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Meeting of the Federal Open Market Committee
May 9, 2007 Presentation Materials -- Text Version

Presentation Materials (PDF)

Pages 112 to 130 of the Transcript

Appendix 1: Materials used by Mr. Dudley

Class II FOMC - Restricted FR

Page 1

Top panel
(1) Correlation of Daily Price/Yield Changes

Source: Bloomberg

Middle panel
(2) Correlation of Daily Price/Yield Changes

Source: Bloomberg

Bottom panel
(3) Correlation of Daily Price/Yield Changes

Source: Bloomberg

Page 2

Top panel
(4)

Title: 60+ Days Delinquencies by Vintage (Subprime ARMs)
Series: Level of 60+ day delinquencies on subprime mortgages backing MBS index. Shows delinquency levels according to year in which subprime MBS was issued.
Horizon: 2001 to 2006
Description: Delinquency rates for mortgages originated during 2006 are increasing much faster than those of recent years.

Source: Moody's

Middle panel
(5)

Title: Losses in 2006 Vintage Far Exceed Previous Years (Subprime ARMs)
Series: Losses on subprime mortgages backing MBS index. Shows losses according to the year in which subprime MBS was issued.
Horizon: 2001 to 2006
Description: Losses in 2006 vintage are increasing faster than any of the previous vintages.

Source: Moody's

Bottom panel
(6)

Title: Subprime BBB-Rated MBS and Related Spreads
Series: MBS CDS BBB, ABX 06-2 BBB, and Cash MBS BBB
Horizon: January 1, 2007 - May 4, 2007
Description: Subprime BBB-rated cash, CDS, and ABX 06-2 widened following February 27, 2007 and have since declined slightly.

Source: Merrill Lynch

Page 3

Top panel
(7)

Title: Mezzanine Structured Finance CDO
Series: Mezzanine Structured Finance CDO: AAA-Rated, AA-Rated, A-Rated, and BBB-Rated
Horizon: July 1, 2006 - May 4, 2007
Description: Since mid-January, spread in various tranches of the mezzanine structured finance CDOs have widened.

Source: Merrill Lynch

Middle panel
(8)

Title: 2007 Earnings Expectations Stabilize
Series: S&P 500 Bottom-Up Growth Estimates
Horizon: January 1, 2007 - April 20, 2007
Description: Bottom-up S&P equity growth estimates have declined since the beginning of 2007 and have stabilized near these low levels in recent weeks.

Source: Thompson Financial

Bottom panel
(9)

Title: Buyouts and Buybacks Shrink Floating Equity Supply
Series: Net Equity Issuance, Four-Quarter Moving Average
Horizon: Q1 2000 - Q4 2006
Description: Net equity issuance has declined sharply since 2004.

Source: Federal Reserve Board Z.1 Release - Flow of Funds Accounts of the United States

Page 4

Top panel
(10)

Title: Debt Spreads
Series: EMBI+, High-Yield, and Investment Grade spreads
Horizon: January 1, 2007 - May 7, 2007
Description: EMBI+ and high-yield spreads have declined since February 27, 2007 while investment grade spreads have remained relatively stable throughout the January to May time horizon.

Source: Bloomberg

Middle panel
(11)

Title: Dollar Softens
Series: Trade-weighted Dollar, Yen vs. USD, Euro vs. USD
Horizon: January 1, 2007 - May 7, 2007
Description: Since the beginning of the year, the U.S. dollar has softened against the euro while it has appreciated slightly against the Japanese yen. Overall, the trade-weighted dollar has also declined since January 01, 2007.

Source: Bloomberg

Bottom panel
(12)

Title: June 2008 Eurodollar and Euribor Contracts and Euro-Dollar Currency Pair
Series: Eurodollar and Euribor Contract Spread and Euro-USD Currency pair
Horizon: January 1, 2007 - May 7, 2007
Description: As the spread between Eurodollar and Euribor contract spreads declined, the euro appreciated against the U.S. dollar.

Source: Bloomberg

Page 5

Top panel
(13)

Title: Net Foreign Acquisitions of U.S. Financial Assets
Series: Overall, Official, and Private Foreign Holdings of Treasury Securities, Agency & GSE-Backed Securities, and Corporate Bonds*.
Horizon: 2004-2006
Description: In the past three years, there has been a shift in overall foreign holdings from Treasury securities to agency & GSE-backed securities and corporate bonds.

* Includes private asset-backed securities  Return to text

Source: Federal Reserve Board Z.1 Release - Flow of Funds Accounts of the United States

Middle panel
(14)

Title: 2007 Fed Funds Futures Curves
Series: Fed funds futures curve as of 12/12/2006, 1/31/2007, 3/21/2007, and 5/7/2007
Horizon: December 12, 2006 - May 7, 2007
Description: Expectations for policy rate changes over the course of 2007 have almost completely returned to levels seen on January 31, 2007

Source: Bloomberg

Bottom panel
(15)

Title: Eurodollar Futures Contract
Series: Eurodollar futures curve as of 12/12/2006, 1/31/2007, 3/21/2007, and 5/7/2007
Horizon: December 12, 2006 - May 7, 2007
Description: As of 5/7/2007, eurodollar futures contracts have priced in two twenty-five basis point rate cuts between then and the 2008 year-end.

Source: Bloomberg

Page 6

Top panel
(16)

Title: Distribution of Expected Policy Target Among Primary Dealers Prior to March 21 FOMC Meeting
Series: Dealer expectations for policy target rate by quarter, average forecast for policy target by quarter, and market rate for policy expectation by quarter as of 3/13/2007
Horizon: Q2 2007 - Q4 2008
Description: There is more dispersion regarding where dealers expect the policy rate to be in Q1, Q2, and Q3 2008.

Source: Dealer Policy Survey

Middle panel
(17)

Title: Distribution of Expected Policy Target Among Primary Dealers Prior to May 9 FOMC Meeting
Series: Dealer expectations for policy target rate by quarter, average forecast for policy target by quarter, and market rate for policy expectation by quarter as of 5/1/2007
Horizon: Q2 2007 - Q4 2008
Description: Compared to the March policy survey, there is less dispersion of policy rate expectation for Q2 and Q3 2007.

Source: Dealer Policy Survey

Appendix 2: Materials used by Mr. Reinhart

Page 1

Class I FOMC - Restricted Controlled (FR)

Board of Governors of the Federal Reserve System
FOMC Secretariat

Date: May 8, 2007
To: Federal Open Market Committee
From: Deborah J. Danker
Subject: Draft Tables and Charts for Projections Trial Run

Attached are tables and histograms summarizing the projections submitted for the trial run. Please note that hard copies of these will also be available at tomorrow's meeting.

Page 2
Summary of Trial Run Economic Projections

Top panel
Table 1: Economic Projections of Board Members and Reserve Bank Presidents

Page 3
Histograms of GDP Growth Projections: 2007-2009

Top panel
Distribution of GDP Growth Projections: 2007

Middle panel
Distribution of GDP Growth Projections: 2008

Bottom panel
Distribution of GDP Growth Projections: 2009

Page 4
Histograms of Projections for Core PCE Inflation: 2007-2009

Top panel
Distribution of Core PCE Inflation Projections: 2007

Middle panel
Distribution of Core PCE Inflation Projections: 2008

Bottom panel
Distribution of Core PCE Inflation Projections: 2009

Page 5
Histograms of Projections for Unemployment Rate: 2007Q4, 2008Q4, 2009Q4

Top panel
Distribution of Unemployment Rate Projections: 2007Q4

Middle panel
Distribution of Unemployment Rate Projections: 2008Q4

Bottom panel
Distribution of Unemployment Rate Projections: 2009Q4

Appendix 3: Materials used by Mr. Reinhart

Material for FOMC Briefing on Monetary Policy Alternatives
Vincent R. Reinhart
May 9, 2007

Class I FOMC - Restricted Controlled (FR)

Exhibit 1
Market Developments

Top-left panel
Announcement effects*

A bar chart showing changes in the two-year and ten-year Treasury yields from 15 minutes before to 1 hour after the FOMC statement release. The chart shows market reactions for each FOMC meeting over the last two years (from May 2005 to March 2007). The bulk of the announcement effects are fairly small, generally 5 basis points or less, with the reaction of the ten-year rate smaller than that of the two-year rate. The reactions to the March 2007 announcement are the largest for the period shown. The two-year rate fell 10 basis points and the ten-year rate fell 5 basis points.

* Change in the on-the-run two-year and ten-year Treasury yields from 15 minutes before to 1 hour after the release of an FOMC statement.  Return to text

Top-right panel
Expected federal funds rates*

A line chart showing the expected path of the federal funds rate from the second quarter of 2007 through the fourth quarter of 2008 as implied by federal funds and Eurodollar futures prices on March 20, 2007 and May 8, 2007. The line for March 20 starts at about 5.25 percent and declines gradually to about 4.4 percent by the end of 2008. The line for May 8 also starts at about 5.25 percent, but remains near that level into the third quarter of 2007 before sloping gradually down to about 4.5 percent by the end of 2008.

* Estimates from federal funds and Eurodollar futures, with an allowance for term premiums and other adjustments.  Return to text

Middle-left panel
Corporate bond spreads

A line chart showing daily spreads of yields on ten-year BBB-rated bonds and five-year high-yield bonds over yields on Treasury securities of comparable maturity for the period since the start of 2001. The Treasury yields are based on an estimated off-the-run yield curve. The BBB spread starts out near 200 basis points in 2001, rises to a peak of about 300 basis points at the end of 2002, falls to only about 100 basis points in early 2005, and then rises gradually to around 130 basis points by early 2007. The high-yield spread follows a generally similar pattern, starting near 700 basis points, peaking at about 1000 basis points, and ending the period near 300 basis points. Over the period since the March 2007 FOMC meeting, both edged down a bit.

Middle-center panel
Implied volatilities

A line chart showing daily implied volatilities from options prices for the S&P 500 (the VIX) and for the three-month Eurodollar rate six months ahead for the period since the start of 2004. The VIX varies in a range between about 15 and 20 percent in early 2004, falling to a range between about 12 and 17 percent in 2005 and early 2006. It spikes to over 20 percent for a time in the second quarter of 2006 before falling back to about 12 percent later in the year. It jumps again to almost 20 percent in February 2007, but then falls back to 12 or 13 percent more recently. The Eurodollar implied volatility varies fairly widely but without a trend over 2004-2006, ranging as high as about 150 basis points and as low as about 75 basis points. At the end of 2006 and in early 2007 the implied volatility falls sharply to about 65 basis points before jumping to about 125 basis points in late February. It then falls back to about 100 basis points.

Middle-right panel
S&P 500

A line chart showing daily readings on the S&P 500 stock price index since the start of 2004. Stock prices generally trended higher between early 2004 and early 2007, rising by a total of about 30 percent. Stock prices fell between 5 and 10 percent in late February and early March of 2007, but subsequently more than reversed those losses. Over the intermeeting period, the S&P 500 rose about 7 percent.

Bottom-left panel
Reasons for higher stock prices

• A. Earnings were solid.
• B. Equity premium narrowed a bit.
• C. Downside risks to the outlook appeared to ease.
• D. All of the above.

Bottom-right panel
Equity valuation

A line chart showing monthly data on the twelve-month forward trend earnings-price ratio and the real long-term interest rate (defined as an estimated Treasury perpetuity yield less the Philadelphia Fed ten-year expected inflation rate). The plot covers 1986 to the present. The shaded region between the two lines (the earnings-price ratio less the real long-term yield) is a rough estimate of the equity premium. This premium generally ranges between about 3 and 4 percent, but it narrowed sharply in the late 1990s, reaching zero for a time in 1999. Over the past two years the premium has been between 3 and 4 percent. It narrowed slightly in the latest data.

Note. + Denotes the latest observation using daily interest rates and stock prices and latest earnings data from I/B/E/S.

Exhibit 2
The Case for Alternative B

Top-left panel
Real GDP

A line chart showing the staff forecast of real GDP growth (calculated as a four-quarter percent change) from the May Greenbook, the corresponding forecast from the March Greenbook, and the 70-percent confidence interval around the May forecast based on stochastic simulations of the FRB/US model. The May forecast of GDP growth is about 2 percent in 2007:Q2, and trends very gradually higher, reaching 2¼ percent by 2008:Q4. The March forecast is virtually identical. The 70-percent confidence interval ranges from about 1 percent to nearly 3 percent at the end of this year, and from about 1 percent to nearly 4 percent by the end of 2008.

Top-right panel
Core PCE

A line chart showing the staff forecast of core PCE inflation (calculated as a four-quarter percent change) from the May Greenbook, the corresponding forecast from the March Greenbook, and the 70-percent confidence interval around the May forecast based on stochastic simulations of the FRB/US model. The May forecast of core inflation is a little over 2 percent in 2007:Q2, edges up a tenth or two by year-end, and then falls back to end 2008 a bit over 2 percent again. The March forecast is about a tenth of a percentage point lower late this year and next year. The 70-percent confidence interval ranges from around 1.8 percent to about 2.6 percent at the end of this year, and from about 1.5 percent to about 2.8 percent by the end of 2008.

Middle panel
Equilibrium real federal funds rate*

The panel reproduces the Bluebook chart on staff estimates of the equilibrium real interest rate, R*. The 90-percent confidence interval around the staff estimates of R* prepared for the current FOMC meeting ranges from roughly 0 to nearly 5 percent. The 70-percent confidence interval ranges from just under 1 to just under 4 percent. The range of the staff estimates is quite narrow, ranging from just over 2 percent to about 2¼ percent. Both the Greenbook-consistent measure of R* and the current actual real federal funds rate (defined as the nominal federal funds rate less the lagged four-quarter change in core PCE prices) are currently a little over 3 percent. Since mid-2006, Greenbook-consistent R* and the actual real federal funds rate have trended higher, moving from a bit under 3 percent to their current level. The range of estimated values of R* has moved down a few tenths over the same period.

* Explanatory notes are provided in appendix A of the Bluebook.  Return to text

Bottom panel
Real GDP

A line chart showing the growth rate of real GDP (calculated as a four-quarter percent change) for the period since 1948. NBER recession periods are shaded, and there is a dashed line at a 2 percent growth rate. The chart shows that periods of growth at or below 2 percent have generally been followed by recessions. The staff forecast currently calls for growth of about 2 percent this year and only a little over 2 percent next year.

Shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research (NBER): 1948:Q4-1949:Q4, 1953:Q2-1954:Q2, 1957:Q3-1958:Q2, 1960:Q2-1961:Q1, 1969:Q4-1970:Q4, 1973:Q4-1975:Q1, 1980:Q1-1980:Q3, 1981:Q3-1982:Q4, 1990:Q3-1991:Q1, and 2001:Q1-2001:Q4.

Exhibit 3
Why Might You Change Policy?

The case for alternative A

Top-left panel

• Housing sector adjustment and possible spillovers.
• Investment spending weakness.
• Financial markets could correct.

Middle-left panel
New home sales and supply of new homes

A line chart showing monthly data on new home sales and on the supply of new homes since 2000. New home sales start at about 900 thousand and rise to about 1.3 million by the first half of 2005. Sales then fall back to about 1 million over the second half of 2006 and then tumble to under 900 thousand in recent months. The supply of new homes varies in a fairly narrow range around 4 months sales between 2000 and mid-2005, then rises to about 6½ months sales in the second half of 2006 before jumping to more than 7½ months sales in the past few months.

Bottom-left panel
Orders and shipments of capital goods excluding aircraft

A line chart showing monthly data on durable goods orders and shipments since 2000. The two lines start the period plotted around $65 billion, and move down to about $50 billion over 2001. They stay near that low level until 2004, and then gradually trend back up to about $65 billion by mid-2006. Orders and shipments then fall back to about $60 billion, though, before rebounding in the latest month.

The case for alternative C

Top-right panel

• Inflation not clearly on a downward trend.
• Oil and other commodity prices higher.
• Inflation expectations could drift up.

Middle-right panel
Core PCE

A line chart showing monthly data on core PCE inflation and market-based core PCE inflation (calculated as twelve-month percent changes) since 2000. Core PCE inflation ranges fairly widely between about 1.5 and 2.5 percent over 2000-2002. In 2003, it falls to its lowest level for the period charted, about 1.3 percent, and then rises steadily to more than 2 percent by mid-2004. Over the remainder of the period, core PCE inflation varies in a range between 2 and 2.5 percent. The pattern for the market-based measure is broadly similar, but at a lower level. In addition, after mid-2004, market-based core PCE inflation has trended higher, moving from about 1.5 percent to about 2 percent, while the total core PCE inflation rate has been about flat on net.

Bottom-right panel
Primary commodity prices

A line chart showing monthly data on the price of WTI crude oil and an index for non-fuel commodities since 2000, with the staff forecast shown through 2008. The oil price starts out near $25 a barrel, but between 2004 and mid-2006 it rises to nearly $75 a barrel. In late 2006, it falls as low as $55 before rebounding to about $65. The staff projection shows the oil price rising back to about $72 a barrel by the end of 2008, about $6 higher than in the March Greenbook. The non-fuel commodity price index varies near 100 over 2000-2003, and then moves up to about 200 more recently In the staff forecast, it is expected to remain near that level, and is now expected to be noticeably higher than in March over the projection period.

Table 1:
Alternative Language for the May 2007 FOMC Announcement