Fed Forecasts Sub-3% Economy for the Next Three Years by Gary D. Halbert

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

September 23, 2014

IN THIS ISSUE:

1.  Fed Reduces Economic Forecasts Through 2017

2.  Could the Economic Outlook Be Even Worse?

3.  US Household Net Worth Hits a Record High

4.  Is the Economy Finally Turning the Corner?

5.  2Q GDP Report Due on Friday Expected to be Upbeat

Overview

The Fed’s policy committee announced last Wednesday that it will end its massive QE bond buying program at the end of next month, thus paving the way for the first Fed funds rate increase sometime next year. This was not a surprise. The Fed’s gargantuan balance sheet will peak near $4.5 trillion in Treasury and mortgage-backed bonds at the end of October.

What was surprising in the Fed’s data release last Wednesday was the downward revisions to its economic forecasts for 2014, 2015 and 2016. Furthermore, in its first-ever forecast for 2017, the Fed expects GDP growth of only 2.3% to 2.5% that year. In the wake of the Fed’s forecast downgrades last week, private economists are revising their estimates lower as well.

On the bright side, Americans’ combined wealth posted a new high in the 2Q, a development that might shift the economy into a higher gear. The net worth of US households and nonprofit organizations rose about $1.4 trillion between April and June to a record $81.5 trillion, according to a new report released by the Fed last Thursday.

This Friday, we get the latest estimate of 2Q GDP. In late August, the government estimated that the economy grew by a stronger than expected 4.2% (annual rate) in the 2Q. The pre-report consensus for Friday’s report suggests another jump to 4.6% in the final estimate. Most forecasters attribute the strong 2Q reading to the severe winter weather in the 1Q that pushed many activities into the April-June quarter. In other words, the 2Q was a “catch-up” period, and most economists expect slower growth for the second half of this year.

Finally, I offer three recommendations to kick-start the economy at the end of today’s E-letter. I trust that most clients and readers would heartily agree with me. Unfortunately, the current occupant of the White House does not.

Fed Reduces Economic Forecasts Through 2017

The Fed Open Market Committee (FOMC) concluded its latest policy meeting last Wednesday and, as expected, voted to halt its enormous “quantitative easing” program at the end of October, according to its official policy statement.

Yet even though QE will end by October 31, the Fed maintained that it will be a “considerable time” before the first Fed funds rate hike sometime next year. For reasons unknown to me, many in the financial media thought the Fed would hint at a rate hike considerably sooner than the middle of next year. It didn’t.

With all the attention focused on whether the Fed would signal an earlier time for the first rate hike, some analysts failed to notice the Fed’s downgrades to its economic forecasts that accompanied the official policy statement. The Fed reduced its economic projections for 2014, 2015 and 2016 – and offered its first forecast for 2017, which was also disappointing.

The FOMC revised its economic projections to the downside from its most recent projections issued after the June policy meeting. The Fed now forecasts US Gross Domestic Product to grow as follows (annual rates), as compared to what they said in June:

2014 2015 2016 2017
2.1-2.3% June 3.0-3.3% June 2.5-3.0% June n/a
2.0-2.2% Sept 2.6-3.0% Sept 2.6-2.9% Sept 2.3-2.5% Sept

This is the second time this year that the FOMC downgraded its economic forecasts. If their forecasts are anywhere near accurate, our anemic economic growth will continue for several more years. For 2014, the Fed now expects GDP growth of only 2.0% to 2.2%, down from 2.1%-2.3% in June. And this is despite the nice pop in GDP to 4.2% in the 2Q.

The Fed’s largest downward revision in its annual forecasts was for 2015 as it now expects GDP growth of only 2.6% to 3.0%, down from 3.0%-3.3% in its June forecast. So much for the economy shifting into a significantly higher gear next year.

Fed economy

 

As you can see in the chart above, the last time that the US economy grew at an annual rate above 3% was in 2005. Now the Fed forecasts that growth will be at 3% or lower through at least 2017. Let’s hope the Fed is wrong but sadly, such long-term economic forecasts are often too optimistic.

Could the Economic Outlook Be Even Worse?

The latest cliché to describe our struggling economic recovery is “secular stagnation,” a term reportedly advanced by former Treasury Secretary Lawrence Summers. The term secular stagnation is a suggestion that our economy is caught in a prolonged period of below-trend growth that may continue for at least several more years. But why?

In part, this reflects the Baby Boomers’ retirement, which will reduce the expansion of the labor force. Baby Boomers are those estimated 76 million Americans who were born between 1946 and 1964. Baby Boomer retirements are now estimated at 10,000 per day, and that number is expected to continue for at least a decade (or longer as life expectancy increases).

Older Americans have been retiring from the labor force for as long as records have been kept. However, because of the magnitude of the Baby Boomer generation, more older Americans will be leaving the workforce than younger folks will be joining it over the next decade. As a result, the labor force participation rate will continue to decline, or at best remain stagnant.

As a result, Northwestern University scholar and economist Robert Gordon contends that mainstream economic growth predictions are wildly optimistic. His own calculations are more restrained. By 2024, he projects that annual Gross Domestic Product will be nearly $2 trillion lower (almost 10% less) than currently projected by the Congressional Budget Office (CBO).

The gist of Gordon’s argument is that the nation’s productive capacity – what economists call “the supply side” – will expand only slowly. It won’t keep up with the stronger consumer demand projected in other forecasts.

As a result, inflationary pressures will be higher and GDP lower. “The economy is on a collision course between demand-side optimism and supply-side pessimism,” Gordon asserts.

Although Gordon’s analysis addresses economics primarily, the underlying issues are political. Since World War II, advanced democracies – Japan, Western Europe and the US – have depended on strong economic growth. It was a political narcotic: Wages and living standards rose, generating taxes to pay for generous “social safety nets” and rising welfare benefits.

Fed economy

The financial crisis in 2008 shattered that complacency, and the prospect is for years of modest economic growth or, in Europe, possibly nonexistent growth. How will political systems cope? Will “class warfare” intensify as groups battle harder for bigger shares of a stagnant pie? Will racial, ethnic, religious, generational and ideological conflicts worsen?

No one denies the reality of slower growth. The question is, how much slower? From 1950 to 1973, the US economy grew almost 4% annually. From 1974 to 2001, growth averaged slightly more than 3% a year. By contrast, the CBO’s

1, 23  - View Full Page