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Fed’s Economic Projections: Myth vs Reality

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    July 4, 2014

    Each quarter the Fed releases their assessment of the economy along with their forward looking projections for three years into the future. (See Fed Projections Myth Vs. Reality for the December analysis)  I started tracking these projections starting in early 2011 and comparing the Fed’s forecasts with what eventually became reality.  The problem has, and continues to be, is that their track record for forecasting has been left wanting.

    The most recent release of the Fed’s economic projections on the economy, inflation and unemployment continue to follow the same previous trends of weaker growth, lower inflation and a complete misunderstanding of the real labor market.


    When it comes to the economy, the Fed has consistently overstated economic strength. Take a look at the chart and table. In January of 2011, the Fed was predicting GDP growth for 2013 at 4.0%. Actual real GDP (inflation adjusted) was just 1.86% for the year or a negative 50% difference. The estimates at that time for long run economic growth were 2.7%, which has now fallen to 2.15% and was guided down from 2.3% in September and 2.5% in June of 2013.

    Unfortunately, 2014 is not shaping up very well either.  At the beginning of 2013, the estimates for the full year of 2014 averaged 3.2%.  With the first quarter of 2014 shaping up to be nearly a 2% decline, it would now require average growth over the next 3 quarters of 5% real growth to meet that goal.  Of course, since that time, the Fed has continually lowered its estimates for 2014 from that 3.2% growth rate to just 2.3% today.  In order for the economy to meet that objective, the growth rate over the next three quarters will need to average roughly 3% per quarter.   The last time that such a surge in economic growth occurred was in early 2004.  With Q2  of 2013 looking to be closer to 2% annualized growth, it is highly likely that the Federal Reserve will be reducing their goals further into the year.


    We have repeatedly stated over the last two years that we are in for a low growth economy due to debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity. The simple fact is that when the economy requires roughly $5 of debt to provide $1 of economic growth – the engine of growth is broken.

    As of the latest Fed meeting, the forecast for economic growth in 2014 was revised down to 2.3% while 2015 nudged slightly higher to 2.9% respectively as the realization of a slow-growth economy is recognized. However, the current annualized trend of GDP suggests growth rates in the next two years could likely be lower than that.

    Economic data continues to show signs of sluggishness, despite intermittent pops of activity, and the global economy remains drag on domestic exports.  With higher taxes, increased healthcare costs and regulation, the fiscal drag on the economy could be larger than expected.

    What is very important is the long run outlook of 2.15% economic growth. That rate of growth is not strong enough to achieve the “escape velocity” required to improve the level of incomes and employment to levels that were enjoyed in previous decades.  Has there been a recovery in the economy? Of course, but much of it has only been statistical.


    The Fed’s new goal of targeting a specific unemployment level to monetary policy could potentially put the Fed into a box. Currently, the Fed sees 2014 unemployment falling to 6% and ultimately returning to a 5.5% “full employment” rate in the long run. The issue with the “full employment” prediction becomes what the definition of “reality” actually is.


    Today, average Americans have begun to question the credibility of the BLS employment reports. Even Congress has made an inquiry into the data collection and analysis methods used to determine employment reports. Since the end of the last recession, employment has improved modestly. However, that improvement, as shown in full-time employment to population ratio chart below, has primarily due to increases in temporary and lower wage paying positions. More importantly, where the Fed is concerned, the drop in the unemployment rate has been due to shrinkage of the labor pool rather than an increase in employment.


    While the unemployment “rate” is declining, it is a very poor measure from which to benchmark the health of the economy. The drop in unemployment is primarily due totemporary hires, labor hoarding and falling labor participation rates.  Real full-time employment as a percentage of the working population shows that employment has only marginally increased since the financial crisis. The drop in jobless claims does not necessarily represent an increasing employment picture but rather of labor hoarding by companies after deep levels of employment reductions over the past 4 years.

    Lastly, it is hard to suggest that “employment” is rapidly returning to normal when there are still 30% of college graduates living at home with parents, the highest number ofindividuals in history over the age of 65 are still working and roughly 1-in-3 Americans on some form of government assistance.


    When it comes to inflation, and the Fed’s outlook, the debate comes down to what type of inflation you are talking about. The table and chart below show the actual versus projected levels of inflation.


    The Fed significantly underestimated official rates of inflation in 2011. However, in 2012 and 2013 their projections and reality became much more aligned.   It was not until this last quarter that the Fed’s preferred measure of inflation rose above their target rate of 2%.

    The Fed’s greatest economic fear is deflation and the stubbornly low levels of annual rates of inflation pressure the Fed to continue to accommodative policy active for longer than most expect.

    However, for the average American the inflation story is entirely different. Reported inflation has little meaning to the consumer as the real cost of living has risen sharply in recent years. Whether it has been the cost of health insurance, school tuition, food, gas or energy – these everyday costs have continued to rise substantially faster than their incomes. This is why personal savings rates continue to fall, and consumer credit has risen, as incomes remain stagnant or weaken. It is the rising “cost of living” that is weighing on the American psyche, and ultimately, on economic growth.

    You Can’t Handle The Truth

    However, it is important to understand that the Federal Reserve CAN NOT tell the truth.  In a liquidity driven world where the financial markets parse and hang on every word uttered by the heads of Central Banks worldwide, can you imagine what would happen to the financial markets if Janet Yellen stated:

    “Despite many years of supporting the financial markets in hopes of a resurgence of economic growth, it is committee’s assessment that Keynesian economic theory is flawed. While our monetary interventions have inflated asset prices as desired, it has only served to widen the “wealth gap” while having little effect on the real economy.  It is the conclusion of the committee that our policies have failed to achieve realistic economic objectives and has potentially imperiled the financial markets with a third ‘asset bubble’ in the last 15 years.”

    The ensuing collapse in the financial markets would immediately create a recessionary environment.  Financial markets would crumble as credit markets froze as economic activity plunged.  This is why there is such great emphasis focused on the Federal Reserve statement and the guidance they provide. This is why the FOMC has repeatedly stated that following the end of the current large scale asset purchase program (LSAP or QE) that they will continue to focus on the use of “forward guidance”as a policy tool.

    The ability to “move” markets with words, rather than actions, has become the trademark of the European Central Bank (ECB) over the last couple of years. It is ultimately the hope that the Federal Reserve can pull off the same trick as they begin to extract liquidity and accommodation from the financial markets as the economic recovery takes hold.  The problem for the Federal Reserve is that they are still looking for that elusive economic recovery to take hold after more than five years. Unfortunately for the Fed, economic recovery cycles do not last forever, and the clock is ticking.

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    Lance Roberts

    Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of “The Lance Roberts Show,” Chief editor of the X-Factor Investment Newsletter and the Streettalklive daily blog. Follow Lance on FacebookTwitter and Linked-In

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.


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