Home Logon FTA Investment Managers Blog Subscribe About Us Contact Us

Search by Ticker, Keyword or CUSIP       
 
 

Blog Home
   Brian Wesbury
Chief Economist
 
Bio
X •  LinkedIn
   Bob Stein
Deputy Chief Economist
Bio
X •  LinkedIn
 
  Fed Forecasts Depend on Data
Posted Under: Monday Morning Outlook
The Federal Reserve is doing everything in its power to hold down long-term interest rates because it thinks that doing so will help lift economic growth. In addition to quantitative easing I & II, the Fed is buying long-term Treasury bonds and also promising to hold short-term interest rates low for an extended period.

Since long-term interest rates are just a series of short-term yields strung together, promising to hold short-term rates down can influence long-term interest rates. The Fed thinks that this will help lift housing and the economy and push down unemployment.
 
Last summer, the Fed promised to hold rates down through mid-2013. Headlines from last week suggest that the Fed now thinks 2014. But, how committed is the Fed to this strategy? What will it take to change course? Some analysts argue that this is an ironclad commitment and there will be no course changes.
 
We believe this is a misreading of the Fed's intentions. There are 19 potential economic views that are important at the Federal Reserve – 7 are on the Board of Governors and 12 are Presidents of regional banks. Right now, two Governorships are un-filled, which means there are 17 forecasters (12 Regional Bank Presidents and 5 Governors). Of these, six expect a rate hike before the end of 2013. Of the 11 who think rates will end 2013 where they are today, five expect a rate hike before the end of 2014. In other words there is more disagreement at the Fed than meets the eye.
 
In his press conference after the release of these forecasts, Fed Chairman Ben Bernanke said that if the economic data proves the Fed either too optimistic or too pessimistic, it would most likely change its forecast and alter policy expectations. 
 
In other words, faster growth, lower unemployment, and higher inflation – like we anticipate – would move up the start of rate hikes before late 2014, possibly even before mid-2013.
 
Within the Fed's new and more transparent communication of its economic beliefs there are some very important pieces of data. While members forecast their near-term expectations for growth, inflation and interest rates, they also put figures on what they deem to be the long-term, steady-state, equilibrium world.
 
Every single one of the 17 forecasts put the long-run forecast of an appropriate (equilibrium) federal funds rate at or above 3.75%. This is not a surprise. Fed forecasters judge the equilibrium growth rate for long-run nominal GDP to be 4.3% to 4.6% - about 2% inflation and 2.3% to 2.6% real GDP. 
 
We look at these two long-run forecasts as consistent with our models which use nominal GDP growth as a target rate for the federal funds rate. The only problem is that nominal GDP grew 3.7% in 2011 and 4.2% at an annual rate over the past two years. In other words, the current economy is already very close to the Fed's long-run forecast. This means that the federal funds rate is currently too low. A zero percent rate with growth already near 4% makes no sense from a monetary policy perspective. The funds rate should be much higher if the goal is keeping inflation stable.
 
But the Fed is convinced that it can keep rates below its long-run levels without risk of inflation because the economy has unused potential (high unemployment and unused capacity). The Fed thinks the housing market needs zero percent interest rates to heal and to grow again.
 
We think this is a mistake. For example, a zero percent interest rate may not even be low enough to boost housing, but the same zero percent rate is already too low for manufacturing or farming or commodities.  In the 1970s, when the Fed unwisely attempted to bring unemployment back down to levels it thought were sustainable, the US experienced its worst inflation ever. We side with those members of the Fed who want rates up sooner rather than later. However, the Fed is a democratic organization and right now those hawkish members are outnumbered by the ones who think the economy can be manipulated.
 
As a result, look for growth and inflation to continue heading higher. This is a short-term positive for stocks and the economy, but it comes with a long-term downside. It's called inflation.

Click here for a printable version.
Posted on Monday, January 30, 2012 @ 3:12 PM • Post Link Print this post Printer Friendly

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
Search Posts
 PREVIOUS POSTS
Personal income increased 0.5% in December while personal consumption was unchanged
The first estimate for Q4 real GDP growth is 2.8% at an annual rate
New single-family home sales fell 2.2% in December to a 307,000 annual rate
New orders for durable goods increased 3.0% in December
Fed Language Goes Dovish, But Policy Unchanged
The New Normal? Don't Tell That To Gartman
Rally Not Built on Complacency
Wesbury 101 Video Commentary - "Things Are Getting Better All the Time"
Existing home sales increased 5.0% in December to an annual rate of 4.61 million units
Housing starts declined 4.1% in December to 657,000 units at an annual rate
Archive
Skip Navigation Links.
Expand 20242024
Expand 20232023
Expand 20222022
Expand 20212021
Expand 20202020
Expand 20192019
Expand 20182018
Expand 20172017
Expand 20162016
Expand 20152015
Expand 20142014
Expand 20132013
Expand 20122012
Expand 20112011
Expand 20102010

Search by Topic
Skip Navigation Links.

 
The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.
Follow First Trust:  
First Trust Portfolios L.P.  Member SIPC and FINRA. (Form CRS)   •  First Trust Advisors L.P. (Form CRS)
Home |  Important Legal Information |  Privacy Policy |  California Privacy Policy |  Business Continuity Plan |  FINRA BrokerCheck
Copyright © 2024 All rights reserved.