Stephen Stanley, chief economist at Pierpont Securities LLC, has derided the Federal Reserve for downplaying improvement in the U.S. economy. Yet his 2.6 percent forecast for growth this year is below the midpoint in the central bank’s projection of 2.4 percent to 2.9 percent.
Stanley’s not alone: The median of 55 estimates compiled this month by Blue Chip Economic Indicators for 2012 is 2.3 percent. All but 16 of the predictions were below the bottom of the Fed’s so-called central tendency. JPMorgan Chase & Co.’s Michael Feroli, John Lonski of Moody’s Capital Markets Group and Wells Fargo Securities LLC’s John Silvia all are relatively more cautious on growth than the policy makers.
The disconnect between the Fed’s optimistic forecast for expansion and its more bearish expectations for the labor market and inflation have made it difficult to predict the course of monetary policy, according to Stanley, who said he’s underestimated central bankers’ emphasis on their goal of full employment. The Fed last month reiterated its plan to keep borrowing costs “exceptionally low” through at least late 2014, in part to bring down “elevated” joblessness.
“I’ve been banging my head against the wall,” said Stanley in Stamford, Connecticut, a former researcher at the Federal Reserve Bank of Richmond, who had predicted an interest-rate increase as early as last year and now says the Fed probably will tighten in the middle of next year. “They’re willing to let things run for longer and let inflation accelerate more than historically.”
The Fed has left its benchmark federal funds rate near zero since December 2008 and in January extended its plan to keep the rate low from an earlier time frame of mid-2013. Chairman Ben S. Bernanke has also undertaken two rounds of asset purchases totaling $2.3 trillion and is scheduled to complete a program in June to push out the average maturity of the central bank’s portfolio.
Bernanke signaled after the April meeting of the Federal Open Market Committee that further easing isn’t likely unless the outlook unexpectedly deteriorates. Even so, he said April 25 he’s “prepared to do more” if conditions worsen.
While policy makers upgraded their outlook in April, they didn’t see a reason to change their 2014 horizon for low rates, partly because they’re uncertain about their forecasts, according to the minutes of last month’s FOMC meeting, which were released last week.
Driving Point Home
“It’s like they’re talking out of both sides of their mouth,” said Lonski, chief economist at Moody’s Capital Markets Group in New York. “The Fed may be trying to drive home the point to investors that, even if there is an unexpected upturn, do not make the mistake of assuming the Fed will necessarily begin to consider a firming of monetary policy.”
That may keep long- and short-term interest rates low and, in turn, “help facilitate the realization of a firmer economic recovery,” Lonski said. He predicts the U.S. will expand at a 2.2 percent rate this year.
Fed officials raised their prediction at the April meeting for the pace of growth in 2012 to 2.4 percent to 2.9 percent from their January projection of 2.2 percent to 2.7 percent. The forecasts are the central tendency of 17 policy makers, which excludes the three highest and lowest estimates. The full range is 2.1 percent to 3 percent.
The median forecast in a Bloomberg News survey of 74 economists in May was for 2.3 percent growth this year, the same as in a January poll. Gross domestic product expanded at a 2.2 percent annual rate in the first quarter.
Several members of the FOMC said additional stimulus could become necessary if the economy loses momentum or if “downside risks to the forecast become great enough,” the minutes said. Those threats include Europe’s debt crisis and a fiscal tightening caused by the failure of U.S. lawmakers to agree on a budget, the minutes showed.
More than $3 trillion has been erased from the value of equities worldwide this month as concern that Greece will exit the euro curbed demand for riskier assets. The country faces elections scheduled for June 17 after inconclusive balloting earlier this month put in second place a party opposed to austerity measures required for international bailouts.
While the Fed has been more optimistic about the U.S. expansion than the average analyst, its expectations for inflation and joblessness have clashed with both economic data and private forecasts. The Fed has a dual mandate of price stability and full employment.
Policy makers have been projecting inflation of 2 percent or less in 2012 for more than two years, even though the personal-consumption-expenditures price index has risen by more than the central bank’s target of 2 percent since April 2011.
The rate was 2.1 percent in March, and Fed officials project inflation of 1.9 percent to 2 percent this year and 1.6 percent to 2 percent in 2013. That compares with January predictions of 1.4 percent to 1.8 percent in 2012 and 1.4 percent to 2 percent next year.
The break-even rate for five-year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable maturity Treasuries, was 1.86 percentage points on May 18. The rate, a measure of the outlook for consumer prices over the life of the securities, has climbed from 1.53 points on Dec. 16.
“They’ve been a little reluctant to acknowledge or embrace the changing growth-employment trade-offs,” said Feroli, chief U.S. economist at JPMorgan in New York. “They are starting to move their inflation forecast closer to reality,” and “they’re also moving their unemployment-rate forecast closer to the realized data.” He sees GDP expanding 2.4 percent this year.
Revised Jobless Forecasts
Central bankers revised their jobless projections in April to 7.8 percent to 8 percent for 2012, down from their January forecast of 8.2 percent to 8.5 percent. The rate fell to 8.1 percent in April from 8.5 percent in December.
Bernanke has been cautious about embracing the improvement. The Fed chief has said the drop overstates gains as people who can’t find jobs get discouraged and stop seeking employment, which means they are no longer in the workforce.
The jobless level may continue to fall more rapidly than the pace of expansion would predict, in part because of structural changes to the economy, such as demographic shifts, and a slowed rate of potential growth, according to a Barclays Plc report this month.
“In terms of their mandate-relevant variables, they’re coming closer to where most of the Street is,” Feroli said.
One reason the Fed is more bullish than Wall Street is that central bankers are more optimistic about the impact of their unprecedented stimulus, said Silvia, chief economist at Wells Fargo Securities in Charlotte, North Carolina. He isn’t as sanguine about the effects of monetary accommodation and predicts growth of 2.1 percent this year and 2 percent next.
“The connective tissue in the models has just broken down,” Silvia said. “The idea in the old days was you change interest rates and people buy houses.” Now “when the Fed lowers rates, that whole credit-money-multiplier process doesn’t work as well.”
Central bankers have acknowledged their policies aren’t having the impact they’d like, as evidenced in the difficulty some borrowers face in refinancing their mortgages even though interest rates have fallen. About 7.4 percent of residential mortgage loans were delinquent nationwide as of the end of the first quarter, according to data compiled by the Mortgage Bankers Association in Washington.
William C. Dudley, president of the New York Fed, called on the government in a Jan. 6 speech to help remove obstacles to the transmission of monetary stimulus, suggesting that mortgage-finance companies Fannie Mae and Freddie Mac reduce the principal of loans they guarantee.
Republican Senator Bob Corker of Tennessee called Dudley’s suggestion “absolutely egregious.” Dudley said Jan. 27 he was “talking about issues that were basically impairing the ability of monetary policy to support economic activity,” not trying to “cause any sort of controversy.”
Even though the policies may fail to spur growth as quickly as the Fed predicts, central bankers still may need to increase rates before their “at-least-late-2014” plan, according to Silvia. The FOMC probably will begin raising in the “spring” of 2014, he predicted.
“I don’t think they’re going to make it until the end of the year,” Silvia said, noting that the Fed “finally” boosted its inflation forecast in April.