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Economy Sep 12, 2012

Will over-optimistic Fed downgrade forecasts again?

Has the Federal Reserve watched the US recession and painfully slow recovery through rose-colored glasses?

A look at the US central bank's economic forecasts over the past five years suggest it has.

Since October 2007, when the Fed's policy committee began giving quarterly predictions for GDP growth and the jobless rate, the central bank has downgraded its nearer-term forecasts almost two-and-a-half times as often as it upgraded them.

The trend of back-pedaling shows how poorly the central bank has fared at reading the economic tea leaves. Reuters

The gap between Wall Street's expectations for 2012 growth and the Fed's own current view points to yet another downgrade on Thursday, when policymakers wrap up a two-day meeting that has world financial markets rapt.

The trend of back-pedaling shows how poorly the central bank has fared at reading the economic tea leaves, with the Fed's optimism a likely factor in policy decisions through the Great Recession and its fallout, economists say.

"The Fed has been kind of consistently overestimating where growth should be ... it has expected too much," said Eric Stein, a portfolio manager at Eaton Vance.

When the forecast proves too optimistic, the central bank trims its expectations, building the case for further policy easing, he said.

"I'm not saying they are intentionally lowering forecasts to try to ease; they are lowering them because that's the reality of the situation," Stein said. "But if they want to ease, having that as justification, particularly with the upcoming political election, is helpful."

In what is often described as an aggressive response, the Fed has kept short-term interest rates near zero for nearly four years and launched two rounds of so-called quantitative easing in a bid to push down longer-term borrowing costs. It has also said it will keep rates low until at least late 2014.

Despite those unprecedented moves, the recovery has been choppy, several times revving up just enough to raise hopes before slowing down again to spark a new round of action by Fed Chairman Ben Bernanke and his colleagues.

This week, most economists expect the Fed will take steps to decisively ease policy again with a third round of bond purchases to give the recovery another kick start.

It will also offer a fresh batch of forecasts for growth, unemployment and inflation - as well as projections for when interest rates will finally rise-this time stretching them over four years into 2015. Previously, the Fed waited until November to add a fourth year.

Looking back at both 2010 and 2011, Fed policymakers bumped up their forecasts for jobs early in the year, only to backtrack later.

Concern that pattern could repeat was one reason Chicago Fed chief Charles Evans gave at the start of this year for sticking to his call for more monetary easing even as economic data improved.

"I think we have to remember that we have a long ways to go," he said in February. "I don't want to become complacent about the fact that 'oh, our forecasts are a little brighter now.'"

The pattern did indeed repeat, with the Fed dialing back expectations on jobs in June after two quarters of increasing optimism.

53 DOWNGRADES VS 22 UPGRADES

All told, disappointed policymakers had to ratchet down GDP growth estimates for the current year and the following year, or lower their unemployment estimates, a total of 53 times over the past five years. That compares to 22 forecast upgrades.

Officials left their estimates unchanged only five times.

Many of the upgrades were clustered from late 2009 to the spring of 2010, as the nation first began emerging from its worst recession in decades. But when job growth faltered and inflation began heading perilously low, policymakers turned more pessimistic and announced a new round of stimulus.

Last year, the Fed's optimism on unemployment was quashed after a springtime slowdown - first attributed to temporary factors like Japan's tsunami and earthquake and a spike in oil prices-dragged into the summer, signaling deeper problems.

The Fed responded by saying it would likely keep interest rates ultra-low through mid-2013-and then, this past January, through at least late 2014.

Optimism over jobs had risen again by early this year. But then the eurozone crisis deepened, raising new worries over the US economy, and in June the central bank downgraded its forecasts once more.

Of course, officials at the US central bank have been far from alone.

"The shocks and surprises have definitely been coming from one direction the last few years," said Peter Hooper, chief US economist at Deutsche Bank Securities in New York. "Everyone was expecting the usual bounce after the recession, but that didn't happen."

Though the Fed's current unemployment forecasts are similar to those of Wall Street, the central bank may have to lower its GDP growth expectations for this year and next year. It forecast 2012 growth in a 1.9 percent to 2.4 percent range in its last projections in June, while the median forecast from Wall Street economists is for 1.8 percent growth.

Reuters


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