Full text of FedViews : January 10, 2019

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Twelfth Federal Reserve District

FedViews
January 10, 2019

Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
https://www.frbsf.org/economic-research/publications/fedviews/

Galina Hale, research advisor at the Federal Reserve Bank of San Francisco, stated her views on the
current economy and the outlook as of January 10, 2019.


The economy has continued to grow at a robust pace, primarily driven by solid gains in consumer
income and spending. We project that GDP growth rate averaged 3.1% for 2018. We forecast that
growth will slow down to 2.0% in 2019, as monetary policy continues to normalize and fiscal stimulus
wanes, and fall gradually to our estimated long-term potential rate of 1.7%.



The labor market remains very strong. The economy added 312,000 jobs in December, significantly
exceeding the breakeven rate, which we estimate at about 90,000 jobs per month. The increases in
payroll numbers were revised up for both October and November to 274,000 jobs and 176,000 jobs,
respectively. Though the December unemployment rate rose 0.2 percentage point to 3.9%, this mainly
reflects a sharp increase in the number of people entering the labor force, and it remains well below our
estimate of the natural unemployment rate of 4.5%. We expect unemployment to decline to 3.7% by the
end of 2019, and then gradually climb to 4.0% by the end of the forecast horizon.



Headline inflation of the personal consumer expenditures (PCE) price index over the past 12 months
came in at 1.8% in November, slightly below the Federal Open Market Committee’s (FOMC) target of
2%. Core inflation, which excludes volatile food and energy prices, rose 1.9%. We forecast that
inflation will remain at this level below target through 2019. The recent softening in inflation is
partially attributable to the pass-through of low commodity prices and lower-than-expected increases in
health-care costs. As the labor market continues to strengthen and the effects of these transitory factors
diminish over time, we expect both headline and core inflation rates to slightly overshoot the 2% target
by the end of 2020.



After the conclusion of the FOMC’s latest meeting held on December 18-19, the committee announced
its decision to raise the target range for the federal funds rate to 2¼ to 2½%. The current level of the
funds rate is still below our estimate of the neutral rate of 2¾%, indicating that monetary policy
remains accommodative. Following the Fed’s release of the December Summary of Economic
Projections (SEP), which included fewer rate hikes than indicated in the September SEP, long-term and
medium-term Treasury rates declined. Short-term rates increased in line with the federal funds rate,
further flattening the Treasury yield curve. As of January 4, 2019, the difference between 10-year and
3-month Treasury security rates is 25 basis points.

The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco.
They are not intended to represent the views of others within the Bank or within the Federal Reserve System. As of January 2019,
FedViews will appear eight times a year around the middle of the month. The next FedViews is scheduled to be released on or
before March 22, 2019.



The stock market has been volatile in the past few months, and ended the year 2018 with a substantial
correction of more than 14% from its most recent peak in October. This decline comes on the heels of
an unprecedented nearly decade-long expansion. The volatility index (VIX) is now near its historical
average.



The Fed’s Financial Stability Report, published for the first time in November 2018, presents the
Federal Reserve Board’s view of the risks to U.S. financial stability. Four sources of potential risks are
considered: asset valuation pressures; non-financial sector borrowing, including both household and
business borrowing; financial sector borrowing; and financial sector liquidity. The November report
states that while the domestic financial system faces risks, arising mainly from elevated asset valuation
pressures and non-financial business sector borrowing, financial institutions, particularly the country’s
largest banks, are currently liquid and well capitalized. This suggests that U.S. financial institutions are
resilient to the risks of repricing and loan losses, and they are unlikely to transmit or amplify shocks to
their balance sheets and liquidity. Read the full Financial Stability Report.