Is This Consistent?

The Fed released their projections this week, including their much-anticipated Fed funds rate projections.  Here are three slides with some quick thoughts:

Slide 1: GDP, Unemployment and Growth Projections

1. Growth projections have dropped for this year and increased for next year.  The highest projection included in the central tendency is that growth will reach 4% in 2014.

2.  Unemployment projections have also decreased.  The expectation is that our unemployment rate will be between 6.7% and 7.6% at the end of 2014.

3. Inflation expectations are below the 2% target.  In one Fed announcement (released this week), they clearly stated that there was an inflation target of 2%.  This had always been assumed, but it was made perfectly clear this week.

Slide 2: FOMC Participants – When Will Rates Rise?

1. Five out of 17 participants think that rates will increase in 2014.

2. Six think it will happen earlier (three this year and three next year).

3. Six think it will happen later (four in 2015 and two in 2016).

Slide 3: Future Fed Funds Rates

1. In this chart, each dot represents where the FOMC participants believe the Fed funds rate will be at the end of each year.  Notice that the participants think of the “normal” Fed funds rate to be near 4% (in the future).  With 2% inflation, that implies a 2% real rate.

2. Notice that several expect the Fed funds rate to be approaching 3% by the end of 2014.  Several others expect the rate (in 2014) to be where it is today.

Is This All Consistent?

When putting together the “central tendency”, the Fed excludes the three highest and three lowest estimates.  But, they include these “outliers” in the “range” – so we know what they are.  If you look at the most optimistic estimates for growth, they are 3%, 3.8% and 4.3% for the next three years.

It strikes me as surprising to think that participants expect such low growth to bring our unemployment rate down to 6.7%.  If we have some growth, I would expect people to re-enter the labor market and this would keep the unemployment rate at higher levels.  If we don’t have significant growth, there’s little reason to expect the unemployment rate to decrease.

It’s also surprising for me to think that these low growth estimates will allow the FOMC to raise rates (as some expect it to approach 3%).  In addition, we’d be raising rates at a time when inflation expectations are low (no estimates are above 2% for the next three years).  Obviously, the FOMC would like to see rates at a higher level so that they would be able to use the Fed funds rate to implement monetary policy again.  (The Fed funds rate has lost its effect when it’s at zero.)  But, it’s hard to see how we’re going to get there based on these estimates.

One final thought…if we do have inflation of 1.5% – 2% for the next five years, that means that investors are locking in a negative real yield when they buy five-year Treasury bonds (which are yielding .77%). That gives you an indication of the fear in the market (and / or the effect of the Fed).

Have a great weekend.

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