Another relatively quiet month in terms of economic news. The recent data has not done much to shift the views of forecasters very significantly. One of the special questions in this months survey was regarding the timing of the next recession. Ben Leubsdorf of the WSJ does a great job discussing those responses.
The big movers this month are crude oil price expectations, which jumped 5.5 dollars for June 2018, and the yield curve spread, which narrowed some more. Oil prices through the end of 2020 are expected to rise but with diminishing amounts, with December 2020 forecasts only rising 1.9 dollars. The yield curve spread is actually quite fascinating as I have noted in past reports.
The graph above shows the yield curve tightening through 2020. More importantly, the variability of these forecasts is interesting as well. The difference between the 5th and 95th percentiles grows dramatically for the fed funds rate but is much more stable for the ten-year bond rates. It is unclear whether it is policy uncertainty or economic uncertainty that is driving this difference. However, it is strange that forecasters predict that the long rate will not respond, at least not one for one, to the stated Fed goal of raising rates at least two more time by the end of the year.
Another curiosity: even though the majority of forecasters expect a recession in 2020, they don't seem to think that the Fed will respond to it. If they did I would expect the median fed forecast to at least be fall from June 2020 to December 2020. However, the recession timing predictions are more or less consistent with the consensus unemployment forecasts hitting their low in mid to late 2019.
The WSJ Forecasts are out for April and we can observe forecasts staying steady with a few exceptions. Most notably 2018Q1 GDP forecasts fell by almost one half a percent over the last month:
While one might immediately think the recent jobs report might have something to do with it, I suspect this is not the case. First, while the reported number was quite low and January and February revisions combined to 50,000 fewer jobs over those months, the 3 month average for Q1 was still about 200,000. Second, the other forecast of GDP growth were more or less unchanged, signaling that, according to the consensus forecasts, underlying fundamentals have not changed much. While the expectation is still for robust growth in the first quarter the reversal in the trend of expectations is a bit surprising.
Despite a bit of a reversal in Q1 GDP growth, most other indicators have remained consistent with pst forecasts. If anything long run unemployment expectations grew stronger with the end of 2020 expectations dropping a tenth of a percent. This makes the consensus forecast of unemployment for the coming two years less than 4 percent. Inflation expectations over all horizons rose moderately, and the recent Federal Reserve policy actions and statements have just confirmed our professional forecasts.
The only signs of major changes came in crude oil prices expectations, which jumped by a dollar or more after 2018. In addition the recession probability forecast rose 1.67 percent to a little over 15 percent. All in all, the recent data has not moved forecasts drastically.
Time again to visit WSJ Economic Forecasts. There was a great jobs report last week and other economic data seem to support a strong medium-run economy in the views of the professional forecasters. The only major downside was a sharp decrease in the forecast of first quarter GDP in 2018 which dropped by a third of a percent to 2.52 percent.
The unemployment rate, which fell below 4 percent with the trough in mid 2019, saw the most optimist changes. This was undoubtedly tied to the jump in payrolls forecasts, which rose by about 20,000 to nearly 200,000 new jobs per month over the next year. The strong jobs report last week drove both of these changes.
Most other variables moved only slightly. Inflation expectations changed marginally, but mostly converged in the direction of the 2% Federal Reserve target. Crude oil price forecasts also fell modestly. Housing market expectations for this year and next were mostly unchanged. The consensus recession probability indicator fell slightly to 13.6 percent.
Finally, we turn to the yield curve spread (the difference between the ten year bond and the federal funds rate) as we have in previous posts. We have an interesting development as short run forecasts through the end of the year see a riding yield curve spread, indicating a steeper yield curve, and the longer horizon (2020) showed a flatter yield curve. This suggests that forecasters are wary of an impending recession in the longer run.
The February WSJ forecasts are in and, in general, we are seeing good news. First off, 2018 Q1 expected GDP growth is up a quarter percent to 2.6 and the expected unemployment rates through 2020 all fell. The trough of unemployment is still hovering around mid 2019. Expected payrolls forecast rose by almost 8400, strengthened by the robust January employment report.
Inflation expectations increased again, standing firmly above 2 percent. Expected housing starts are more or less unchanged, but housing price forecasts for 2018 and 2019 both rose a tenth of a percent. We also saw a huge increase in crude oil expectations as almost all future prices rose by more than 2 dollars, with price expectations above 60 dollars for the next two years. Finally, consensus recession expectations rose, but still remain low, with less than a 14 percent chance of a recession in the coming 12 months.
As I have noted in previous reports, December and January Reports, the spread between the expected future federal funds rate and the ten-year bond rate has been tightening. This month, ten-year bond rate forecast all rose by over a tenth of a percent, whereas consensus expected Federal funds rate increases were more modest. This is good news for monetary policy makers, because they will be able to use the long end of the yield curve when the next recession begins. However, in the short term, particularly given the recent sell off of stocks, this presents a potential head wind against our waning economic recovery.
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.