the year.

1

+

_0

1

2

3

4

5


20162015201420132012201120102009

12. Change in real gross domestic product and grossdomestic income

Q1


Gross domestic product

Gross domestic income

4

2

+

_0

2

4

6


2016201520142013201220112010

13. Change in real personal consumption expendituresand disposable personal income

H1

NOTE: The reading for 2016:H1 is the annualized April/Q4 change.SOURCE: Department of Commerce, Bureau of Economic Analysis.

Personal consumption expenditures

Disposable personal income


18/44


The improvement in the labor market hascontinued to support income growth, andlow energy prices are boosting householdspurchasing power. As a result, real disposable

personal incomethat is, income after taxesand adjusted for inflationwas reported tohave advanced at an annual rate of about3 percent over the first four months of thisyear, just a touch below the pace in 2015.

Ongoing gains in household net worth likelyhave also supported growth in consumerspending. House prices, which are ofparticular importance for the balance sheetpositions of a broad set of households, havecontinued to move higher, with the CoreLogic

national index showing a rise of about6 percent over the 12 months ending in April(figure 14). Elsewhere, although equity priceshave only increased slightly, on net, so far thisyear, the prior gains of the past few years havehelped improve households financial positions.In the first quarter of this year, the ratio ofaggregate household net worth to disposableincome, which had previously returned to itspre-recession highs, ticked down slightly butremained far above its long-run historicalaverage (figure 15).

Consumers are upbeat about theireconomic prospects . . .

The solid pace of income growth over the pastyear has helped households retain fairly upbeatperceptions about their economic prospects.The Michigan surveys composite index ofconsumer sentimentwhich incorporateshouseholds views about their own financialsituations as well as economic conditionsmore broadlyhas improved again recently

following a moderate deterioration earlierin the year, and the latest readings werenear the upper end of the range of valuesrecorded during the previous economicexpansion (figure 16). After having laggedbehind improvements in headline sentimentearlier in the recovery, the survey measuresof households expectations for real incomechanges over the next year or two have alsoimproved noticeably and now stand close totheir pre-recession levels.

CoreLogicprice index

S&P/Case-Shiller

national index

20

15

10

5

+

_0

5

10

15

20

Percent change from year earlier

201620142012201020082006

14. Prices of existing single-family houses

Monthly

Zillow index

NOTE: The data for the S&P/Case-Shiller index extend through March2016. The data for the Zillow and CoreLogic indexes extend through April2016. For Dow Jones Indices licensing information, see the note on theContents page.

SOURCE: CoreLogic Home Price Index; Zillow; S&P/Case-Shiller U.S.National Home Price Index (Index). The S&P/Case-Shiller Index is aproduct of S&P Dow Jones Indices LLC and/or its affiliates.

5.0

5.5

6.0

6.5

Ratio

201620122008200420001996

15. Wealth-to-income ratio

Quarterly

NOTE: The series is the ratio of household net worth to disposable personalincome.

SOURCE: For net worth, Federal Reserve Board, Statistical Release Z.1,Financial Accounts of the United States; for income, Department ofCommerce, Bureau of Economic Analysis.


19/44


. . . and household credit availability isgenerally favorable

Consumer credit has continued to expandthis year amid stable credit performance

(figure 17). Auto and student loans remainwidely available, even to borrowers with lowercredit scores, and outstanding balances ofthese types of loans expanded at a robust pace.Credit card borrowing has also accelerated abit, on balance, and the outstanding balancein April was 5 percent above its level ayear earlier. Although there have been sometentative signs of easing overall, credit cardstandards have remained tight for nonprimeborrowers.

Low interest rates and rising incomes haveenabled many households to lower their debtpayment burdens. The household debt serviceratiothat is, the ratio of required principaland interest payments on outstandinghousehold debt to disposable personalincomehas remained at a very low level byhistorical standards (figure 18). Interest rateson 30-year fixed-rate mortgages are downabout percentage point from the level atthe December liftoff date, and rates on auto

loans, on net, have been little changed sincethen. Going forward, the effect of any policyrate tightening on mortgage rates and, in turn,on households debt burdens will likely showthrough only gradually, as the current stock ofhousehold debt is disproportionately held inloan products with fixed interest rates.

Residential construction activity hasimproved at a gradual pace

The recovery in residential constructionactivity has maintained a moderate pace.

Single-family starts continued to edge upslowly over the past year, while multifamilystarts receded a little from their elevated levelsin the middle of 2015 (figure 19). Lookingfurther back, the rise in multifamily starts overthe past five years has been substantial andhas far exceeded the percent gain in single-family housing starts. The relative strength inmultifamily construction partly reflects a shift

600

400200

+

_0

200

400

600

800

1,000

Billions of dollars, annual rate

2016201520142013201220112010200920082007

17. Changes in household debt

Sum

Q1

SOURCE: Federal Reserve Board, Statistical Release Z.1, FinancialAccounts of the United States.

Mortgages

Consumer credit

10

11

12

13

14

Percent of disposable income

2016201220082004200019961992198819841980

18. Household debt service

Quarterly

NOTE: Debt service payments consist of estimated required payments onoutstanding mortgage and consumer debt.

SOURCE: Federal Reserve Board, Statistical Release, Household DebtService and Financial Obligations Ratios.

Consumer sentiment

50

60

70

80

90

100

110

Index

50

60

70

80

90

100

20162011200620011996

Diffusion index

16. Indexes of consumer sentiment and income expectations

Real income expectations

NOTE: The data are three-month moving averages and extend through June2016. June data are preliminary. Consumer sentiment is indexed to 100 in1966. Real income expectations are calculated as the net percent of surveyrespondents expecting family income to go up more than prices during the

next year or two, plus 100.SOURCE: University of Michigan Surveys of Consumers.


20/44


in demand away from owner-occupied housingtoward rental housing since the recession.Elsewhere, outlays for improvements toexisting homes increased more than 10 percent

over the past year, and commissions and feespaid on the sale of residential real estate rosemoderately, in line with the uptrend in sales ofexisting homes and contracts for new homes(figure 20).In all, residential investment rosealmost 10 percent in 2015 and appears ontrack to maintain a similar pace in the firsthalf of this year.

Low interest rates and an ongoing easing inmortgage credit standards have continued tosupport the expansions in housing demand

and construction activity. In the AprilSenior Loan Officer Opinion Survey onBank Lending Practices (SLOOS), banksreported having eased lending standards andexperienced stronger demand for most types ofresidential real estate loans in the first quarter.4Even so, for individuals with relatively lowcredit scores, mortgages remain difficult toobtain. With mortgage interest rates havingagain moved down close to their all-time lows,housing affordability has remained favorabledespite the moderate growth in house prices

over the past year (figure 21).

Business fixed investment hasdeclined . . .

A worrisome development in recent quartershas been the weakening in business fixedinvestment (private nonresidential fixedinvestment). Over the past year, real outlaysin the nonresidential structures categorywhich constitutes roughly one-fourth of totalbusiness fixed investmenthave fallen sharply,

as investment in oil wells and other drillingand mining structures has followed the steepdrop in oil prices (figure 22). The declinein the number of drilling rigs in operationhas been so pronounced that investment indrilling and mining structures has shrunk to

4. The SLOOS is available on the Boards website at

www.federalreserve.gov/boarddocs/snloansurvey .

Existing home sales

.2

.4

.6

.8

1.0

1.2

1.4

1.6

1.8

Millions, annual rate

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

2016201420122010200820062004

20. New and existing home sales

Millions, annual rate

New home sales

NOTE: The data extend through April 2016. Existing home sales includessingle-family, condo, townhome, and co-op sales.

SOURCE: For new single-family home sales, Census Bureau; for existingome sales, National Association of Realtors.

Multifamily starts

Single-family permits

.2

.6

1.0

1.4

1.8

Millions of units, annual rate

20162014201220102008200620042002

19. Private housing starts and permits

Monthly

Single-family starts

SOURCE: Department of Commerce, Bureau of the Census.

Mortgage rates

85

105

125

145

165

185

205

Index

3

4

5

6

7

20162014201220102008

21. Mortgage rates and housing affordability

Percent

Housing affordability index

NOTE: The housing affordability index data are monthly through April2016, and the mortgage rate data are weekly through June 15, 2016. At anindex value of 100, a median-income family has exactly enough income toqualify for a median-priced home mortgage. Housing affordability isseasonally adjusted by Board staff.

SOURCE: For housing affordability index, National Association of Realtors;or mortgage rates, Freddie Mac Primary Mortgage Market Survey.
http://www.federalreserve.gov/boarddocs/snloansurveyhttp://www.federalreserve.gov/boarddocs/snloansurvey


21/44


less than one-third its peak in 2014, and theongoing contraction has subtracted nearly percentage point from real GDP growthover the past four quarters. Outside of the

energy sector, business outlays for structuresrecorded relatively modest increases followingthe sizable gains observed in the first halfof 2015. Meanwhile, business spending onequipment and intellectual property productsmoved down in the fourth quarter of last yearand the first quarter of 2016, and the availableindicators, such as orders and shipmentsof capital goods and surveys of businessconditions, point to continued softness in thecurrent quarter.

Although investment spending continues to besupported by low interest rates and generallyaccommodative financial conditions, spendingis likely being restrained by a slowing in actualand expected business output growth. Weakforeign demand and the stronger dollar arealready having an adverse effect on domesticbusinesses, and analysts forecasts for year-ahead corporate earnings have been reviseddown considerably, even outside of the energysector. Meanwhile, as reported by the Bureauof Economic Analysis, corporate profits

recorded only a slight increase in the firstquarter after falling sharply at the end of lastyear, although here, too, the weakness washeavily concentrated in the energy sector.

. . . while corporate financing conditionshave remained generally accommodative

Corporate financing conditions remainedgenerally accommodative in the first halfof this year, although ongoing oil marketdevelopments and episodes of global financial

stress led to sporadic periods of heightenedperceptions of risk. In particular, corporatebond markets showed strains early in theyear, especially for those firms most affectedby the low energy prices. In recent months,however, pressures in bond markets haveeased somewhat, and corporate bond yieldsoverall have returned to historically lowlevels (figure 23). In the April SLOOS, banksindicated that they had tightened their

30

20

10

+

_0

10

20


2016201520142013201220112010200920082007

22. Change in real private nonresidential fixed investment

Q1


Structures

Equipment and intangible capital

Double-A

High-yield

0

2

4

6

8

10

12

14

16

18

20

Percentage points

1998 2001 2004 2007 2010 2013 2016

23. Corporate bond yields, by securities rating

Daily

Triple-B

NOTE: The yields shown are yields on 10-year bonds.SOURCE: BofA Merrill Lynch Global Research, used with permission.


22/44


standards on commercial and industrial (C&I)loans to large and middle-market firms inthe first quarter, but even so, such financingremained broadly available. For the first

quarter as a whole, corporate bond issuanceand the growth of C&I loans on banksbalance sheets were quite strong (figure 24).Firms equity issuance was also generally solid,though initial public offerings have been weak.Meanwhile, the growth of small business loanswas subdued.

Financing conditions in the commercialreal estate (CRE) sector have remainedaccommodative overall, but here, too, therehave been some signs of tightening. Growth of

CRE loans at banks remained strong duringthe first half of the year. However, banksindicated that they had further tightenedtheir lending standards on CRE loans in thefirst quarter of 2016, according to the AprilSLOOS. In addition, spreads on interest ratesfor CRE loans relative to 10-year swap ratesand to yields on commercial mortgage-backedsecurities rose sharply further early this year,and although they have retreated significantlysince then, these measures remain well abovetheir historical average levels.

Exports and imports have both been weakthis year

Based on recently released trade prices andthe nominal census trade data, it appearsthat real exports were roughly flat in the firstquarter of 2016, held back by slow foreigngrowth and the considerable appreciation ofthe dollar over the past two years. Despite theappreciation of the dollar, real imports lookedto have declined in the first quarter, with

weakness in both capital- and consumer-goodscategories. Overall, the net export contributionto GDP growth was about neutral. Whilethe nominal trade deficit narrowed a little inthe first quarter, the current account deficitwidened a touch to 2.7 percent of nominalGDP (figure 25). The April trade data suggestthat net exports will be a small drag on GDPgrowth in the current quarter, as the tradedeficit increased, with imports reboundingfrom a very weak March level.

40

20

+

_0

20

40

60

80

Billions of dollars, monthly rate

20162015201420132012201120102009200820072006

24. Selected components of net debt financing fornonfinancial businesses

Sum

Q1

SOURCE: Federal Reserve Board, Statistical Release Z.1, FinancialAccounts of the United States.

Commercial paper

BondsBank loans

Current account7

6

5

4

3

2

1

+

_0

Percent of nominal GDP

20162014201220102008200620042002200019981996

25. U.S. trade and current account balances

Quarterly

Trade

NOTE: GDP is gross domestic product.SOURCE: Department of Commerce, Bureau of Economic Analysis.


23/44


The drag from federal fiscal policy hasended . . .

Fiscal policy at the federal level had a roughlyneutral influence on GDP growth in 2015, as

the substantial contractionary effects of earlierfiscal consolidation have abated. Policy actionshad little effect on taxes, while transfersand federal purchases of goods and servicesmerely edged up (figure 26). Going forward,if the increased spending authority enacted inlast years budget agreement is fully utilized,federal fiscal policy would likely be mildlysupportive of GDP growth over 2016and 2017.

After narrowing significantly over the pastseveral years, the federal unified budget deficithas recently widened slightly. At 18 percentof GDP, receipts have remained high relativeto the recession and early recovery period(figure 27). At 21 percent, expenditures asa share of GDP are above the levels thatprevailed before the start of the most recentrecession. Although the ratio of federal debtheld by the public to nominal GDP is alreadyquite elevated, the deficit currently remainssmall enough to roughly stabilize this ratio at

around 75 percent (figure 28).

. . . and state and local governmentexpenditures are rising

The expansion of economic activity andfurther gains in house prices continue tosupport a gradual improvement in the fiscalposition of most state and local governments.Consistent with their improving finances,states and localities significantly expanded realconstruction spending in 2015 and in the earlypart of this year. By contrast, employment

growth in the state and local sector wasmuted last year, but the pace has stepped upsomewhat so far in 2016 (figure 29).

Financial Developments

Financial conditions tightened early inthe year but then eased

Early in 2016, domestic financial conditionstightened, as uncertainty about the outlook

9

6

3

+

_0

3

6

9


201620152014201320122011201020092008

26. Change in real government expenditures onconsumption and investment

Q1


Federal

State and local

Expenditures

14

16

18

20

22

24

26

Percent of nominal GDPPercent of nominal GDPAnnual

27. Federal receipts and expenditures

1996 2000 2004 2008 2012 2016

Receipts

NOTE: Through 2015, receipts and expenditures are for fiscal years(October to September); gross domestic product (GDP) is for the fourquarters ending in Q3. For 2016, receipts and expenditures are for the12 months ending in May, and GDP is the average of 2015:Q4 and 2016:Q1.Receipts and expenditures are on a unified-budget basis.

SOURCE: Office of Management and Budget.


24/44


for the Chinese economy, lower oil prices,and weak data on economic activity in severaleconomies contributed to concerns about theprospects for global economic growth and

to a pullback from risky assets. At that time,Treasury yields declined across maturities,equity prices fell steeply, equity price volatilityrose, and risk spreads on corporate bondswidened notably. In addition, investors cameto expect a more gradual increase in thetarget range for the federal funds rate thanthey had previously anticipated. However,investors concerns appeared to diminishbeginning in mid-February, and since then,amid mixed U.S. economic data, domesticfinancial conditions have generally eased on

balance: Stock prices rose notably, equityprice volatility declined, and credit spreads oncorporate bonds narrowed. (For a discussionof financial stability developments over thissame period, see the box DevelopmentsRelated to Financial Stability.)

On balance to date this year, theexpected path for the federal funds rateover the next several years declined . . .

The path of the federal funds rate implied

by market quotes on interest rate derivativesflattened, on net, since December. Theturbulence in global financial markets earlyin the year, the FOMCs communications,and some indications of a slowing in thepace of improvement in the labor marketof late contributed to market participantsexpectation that U.S. monetary policy wouldbe more accommodative than they hadanticipated late last year.

Survey-based measures of the expected

path of policy also moved down this year.Respondents to the Survey of Primary Dealersand to the Survey of Market Participants inJune expected fewer 25 basis point increases inthe FOMCs target range for the federal fundsrate this year than they projected in December.Market-based measures of uncertainty aboutthe policy rate approximately one to two yearsahead declined, on balance, from their year-end levels.

20

30

40

50

60

70

80

Percent of nominal GDPQuarterly

28. Federal government debt held by the public

1966 1976 1986 1996 2006 2016

NOTE: The data for gross domestic product (GDP) are at an annual rate.Federal debt held by the public equals federal debt less Treasury securitieseld in federal employee defined benefit retirement accounts, evaluated at the

end of the quarter.SOURCE: For GDP, Department of Commerce, Bureau of Economic

Analysis; for federal debt, Federal Reserve Board, Statistical Release Z.1,Financial Accounts of the United States.

30

20

10

+

_0

10

20

Thousands of jobs, monthly average

2016201420122010200820062004

29. State and local government employment change

H1

NOTE: The value for 2016:H1 is calculated with data extending throughMay. The value for 2013 is -0.08.



25/44


Common equity tier 1 ratio

4

6

8

10

12

Percent

20162014201220102008200620042002

A. Regulatory capital ratios at the top 25 bank holdingcompanies

Quarterly

Leverage ratio

NOTE: The common equity tier 1 ratio equals core equity capital divided byisk-weighted assets, while the leverage ratio equals tier 1 capital divided by

average total consolidated assets. Exact calculations for the two regulatorycapital ratios can be found in schedule HC-R of the Federal Reserve Board'seporting form FR Y-9C. Before 2014:Q1, the numerator of the common

equity tier 1 ratio is tier 1 common capital. Beginning in 2014:Q1 foradvanced approaches bank holding companies and in 2015:Q1 for all other

ank holding companies, the numerator is common equity tier 1 capital. Theshaded bars indicate periods of business recession as defined by the NationalBureau of Economic Research.

SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated FinancialStatements for Bank Holding Companies.

Capital positions also have remained relativelyelevated at insurance companies and broker-dealers. In

addition, net secured borrowing by dealersprimarilyused to finance their own portfolios of securitieshasstayed near its lowest levels since 2001. Margin creditextended by dealerswhich funds clients positions intraded stockshas fluctuated within the upper part ofits historical range, but margin calls reportedly weremet without disruption or a marked increase in disputesduring the heightened market volatility at the start ofthe year.

The stock of private, short-term, money-likeinstruments, which form funding intermediation chainsthat are vulnerable to runs, has continued to trenddown relative to gross domestic product (GDP) andtotal nonfinancial debt, suggesting vulnerabilities from

maturity transformation have continued to fall. Assetsin money market mutual funds (MMFs) have beenrelatively stable this year, though assets in institutionalprime MMFs have been declining, primarily becauseSecurities and Exchange Commission (SEC) reformsaimed at mitigating the funds susceptibility to investorruns have induced conversions of prime funds intogovernment-only funds. Nevertheless, some structuralvulnerabilities are expected to persist in MMFs evenafter SEC reforms go fully into effect in October 2016.For open-end mutual funds, the Financial StabilityOversight Council highlighted potential risks tofinancial stability from liquidity transformation

Financial vulnerabilities in the United Statesoverall remain at a moderate level. This assessment is

supported by the resilience demonstrated by domesticfinancial firms and markets during the period ofheightened financial volatility near the start of the year.Capital and liquidity ratios at large banks have stayedat high levels relative to historical standards, and debtgrowth in the household sector has been modest.However, leverage of nonfinancial corporationscontinues to be elevated by historical standards,leaving lower-rated firms potentially vulnerable toadverse developments. Stresses on energy firmsremain high given the low level of oil prices. Valuationpressures have increased somewhat in equitymarkets as expected profits have been marked down.Commercial real estate (CRE) prices are near or above

their previous peaks. Even given moderate financialvulnerabilities, a number of possible external shocks,including if the United Kingdom chooses to leave theEuropean Union in a pending referendum, could poserisks to financial stability.

Stronger capital positions at domestic bankingorganizations have substantially contributed to theimproved resilience of the U.S. financial system(figure A). The results of the stress tests mandated bythe Dodd-Frank Wall Street Reform and ConsumerProtection Act of 2010 and the accompanyingComprehensive Capital Analysis and Review arescheduled to be released June 23 and June 29, 2016,respectively.1In addition, large domestic banks have

continued to hold high levels of liquid assets andhave shifted the composition of their liabilities towardmore-stable funding sources. However, measures ofprofitability, such as return on assets and return onequity, declined noticeably in the first quarter as manybanking firms increased provisions for loan losses.The pickup in provisions to date primarily reflectsrising delinquencies for loans to energy-related firms.Energy exposures for most banks appear manageable,but some small domestic banks still have significantexposure to the oil sector, and others could be affectedby spillovers from the energy sector to other businesslines. A few large domestic banks have material tiesto global banks that appear to be more susceptible to

low oil prices due to their significant exposures to oil-producing emerging market economies.

1. The exercise tests the ability of the 34 participatingbank holding companies to maintain adequate capital ratiosand continue to provide intermediary services in the faceof a hypothetical severe recession. For descriptions of thescenarios, see Board of Governors of the Federal ReserveSystem (2016), 2016 Supervisory Scenarios for Annual StressTests Required under the Dodd-Frank Act Stress Testing Rulesand the Capital Plan Rule(Washington: Board of Governors,

January), https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a2.pdf.

Developments Related to Financial Stability
https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a2.pdfhttps://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a2.pdfhttps://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a2.pdfhttps://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a2.pdf


26/44


The Federal Reserve Board has taken several furthersteps to improve the resilience of financial institutionsand overall financial stability, including three proposalsthat apply only to large banking organizations andincrease in stringency with the systemic footprintof the organization. First, the Board issued forpublic comment a proposed rule that would imposesingle-counterparty credit limits to help constraininterconnectedness within the financial system.2Second, the Board and the other federal bankingagencies issued for public comment a proposed rulethat would require large U.S. banking organizationsto maintain a minimum net stable funding ratio(NSFR).3The proposal would require those institutionsto maintain sufficient levels of stable fundingrelative to the liquidity of their assets, derivatives,and commitments over a one-year period, reducingliquidity risk in the banking system. The NSFR proposalwould also serve as a complement to the liquiditycoverage ratio rule. Third, the Board issued for publiccomment a proposed rule that would reduce the threatof disorderly liquidation of financial firms by requiringU.S. global systemically important banks (G-SIBs) andthe U.S. operations of foreign G-SIBs to restrict theability of counterparties to terminate qualified financialcontracts early if the firm enters bankruptcy or aresolution process.4

In addition, the Board and the Federal DepositInsurance Corporation announced their determinationsand provided firm-specific feedback on the 2015

resolution plans of eight U.S. G-SIBs.

5

The twoagencies ordered five of the firms to address identifieddeficiencies in their plans by October 1, 2016, orpossibly be subjected to more stringent prudentialrequirements.

through funds that hold less liquid assets and couldface elevated redemptions, and the council suggestedpossible actions to mitigate those risks.

Valuation pressures have generally stayed at amoderate level since January, though they rose fora few asset classes. Forward price-to-earnings ratiosfor equities have increased to a level well abovetheir median of the past three decades. Althoughequity valuations do not appear to be rich relative toTreasury yields, equity prices are vulnerable to risesin term premiums to more normal levels, especially ifa reversion was not motivated by positive news abouteconomic growth. In contrast, valuation pressures incorporate bond marketswhich manifest in low yieldsand credit spreadswere about unchanged. Creditspreads for 10-year investment- and speculative-gradebonds changed little, on balance, and far-term forwardspreads on speculative-grade corporate bonds haverisen slightly, suggesting only a small decrease ininvestors risk appetite. Although respondents to theBoards Senior Credit Officer Opinion Survey on DealerFinancing Terms reported some deterioration in marketliquidity during the heightened financial volatility nearthe start of the year, standard measures of liquidityin corporate bond markets decreased only about inline with what might be expected given historicalrelationships between liquidity and volatility.

Valuations in the CRE sector appear increasinglyvulnerable to negative shocks, as CRE prices havecontinued to outpace rental income and exceed,

by some measures, their pre-crisis peaks. However,leverage in the sector does not appear excessive, andsome evidence points to a recent reduction in riskappetite among CRE investors. Overall growth of CREdebt is moderate, and the ratio of debt backed bynonfarm nonresidential property to GDP is below anestimate of its long-run historical trend. In addition,according to the January and April results of the BoardsSenior Loan Officer Opinion Survey on Bank LendingPractices, banks tightened lending standards in thefourth quarter of 2015 and first quarter of 2016.

The private nonfinancial-sector credit-to-GDP ratiohas stayed near the levels that prevailed in the mid-2000s, though it is below conventional estimates of

its long-term upward trend. In addition, debt growthin the household sector remained modest and mostlyattributable to prime borrowers. In contrast, leverage forthe nonfinancial corporate sector has stayed elevatedand indicators of corporate credit quality, though stillsolid overall, continued to show signs of deteriorationfor lower-rated firms, especially in the energy sector.Even so, the risks posed by the elevated indebtednessof nonfinancial corporations may be attenuated bysubstantial cash holdings of investment-grade firms,relatively low interest expenses, and limited short-term debt.

2. See Board of Governors of the Federal Reserve System(2016), Federal Reserve Board Proposes Rule to Address RiskAssociated with Excessive Credit Exposures of Large BankingOrganizations to a Single Counterparty, press release,March 4, https://www.federalreserve.gov/newsevents/press/bcreg/20160304b.htm.

3. See Board of Governors of the Federal Reserve System,Federal Deposit Insurance Corporation, and Office of theComptroller of the Currency (2016), Agencies Propose NetStable Funding Ratio Rule, joint press release, May 3, https://www.federalreserve.gov/newsevents/press/bcreg/20160503a.

htm.4. See Board of Governors of the Federal Reserve System

(2016), Federal Reserve Board Proposes Rule to Support U.S.Financial Stability by Enhancing the Resolvability of Very Largeand Complex Financial Firms, press release, May 3, https://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htm.

5. See Board of Governors of the Federal Reserve Systemand Federal Deposit Insurance Corporation (2016), AgenciesAnnounce Determinations and Provide Feedback onResolution Plans of Eight Systemically Important, DomesticBanking Institutions, joint press release, April 13, https://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htm.
https://www.federalreserve.gov/newsevents/press/bcreg/20160304b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160304b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160413a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160503a.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160304b.htmhttps://www.federalreserve.gov/newsevents/press/bcreg/20160304b.htm


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. . . longer-term nominal Treasury yieldsdecreased . . .

Yields on 5-, 10-, and 30-year nominalTreasury securities declined in the first half

of the year on balance (figure 30). Treasuryyields decreased most notably in the earlypart of the year amid an increase in safe-haven demands and a pullback from riskyassets. Yields changed little since then, onnet, as risk sentiment generally improved butconcerns about longer-term economic growthremained. Consistent with the change inyields on Treasury securities, yields on 30-yearagency mortgage-backed securities (MBS)animportant determinant of mortgage interestratesdecreased, on balance, in the first halfof 2016 (figure 31).

. . . broad equity price indexes increasedslightly, and those of companies linked toenergy sectors rose substantially . . .

After incurring sharp declines early in the year,broad equity price indexes rebounded as risksentiment improved, resulting in levels thatwere slightly higher, on net, than at year-end(figure 32). In addition, reflecting the reboundin oil prices since the turn of the year, stock

prices of companies in the energy sectoroutperformed broad equity market indexesover the first half of 2016. Meanwhile, impliedvolatility of the S&P 500 index increasedthrough mid-February and then declined,ending the period above its year-end level.

. . . while risk spreads on corporate bondsnarrowed

Similar to the movements in equity markets,spreads on corporate bonds over comparable-

maturity Treasury securities widened earlyin the year but later retraced those moves,leaving spreads generally little changed, onnet, over the first half of the year. Spreadson the lowest-rated speculative-grade issuesdeclined appreciably. Nonetheless, corporatebond spreads stayed notably above theirhistorical median levels, consistent with somedeterioration in credit quality in thecorporate sector.

5-year

30-year

0

1

2

3

4

5

6

7

Percent

201620142012201020082006200420022000

30. Yields on nominal Treasury securities

Daily

10-year

NOTE: The Treasury ceased publication of the 30-year constant maturityseries on February 18, 2002, and resumed that series on February 9, 2006.

SOURCE: Department of the Treasury.

Yield

0

50

100

150

200

250

300

350

400

Basis points

2

3

4

5

6

7

8

9

201620142012201020082006200420022000

31. Yield and spread on agency mortgage-backedsecurities

Percent

Spread

NOTE: The data are daily. Yield shown is for the Fannie Mae 30-yearcurrent coupon, the coupon rate at which new mortgage-backed securities

ould be priced at par, or face, value. Spread shown is to the average of the5- and 10-year nominal Treasury yields.

SOURCE: Department of the Treasury; Barclays.

S&P 500 index

20

40

60

80

100

120

140

160

December 31, 2007 = 100

20162013201020072004200119981995

32. Equity prices

Daily

Dow Jones bank index

NOTE: For Dow Jones Indices licensing information, see the note on theContents page.

SOURCE: Standard and Poors Dow Jones Indices via Bloomberg.


28/44


Bank credit continued to expand, butprofitability declined

Aggregate credit provided by commercialbanks increased at a solid pace through May

(figure 33). The expansion in bank creditreflected strong loan growth coupled witha modest increase in banks holdings ofsecurities. The growth of loans on banksbooks was generally consistent with banksreports in the April SLOOS of strongerdemand for most loan categories and easierlending standards for loans to households.

Measures of bank profitability remainedbelow their historical averages and declined inthe first quarter of 2016, pressured by higherprovisioning for losses on loans to borrowersin the oil and gas sectors, reduced trading andinvestment banking revenues, and continuedlow net interest margins (figure 34). However,with the exception of C&I loans, loandelinquency and charge-off rates continuedto decline across most major loan types andremained near or at their lowest levels sincethe financial crisis. Stock prices of large bankholding companies decreased over the firsthalf of the year, while banks credit default

swap spreads increased and stayed above theiraverage level over the past two years.

Measures of liquidity conditions andfunctioning in financing markets weregenerally stable

Available indicators of Treasury marketfunctioning have remained broadly stable overthe first half of 2016. A variety of liquiditymetricsincluding bid-asked spreads andbid sizes in secondary markets for Treasurysecuritieshave displayed no notable signs

of liquidity pressures over the same period.In addition, Treasury auctions generallycontinued to be well received by investors.

Liquidity conditions in the agency MBSmarket also appeared to be generally stable.Dollar-roll-implied financing rates forproduction coupon MBSan indicator ofthe scarcity of agency MBS for settlement

55

60

65

70

75

Percent

201620142012201020082006

33. Ratio of total commercial bank credit to nominal grossdomestic product

Quarterly

SOURCE: Federal Reserve Board, Statistical Release H.8, Assets andLiabilities of Commercial Banks in the United States; Department ofCommerce, Bureau of Economic Analysis.

Return on assets

30

20

10

+

_0

10

20

30


2.0

1.5

1.0

.5

+

_0

.5

1.0

1.5

2.0

2016201320102007200420011998

34. Profitability of bank holding companies


Return on equity

NOTE: The data are quarterly and are seasonally adjusted.SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial

Statements for Bank Holding Companies.


29/44


suggested limited settlement pressures overthe first half of 2016. In addition, measuresof corporate bond market liquidity, suchas gauges of the effect of trades on market

prices, stayed at levels comparable with thoseseen prior to the financial crisis. However,accurately measuring liquidity in fixed-incomemarkets can be challenging, and liquidityconditions may vary in certain segments of themarket or during times of stress.

Short-term dollar funding markets alsocontinued to function smoothly during the firsthalf of 2016. There were generally no signs ofstress in either secured or unsecured moneymarkets, including at March quarter-end.

Municipal bond markets functionedsmoothly despite recent developments onPuerto Ricos debt

Credit conditions in municipal bondmarkets continued to be stable even asthe situation facing Puerto Rico and itscreditors deteriorated further. Gross issuanceof municipal bonds remained solid in thefirst quarter, and yield spreads on generalobligation (GO) municipal bonds overcomparable-maturity Treasury securitiesincreased a bit on net. Puerto RicosGovernment Development Bank missed asubstantial debt payment due in early May,and investors remained focused on the nextsizable payment of GO bonds due in July.

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