Federal Funds Rate Forecasts

This post looks at the May WSJ Economic Forecasting Survey. Academic economists and seasoned professionals have found it notoriously difficult to forecast recessions. The survey asks panelists point blank about the probability of a recession in the coming 12 months. The consensus was 15 percent, about the same as the previous months. However, firms, governments, and individuals, may want to have a longer range forecast than the next year. To assess long-run forecasts we can turn to the analysts forecasts of the federal funds rate.

The federal funds rate is the interest rate at which commercial banks lend to one another overnight. By purchasing and selling assets (historical these were always government bonds, but the Fed has had more latitude to hold non-government securities and derivatives since the financial crisis), the Federal Reserve influences the market forces to acheive some interest rate target. Currently that target is between 0.75 and 1 percent (the daily actual interest rate tends to be 0.91 percent).

The forecasting survey asks participants for a predicted Federal Funds rate every June and December through 2019. Instead of focusing on the values, we can draw insight from changes. For example, if a forecaster has a higher forecast for June 2018 then Decemeber 2017, then the implicit assumption is that the Fed percieves will still perceive strong economic growth. However, a lower forecast implies that the future Fed decision reflects weak economic growth.

Until June 2019, 98 percent of survey participants foresee the Fed holding rates steady or increasing, suggesting continued economic expansion until then. That forecast is consistent with the low probability of recession predicted for the coming year. In December that percentage drops to 91, with only two analysts predicting a declining Fed Funds Rate. If the analysts predictions hold true, then the coming year or two promises to be strong. In addition, it is likely that the weak advance Q1 growth estimate of 2017, is either an aberration, or will be revised upward.

In the short-run, 91 percent of analysts predict the Fed will increase rates by June 2017, as compared to 84 percent in April, and 60 percent in March. The strong employment numbers from April confirm that analysis. Continued positive news on other economic indicators will reinforce the likelihood of a rate hike in May or June.