In general, we observe WSJ forecasters responding to favorable economic data. Consensus GDP forecasts through Q4 of 2018 are all above 2.5 percent, with inflation just above 2 percent through the same time period. However, the longer range projections suggest an economic slow down approaching.
Sticking to the good news: housing price and housing start expectations are up. In addition, consensus unemployment figures dropped yet again, with the expected consensus low occurring in the middle of 2019 at 3.8 percent. The recession probability dropped a full percentage point to 13 percent.
Unfortunately, there are some more expected headwinds. Crude oil prices rose sharply in short run forecasts, with the June 2018 jumping almost 3 dollars to 58.55. The longer run forecasts of oil prices also rose, but by smaller amounts. However, the most concerning bit about current consensus expectations is the flattening of the yield curve. I have mentioned this several times in previous blog posts in my November and December updates. Here is a graph to illustrate the point with the newest data:
The graph above shows the difference between the consensus forecasts of the ten year bond rate and the federal funds rate. The color shade represents different future dates the darkest being the furthest in the future. We observe an abrupt jump down for the 2018 and 2019 spreads. A flatter yield curve has been cited as an indicator for a coming recession, and these forecasts suggest that tightening will happen over the next year or so.
The WSJ forecasters consensus is that 2018 should be a pretty strong economic year, but this expansion is heading towards its close as we move to 2019.
The Fed raised rates recently keeping their promise of raising the rate in the face of positive economic data. The WSJ forecasts corroborate this rosy picture of the future economy and improving their forecasts from last month.
The consensus GDP growth forecast for the coming four quarters rose by a tenth of a percent or more, and all future unemployment numbers went down. It also looks like the forecast for the turning point in unemployment is being pushed out until mid 2019. The consensus probability of a recession in the next 12 months dropped half a percent to 14.1 percent.
Some of the details however do not indicate the same degree of certainty in the future economic position. The expected gap between the federal funds rate at ten year bonds continues to tighten signaling a flattening yield curve, which means the Fed may struggle normalize long rates in time for the next recession. Expected housing starts and housing prices dipped a little, but not enough to be overly concerning. Of course it is no surprise given political turmoil in Saudi Arabia, OPEC extension of production cuts, and now the North Sea pipeline problems, that expected oil prices increased significantly. Expected prices increased by 2 dollars or more through 2018.
All in all, there is a strong belief amongst the Fed and professional forecasters that board scope economic futures look robust, but there are still some potential weaknesses.
The most recent economic data continues to suggest a robust economy, and the WSJ Economic Forecasts reflect those facts. This post will present a brief overview of the changes in the average WSJ forecasts.
The main highlight from the GDP forecasts is a tenth of a percent increase in annual GDP growth for 2017, though only one quarter exhibited a decrease. Inflation forecasts also inched up in the near term (through 2018), but fell slightly post 2018. The positive employment reports have caused the predicted path of unemployment to shift down by almost a tenth of a percent as well, but the predict peak of employment is still around the end of 2018 or beginning of 2019. The probability of a recession in the next 12 months decreased by more than one percentage point to 14.6 percent.
The expected spread between the ten-year bond yields and the federal funds rate continue to tighten. This means that the yield curve may flatten out over the coming years. If that comes to pass monetary policy makers will not have as many tools at their disposal for the next recession since they will only be able to impact the short end of the yield curve.
End-of-year expected crude oil prices jumped up by over 3 dollars, however, longer term forecast rose more moderately. Housing price growth forecasts continue to increase. The end of the 2017 consensus is now expected to reach 6 percent. However, expected housing starts declined slightly through 2019.
All in all, the recent data has moved forecasters to have a generally bullish view on the future economy.
The new WSJ forecasts were released last Friday and it looks as if the recent data has caused the forecasters to be pessimistic about the short-term, but optimistic about the long-term. Forecasts for inflation and unemployment through 2018 worsened (unemployment ticked up, while inflation decreased), but consensus predictions for for both variables in 2019 improved. In addition, only the last two quarters of 2017 GDP growth were revised downward, and all subsequent quarters and annual projections rose.
These general macroeconomic indicator forecasts were somewhat at odds with the changes in specific indicators like the ten-year bond rates and crude oil prices. Bond rates were all revised downward, despite increases of the expected federal funds rate in 2019. Crude oil prices are still expected to rise slowly over the next two years, but only reaching the low 52 dollar mark, instead of 53 or 54 from a couple of months ago. Despite the lackluster September employment report, payroll forecasts for next year rose by over 10,000 to 16,080.
These numbers suggest that the recent data implies that the economy is sliding a little below the long-run growth path. As I pointed out while discussing the recent payroll report, long-run time-series dynamics seem to be dominating current forecasting (as opposed to structural modeling and forecasting). I believe these recent round of forecasts supports that idea, because this pattern of revision is consistent with the behavior we observe. To see what I mean look at Crude Oil Price forecasts:
The graph above shows forecasts at different points in time (light to dark indicates old to new). All we see are level shifts (the intercept) holding the dynamics (the slope) the same. That suggest the new data are not changing anything about the fundamentals, which would alter the trajectory, but instead only reveal changes in the starting point of a more or less unchanged dynamic system.
But is that good news or bad news? The good news: there really isn't any bad fundamental news. The bad news: models based on dynamic systems are correct on average, but since they are essentially data driven, it makes forecasters appear to be agreeing with each other. So the recent drop in forecast uncertainty (defined as the standard deviation amongst forecasters), does not necessarily indicate that we know a lot about where the economy is heading.
A logical analysis of expectations might argue that historical averages drive long-run forecasts with macroeconomic fundamentals and announced policies providing slight mitigation. In contrast, recent economic data drive short-run forecasts. WSJ expected inflation for 2017 provides a good example of this:
Almost 3 years in advance, the forecasts match the Fed's stated policy and historical averages. At the beginning of the 2017 it looked as though year over year CPI inflation (yellow line) and expectations were converging. However, the last few months of slow price growth have caused expectations to dip following, with a lag, the path of year over year inflation.
This post points out that this pattern of behavior need not exist for all variables.
Instead consider the federal funds rate. These expectations, more so than those for inflation, driven by mostly by policy statements and projections released by the Federal Reserve. It is therefore not surprising how high expectations were at the beginning of 2015 and how quickly they have fallen over the past 2 years. In 2015 the discussion was over normalization of policy or "the lift-off," but the data at the time did not support action at that time. As policy statements and Fed projections became more clear expectations dropped quickly. Notice also the drop in uncertainty, a point I have emphasized in a previous post on federal funds rate expectations.
The drivers of inflation and the federal funds rate have no direct impact on the bottom line of the forecasters or the firms for which they provide their forecasts. However, take ten-year government bond rates for example:
These expectations more closely follow the path of the actual bond rates even 2-3 years in advance of the realization. While bond rates should, in theory, be just as sensitive to monetary policy one would expect a similar pattern, however the gap observed at the beginning of this series does not appear as wide and the overall time-series movement between expectations and actual observations are remarkable similar.
How we think about long-run and short-run expectations depends critically on the relative importance of the outcome to our objectives.
A couple of months ago I wrote about the surprising decline of Federal Funds rate uncertainty in the WSJ economic forecasts. This post revisits that topic presenting a revised version of the data. Unfortunately, the revisions do not look as favorable for the Fed, but it still looks as though the Fed is effectively communicating their policy trajectory.
The graph above shows forecast uncertainty (std deviation of fed funds rate forecasts) for several future forecasts. The x-axis is the number of months out from the date being forecast. The striking feature of this graph is that the darker lines have shifted lower over time. This is more or less what I discussed in that previous post. However, when I looked back at the data (with the new forecasts add in) I noticed some anomalies and reweighed those results by the standard deviations of the payroll employment forecasts.
Once we recalculate federal funds rate uncertainty relative to the general level of uncertainty we find almost no change in fed funds rate uncertainty. If instead we calculate the same relative uncertainty for 10-year bonds, then we actually find that forecast uncertainty for 2019 is higher than normal:
Since there has not been a dramatic shift in the more recent 2018 and 2017 forecasts, I suspect that the additional uncertainty is due to some forecasters projecting a recession (or at the very least a slow growth economy) while others foresee a continuing economic boom. To further support that claim we can see a similar pattern in quarterly GDP forecast uncertainty:
The forecast uncertainty of the Federal Funds Rate has remained similar to the past, relative to payrolls uncertainty. However, other variables appear to be getting more uncertain relative to payrolls uncertainty. For those facts to line up forecasters must understand and believe the Fed's announced policy trajectory.
The August WSJ forecasts are out, and it is another mixed bag, though mostly negative. On the positive side, third and fourth quarter GDP forecasts went up by a tenth of a percent. Forecasts for unemployment through 2019 all went down and payrolls employment increased slightly.
However, annual growth for both 2017 and 2018 ticked down slightly. In addition, all the consensus federal funds rate forecasts decreased, indicating lower expectations for the future job markets. This coincides with lower expectations for inflation through 2019.
These changes in forecasts reflect the recent low inflation numbers, despite the upbeat employment report. St. Louis Fed President Jim Bullard recently commented on inflation and current monetary policy, which provides a window into the subdued outlook by the WSJ forecasters. In Bullard's view, low commodity (mostly oil) prices have been having the greatest impact on headline inflation, which, he believes, will outweigh any impact of any future improvements in the job market.
If we take that insight as given, the WSJ forecasters are predicting increase in oil prices (and housing prices) over the coming years. Should those increases materialize, the Fed might final realize their two percent target inflation rate.
The recent release of second quarter GDP growth came in below WSJ expectations as well as a downward revision of first quarter growth (from 1.4 to 1.2). This new data follows weak inflation numbers from last week.
1. For the past two years expectations exhibit an upward bias. Which, if that bias holds true, means low future expected growth would indicate even lower actual growth. Projected growth in 2018 is 2.38 percent, and 1.94 percent in 2019. These are significantly below the administrations overly optimistic 3 percent promise.
2. Expected federal funds rates have been falling since the beginning of the year. Not by a lot, but it has been consistent, suggesting that new data will give the Fed pause in increasing their target rates.
3. Expected housing starts continue to fall. At the beginning of 2016 expected housing starts were quite robust, however, subsequent data have curtailed consensus optimism. If this expectation falls below 1200, that could be a signal the beginnings of a slow down in the housing market.
While there some signs of growth remain, these three sets of expectations should worry investors and the current administration. All indicate at the very least, that the economy will not grow particularly quickly in the coming year. In the worst case scenario we may see the beginnings of a recession by the end of 2018.
The BLS recently released the new CPI and inflation statistics. This signals a weakening economy along the lines of Tim Duy's analysis. As Mark Thoma points out, the Fed does not have a lot room to defend the economy against a recession, and congress seems incapable of doing anything at the moment. The WSJ Economic Forecasters expectations indicate further trouble, since they are above actual inflation, but are dropping:
If lower inflation expectations exist in the rest of the economy we can expect slower growth in the coming months. Lower inflation expectations usually are a self fulfilling prophecy, since workers, firms, and households make decisions that reinforce the low inflation future. For example, firms might anticipate lower revenues and therefore lower prices in order to drive up sales.
How do these lower inflation expectations fit into the larger long term picture? Well, the same analysts forecast GDP growth at 2.38 and 1.94 in the 2018 and 2019, respectively. In addition, my previous post on Fed funds rate expectations uncertainty indicates that Federal Reserve credibility (at least in terms of future interest rates) has improved. Inflation expectations for 2017 are low, but expectations for 2018 and 2019 are both firmly above 2 percent. This suggests that analysts believe the economy will slow down in the next two years and that the Fed will take appropriate measures (with what little room they will have) to fend off or minimize a recession.
The WSJ economic forecasting survey published mostly good news. Surprisingly, the positive jobs report did little to change forecasts of payroll employment, however it has lowered expectations of a federal funds rate hike by December:
Most of the consensus revisions saw improvements over the next six months to a year, most notably with the probability of a recession dropping by almost one percentage point to 14.77 percent. The consensus also revised oil prices in December down by almost 3.5 dollars to 47.44. Though predicted GDP growth for the year increased slightly, predictions for Q2 fell by 0.2 percentage points to 2.72 percent. The table below summarizes the changes in forecasts for some key variables.
Inflation revisions seem correlated with significant drops in crude oil prices, however the unemployment revisions seem at odds with the federal funds rate revisions. If unemployment is expected to be better, forecasters should be predicting increasing federal funds rates. Perhaps they believe that their lower inflation forecasts imply a more accommodating stance from the Fed.