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May 9, 2007 Authorized for Public Release Appendix 1: Materials used by Mr. Dudley 112 of 130 May 9, 2007 Authorized for Public Release 113 of 130 Class II FOMC – Restricted FR Page 1 of 6 (1) Correlation of Daily Price/Yield Changes January 01, 2007 – February 26, 2007 Variables 2YR Yield 10YR Yield S&P USD/JPY Swap Spreads VIX Merrill-HY 2YR Yield 0.94 -0.24 0.39 0.41 0.00 -0.71 Source: Bloomberg 10YR Yield -0.21 0.41 0.41 0.00 -0.71 S&P -0.26 -0.33 -0.82 0.10 Swap USD/JPY Spreads 0.17 0.16 -0.37 VIX Merrill-HY 0.22 -0.40 0.13 Blue boxes denote correlations greater than 0.50 or less than -0.50 (2) Correlation of Daily Price/Yield Changes February 27, 2007 – March 21, 2007 Variables 2YR Yield 10YR Yield S&P USD/JPY Swap Spreads VIX Merrill-HY 2YR Yield 0.97 0.67 0.83 -0.49 -0.79 -0.82 Source: Bloomberg 10YR Yield S&P Swap USD/JPY Spreads VIX Merrill-HY 0.69 0.83 0.86 -0.50 -0.81 -0.66 -0.78 -0.95 -0.84 0.78 -0.80 -0.78 -0.86 0.64 0.80 Blue boxes denote correlations greater than 0.50 or less than -0.50 (3) Correlation of Daily Price/Yield Changes March 22, 2007 – May 7, 2007 Variables 2YR Yield 10YR Yield S&P USD/JPY Swap Spreads VIX Merrill-HY 2YR Yield Source: Bloomberg 0.92 0.26 0.65 0.11 -0.30 -0.57 10YR Yield S&P Swap USD/JPY Spreads VIX Merrill-HY 0.14 0.49 0.40 0.19 -0.11 0.10 -0.27 -0.70 -0.30 0.11 -0.69 -0.30 -0.37 0.01 0.30 Blue boxes denote correlations greater than 0.50 or less than -0.50 May 9, 2007 Authorized for Public Release 114 of 130 Class II FOMC -- Restricted FR Percent Page 2 of 6 Percent (4) 60+ Days Delinquencies by Vintage (Subprime ARMs) 18 16 14 12 10 8 6 4 2 0 2001 2002 2003 2005 2006 1 3 5 2004 7 9 Source: Moody’s Percent 2001 17 19 21 23 Percent 2004 2005 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 2002 2003 1 11 13 15 Index Age in Months (5) Losses in 2006 Vintage Far Exceed Previous Years 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 18 16 14 12 10 8 6 4 2 0 2006 3 5 7 9 11 13 15 17 19 21 23 Index Age in Months Source: Moody’s (6) Subprime BBB-Rated MBS and Related Spreads January 01, 2007 – May 4, 2007 BPS BPS 1200 1200 Cash 1000 CDS ABX 06-2 800 1000 800 600 600 400 400 200 200 0 0 01/01/07 02/01/07 Source: Merrill Lynch 03/01/07 04/01/07 05/01/07 May 9, 2007 Authorized for Public Release 115 of 130 Class II FOMC – Restricted FR Page 3 of 6 (7) Mezzanine Structured Finance CDO July 1, 2006 – May 4, 2007 BPS 800 BPS 800 AAA AA A BBB 600 600 400 400 200 200 0 0 07/01/06 09/01/06 11/01/06 01/01/07 03/01/07 05/01/07 Source: Merrill Lynch (8) 2007 Earnings Expectations Stabilize January 01, 2007 – April 20, 2007 Percent 10 Percent 10 9 9 8 8 S&P 500: Bottom-Up Equity Analyst Forecasts 7 7 6 6 5 5 01/01/07 02/01/07 03/01/07 04/01/07 Source: Thompson Financial Billions (9) Buyouts and Buybacks Shrink Floating Equity Supply Net Equity Issuance, Four-Quarter Moving Average Billions 200 200 100 100 0 0 -100 -100 -200 -200 -300 -300 -400 -400 -500 -500 Q1-2000 Q1-2001 Q1-2002 Q1-2003 Q1-2004 Q1-2005 Q1-2006 Source: Federal Reserve Board Z.1 Release - Flow of Funds Accounts of the United States May 9, 2007 Authorized for Public Release 116 of 130 Class II FOMC – Restricted FR Page 4 of 6 (10) Debt Spreads January 01, 2007 – May 7, 2007 BPS BPS 200 350 EMBI + (LHS) 175 325 150 300 High-Yield (RHS) 125 275 100 250 Investment Grade (LHS) 75 225 50 200 01/01/07 02/01/07 Source: Bloomberg 03/01/07 04/01/07 05/01/07 (11) Dollar Softens January 01, 2007 – May 7, 2007 104 Trade-Weighted Dollar 102 Dollar Depreciation 100 98 96 Index to 100 on 1/1 104 Dollar Appreciation Index to 100 on 1/1 Yen vs. Dollar 102 100 98 Euro vs. Dollar 96 94 94 01/01/07 02/01/07 03/01/07 04/01/07 05/01/07 Source: Bloomberg (12) June 2008 Eurodollar and Euribor Contracts and Euro-Dollar Currency Pair January 01, 2007 – May 7, 2007 BPS 105 $/Euro 1.38 95 1.36 Euro-$ (RHS) 85 1.34 75 1.32 65 1.3 55 1.28 Eurodollar – Euribor Futures Contract (LHS) 45 1.26 35 1.24 01/01/07 Source: Bloomberg 02/01/07 03/01/07 04/01/07 05/01/07 May 9, 2007 Authorized for Public Release 117 of 130 Class II FOMC – Restricted FR Page 5 of 6 (13) Net Foreign Acquisition of U.S. Financial Assets 2004-2006 Billions 500 Corporate Bonds* Agency and GSE-backed Securities Treasury Securities 400 Overall Official Private * Includes private asset-backed securities 2006 2005 2006 2005 2004 Official 2004 2006 2004 Overall 2005 2006 2005 2004 2005 2004 2006 0 2006 2005 2006 100 2004 2004 200 2005 300 Private Overall Source: Federal Reserve Board Z.1 Release - Flow of Funds Accounts of the United States Percent Percent (14) Fed Funds Futures Curves 5.40 5.40 5.20 5.20 5.00 5.00 4.80 4.80 4.60 4.60 12/12/2006 1/31/2007 3/21/2007 5/7/2007 4.40 4.40 May-07 Jun-07 Jul-07 Sep-07 Oct-07 Nov-07 Dec-07 Fed Funds Futures Contracts Source: Bloomberg Percent Aug-07 Percent (15) Eurodollar Futures Curves 5.40 12/12/2006 1/31/2007 5.40 3/21/2007 5/7/2007 5.20 5.20 5.00 5.00 4.80 4.80 4.60 4.60 4.40 4.40 Jun-07 Sep-07 Source: Bloomberg Dec-07 Mar-08 Jun-08 Eurodollar Futures Contracts Sep-08 Dec-08 May 9, 2007 Authorized for Public Release 118 of 130 Class II FOMC – Restricted FR Percent 6.5 Page 6 of 6 (16) Distribution of Expected Policy Target Among Primary Dealers Prior to March 21 FOMC Meeting 6.0 5.5 5.0 4.5 4.0 Survey Response -size indicates freq 3.5 March Average Forecast 3.0 Market Rates as of 3/13 2.5 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Source: Dealer Policy Survey Percent 6.5 (17) Distribution of Expected Policy Target Among Primary Dealers Prior to May 9 FOMC Meeting 6.0 5.5 5.0 4.5 4.0 3.5 3.0 Survey Response -size indicates freq May Average Forecast Market Rates as of 5/1 2.5 Q2 2007 Q3 2007 Source: Dealer Policy Survey Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 May 9, 2007 Authorized for Public Release Appendix 2: Materials used by Mr. Reinhart 119 of 130 May 9, 2007 Authorized for Public Release 120 of 130 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 1 of 5 May 9, 2007 Authorized for Public Release 121 of 130 Class I FOMC - Restricted Controlled (FR) Summary of Trial Run Economic Projections Table 1: Economic Projections of Board Members and Reserve Bank Presidents 2007 2008 2009 2.0 to 2.5 (2.5 to 3.0) 1.8 to 2.6 2.2 2.5 to 2.8 (2.8 to 3.0) 2.4 to 3.0 3.0 2.5 to 3.0 2.1 to 2.3 (2.0 to 2.3) 2.0 to 2.3 0.9 1.8 to 2.1 (1.8 to 2.0) 1.8 to 2.4 1.3 4.7 to 4.8 (4.6 to 4.8) 4.5 to 4.9 0.7 4.7 to 4.9 (4.6 to 4.8) 4.6 to 5.0 1.2 GDP Growth Central Tendency Memo: Central Tendency at January 2007 Meeting Range Width of Median 70 Percent Confidence Band 2.5 to 3.0 3.4 Core PCE Inflation Central Tendency Memo: Central Tendency at January 2007 Meeting Range Width of Median 70 Percent Confidence Band 1.6 to 2.0 1.5 to 2.3 1.4 Unemployment Rate Central Tendency Memo: Central Tendency at January 2007 Meeting Range Width of Median 70 Percent Confidence Band Page 2 of 5 4.7 to 5.0 4.6 to 5.1 1.6 May 9, 2007 Authorized for Public Release 122 of 130 Class I FOMC - Restricted Controlled (FR) Histograms of GDP Growth Projections: 2007-2009 Distribution of GDP Growth Projections: 2007 8 Number of Respondents 7 6 5 4 3 2 1 0 >1.6 to 1.8 >1.8 to 2.0 >2.0 to 2.2 >2.2 to 2.4 >2.4 to 2.6 >2.6 to 2.8 >2.8 to 3.0 Distribution of GDP Growth Projections: 2008 8 Number of Respondents 7 6 5 4 3 2 1 0 >1.6 to 1.8 >1.8 to 2.0 >2.0 to 2.2 >2.2 to 2.4 >2.4 to 2.6 >2.6 to 2.8 >2.8 to 3.0 Distribution of GDP Growth Projections: 2009 8 Number of Respondents 7 6 5 4 3 2 1 0 >1.6 to 1.8 >1.8 to 2.0 >2.0 to 2.2 >2.2 to 2.4 Page 3 of 5 >2.4 to 2.6 >2.6 to 2.8 >2.8 to 3.0 May 9, 2007 Authorized for Public Release 123 of 130 Class I FOMC - Restricted Controlled (FR) Histograms of Projections for Core PCE Inflation: 2007-2009 Distribution of Core PCE Inflation Projections: 2007 12 Number of Respondents 10 8 6 4 2 0 > 1.4 to 1.6 >1.6 to 1.8 >1.8 to 2.0 >2.0 to 2.2 >2.2 to 2.4 Distribution of Core PCE Inflation Projections: 2008 12 Number of Respondents 10 8 6 4 2 0 > 1.4 to 1.6 >1.6 to 1.8 >1.8 to 2.0 >2.0 to 2.2 >2.2 to 2.4 Distribution of Core PCE Inflation Projections: 2009 12 Number of Respondents 10 8 6 4 2 0 > 1.4 to 1.6 >1.6 to 1.8 >1.8 to 2.0 Page 4 of 5 >2.0 to 2.2 >2.2 to 2.4 May 9, 2007 Authorized for Public Release 124 of 130 Class I FOMC - Restricted Controlled (FR) Histograms of Projections for Unemployment Rate: 2007Q4, 2008Q4, 2009Q4 Distribution of Unemployment Rate Projections: 2007Q4 14 Number of Respondents 12 10 8 6 4 2 0 >4.4 to 4.6 >4.6 to 4.8 >4.8 to 5.0 >5.0 to 5.2 Distribution of Unemployment Rate Projections: 2008Q4 14 Number of Respondents 12 10 8 6 4 2 0 >4.4 to 4.6 >4.6 to 4.8 >4.8 to 5.0 >5.0 to 5.2 Distribution of Unemployment Rate Projections: 2009Q4 14 Number of Respondents 12 10 8 6 4 2 0 >4.4 to 4.6 >4.6 to 4.8 Page 5 of 5 >4.8 to 5.0 >5.0 to 5.2 May 9, 2007 Authorized for Public Release Appendix 3: Materials used by Mr. Reinhart 125 of 130 May 9, 2007 Authorized for Public Release 126 of 130 Class I FOMC - Restricted Controlled (FR) Material for FOMC Briefing on Monetary Policy Alternatives Vincent R. Reinhart May 9, 2007 May 9, 2007 Authorized for Public Release 127 of 130 Exhibit 1 Market Developments Expected federal funds rates* Announcement effects* Percent Basis points 15 Two-year Ten-year 6.0 May 8, 2007 March 20, 2007 10 5.5 5 0 5.0 -5 -10 4.5 -15 2005 2006 2007 -20 4.0 2007 * 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. Corporate bond spreads* Basis points March FOMC Daily 400 Ten-year BBB Five-year high-yield 350 *Estimates from federal funds and Eurodollar futures, with an allowance for term premiums and other adjustments. Implied volatilities Basis points 450 2008 Percent 1400 50 Daily 1200 40 S&P 500 Basis points March S&P 500 (VIX) FOMC Eurodollar* Index(12/31/03=100) 200 March FOMC Daily 150 140 150 1000 130 300 800 30 250 100 600 200 120 20 110 400 150 50 10 100 200 100 50 0 2001 2003 2005 2007 *Measured relative to an estimated off-the-run Treasury yield curve. 0 0 2004 2005 90 2006 2004 2005 2006 *Six months ahead. Reasons for higher stock prices Equity valuation Percent 12 Monthly A. Earnings were solid. 10 8 12-month forward trend E/P ratio B. Equity premium narrowed a bit. + C. Downside risks to the outlook appeared to ease. 6 4 + D. All of the above. 2 Real long-term treasury yield* 0 1988 1992 1996 2000 2004 *Perpetuity Treasury yield minus Philadelphia Fed 10-year expected inflation. Note. + Denotes the latest observation using daily interest rates and stock prices and latest earnings data from I/B/E/S. Page 1 of 4 May 9, 2007 Authorized for Public Release 128 of 130 Exhibit 2 The Case for Alternative B Real GDP 4-quarter percent change Current Greenbook 70 percent confidence interval* Previous Greenbook Core PCE 4-quarter percent change 5 Current Greenbook 70 percent confidence interval* Previous Greenbook 4 3.5 3.0 3 2.5 2 2.0 1 1.5 0 Q1 Q2 Q3 2006 Q4 Q1 Q2 Q3 2007 Q4 Q1 Q2 Q3 2008 1.0 Q4 Q1 Q2 Q3 2006 Q4 Q1 Q2 Q3 2007 Q4 Q1 Q2 Q3 2008 Q4 *Confidence intervals based on FRB/US stochastic simulations. Equilibrium real federal funds rate* Short-run estimates with confidence intervals Percent Actual real federal funds rate Range of model-based estimates 70 percent confidence interval 90 percent confidence interval Greenbook-consistent measure 9 8 7 6 5 4 3 2 1 0 -1 -2 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 *Explanatory notes are provided in appendix A of the Bluebook. Real GDP 4-quarter percent change 14 2007:Q1 12 10 8 6 4 2 0 -2 -4 1948 1952 1956 1960 1964 1968 1972 1976 1980 Page 2 of 4 1984 1988 1992 1996 2000 2004 2008 May 9, 2007 Authorized for Public Release 129 of 130 Exhibit 3 Why Might You Change Policy? The case for alternative A The case for alternative C • Housing sector adjustment and possible • Inflation not clearly on a downward spillovers. trend. • Investment spending weakness. • Oil and other commodity prices higher. • Financial markets could correct. • Inflation expectations could drift up. New home sales and supply of new homes Millions 1.5 Core PCE Months Monthly New home sales (left scale) Supply of new homes (right scale) 1.4 12-month percent change 8 Monthly Core PCE Market-based core PCE 7 2.5 1.3 6 2.0 5 1.2 1.5 1.1 1.0 0.9 4 1.0 0.8 2000 2001 2002 2003 2004 2005 Orders and shipments of capital goods excluding aircraft 2006 2007 2000 2001 2002 2003 2004 2005 2006 2007 Primary commodity prices $ Billions Index, Jan. 2000=100 80 Monthly Orders Shipments 400 $/barrel 75 Monthly 75 70 65 65 320 WTI oil (right scale) March GB 240 55 45 60 55 March GB 160 25 50 Non-fuel (left scale) 80 2000 2001 2002 2003 2004 2005 2006 35 2007 Page 3 of 4 15 2000 2002 2004 2006 2008 May 9, 2007 Authorized for Public Release 130 of 130 Table 1: Alternative Language for the May 2007 FOMC Announcement March FOMC Rationale Assessment of Risk Alternative B Alternative C 1. The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5¼ percent. The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 5 percent. The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5¼ percent. The Federal Open Market Committee decided today to raise its target for the federal funds rate 25 basis points to 5½ percent. 2. Recent indicators have been mixed and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters. Policy Decision Alternative A The economy seems most likely to expand at a moderate pace over coming quarters. But weakness in housing and capital spending imply a significant risk that economic activity might grow more slowly than anticipated. Economic growth slowed in the first part of this year and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to expand at a moderate pace over coming quarters. Despite the ongoing adjustment in the housing sector, the economy seems likely to expand at a moderate pace over coming quarters. 3. Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures. Core inflation remains somewhat elevated on balance. Although the high level of resource utilization has the potential to sustain inflation pressures, those pressures seem likely to moderate over time. Core inflation remains somewhat elevated on balance. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures. 4. In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information. In these circumstances, future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information. Core inflation remains somewhat elevated on balance. Inflation pressures seem likely to moderate over time, but considerable uncertainty surrounds that judgment. Moreover, the high level of resource utilization, in combination with the recent increases in energy and other commodity prices, has the potential to sustain those pressures. Even after this action, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information. Page 4 of 4 [Unchanged]
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