The Federal Reserve will update its economic forecasts this week. It's something it does quarterly, and it is time once again for it. Three key data points are projected, including GDP, PCE price inflation and employment expectations. It is no news to followers of my column that I find issue with the Fed's forecast for Real GDP. Well, I believe that it will have to come clean Wednesday, in that it will finally adjust its growth outlook lower. Many other major institutions see slower growth for the U.S. than the Federal Reserve sees, and the Fed has even contradicted itself in this regard. So an economic shocker is in the cards if the Fed cuts its growth outlook significantly this coming week, though readers of this column would not be surprised.
The Fed has pretty much been forecasting the same level of growth for 2013 for far too long now. Even while the Fed Chairman states publicly that he agrees with the Congressional Budget Office's estimated impact of the Sequester spending cuts and the expiration of the payroll tax break, the Fed still seems to leave out any adjustment in its forecasts. I can say this confidently because it has had just about the same growth forecast both before and after each of the two events occurred. Something should have changed in between, unless a new positive growth catalyst perfectly offset the 1.5% projected detrimental impact. That's a farfetched possibility, especially since the Fed has had nothing to say on that end. I discussed this subject in detail in my article, The Fed's Math Just Doesn't Add Up.
Date of Forecast Publishing
2013 GDP Growth Range Forecast
2.3% to 2.8%
2.3% to 3.0%
2.5% to 3.0%
As you can see, the Fed slightly adjusted the low end of its range in December and kept the top end the same, and then in March lowered the top end by the same two-tenths of a percent. A 1.5% impact should have severely altered this growth forecast, even when incorporating some new positive developments that may have come into play.
This is not the only discrepancy though. The Conference Board and the World Bank each have significantly lower growth expectations for our economy than the Federal Reserve. The Conference Board sees 1.7% GDP growth for the U.S. economy in 2013, and the World Bank estimates 2.0% GDP growth for the U.S. Each of those is obviously deeply short of the bottom end of the Fed's range when it last published in March 2013. The Fed's range of 2.3% to 2.8% would indicate an expectation for 2.55% GDP growth. I believe but cannot verify that the U.S. private sector also has lower estimates for the American economy in 2013; readers are welcomed to share info about private sector estimates in the comment section below this article.
If the Fed is off by a half a point and makes that significant an adjustment on Wednesday, it would serve two purposes. First, it would reset expectations for recently rising cyclical stocks like General Electric (GE) and Bank of America (BAC). Secondly, it would likely serve to reassure investors of the likelihood of further Fed asset purchases and a continuation of its low rate policy, which would calm mortgage rates. That in turn would return capital to high yielding and real estate relative stocks like Annaly Capital (NLY) and American Capital Agency (AGNC), which have been on the downslide of late. What the broader market would do depends on how severe any economic reconsideration is. The SPDR S&P 500 (SPY) is up 14.6% year-to-date, including 4.1% over the last three months. If the economic perspective is significantly altered, those gains could give way, especially if the Fed continues to communicate poorly regarding "tapering" possibilities.
You can see how the four stocks mentioned have diverged over the last month or so since the market began to actively speculate about Fed policy.
In my opinion, an adjustment to the economic perspective is long and late in coming. Supports in Europe are softening, and growth in China has been bothered by it. Here in the U.S., I've been regularly noting the gross understatement of unemployment and the missing 7+ million Americans from the workforce. Meanwhile, it appears that the real estate recovery has now been interrupted by higher mortgage rates that resulted from what I would call less than optimal communication from the Fed and a faulty perspective of current economic health by the same. So, in conclusion, I suggest buckling your seatbelt, because we may be in for an economic shocker this coming week. Though, at least followers of this column have been warned.