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Fed’s Economic Projections – Myth Vs. Reality (Dec 2013)

Submitted by Lance Roberts of STA Wealth Management,

Each quarter the Fed releases their assessment of the economy along with their forward looking projections for three years into the future. (See Fed Projections Myth Vs. Reality for the September analysis) I started tracking these projections beginning in early 2011 and comparing the Fed's forecasts with what eventually became reality. The problem has, and continues to be, is that their track record for forecasting has been left wanting. The reality is, however, is that the Federal Reserve simply cannot verbally state what they really see during each highly publicized meeting as it would roil the markets. Instead, they use their communications to guide the markets expectations toward reality in the hopes of reducing the risks of market dislocations.

The most recent release of the Fed's economic projections on the economy, inflation and unemployment continue to follow the same previous trends of weaker growth, lower inflation and a complete misunderstanding of the real labor market.

Economy

When it comes to the economy, the Fed has consistently overstated economic strength. Take a look at the chart and table. In January of 2011, the Fed was predicting GDP growth for 2013 at 4.0%. Actual real GDP (inflation adjusted) is currently estimated at 2.0% for the year or a negative 50% difference. The estimates at that time for long run economic growth was 2.7% which has now fallen to 2.15% and was guided down from 2.3% in September and 2.5% in June.

We have been stating repeatedly over the last 2 years that we are in for a low growth economy due to the debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity. The simple fact is that when an economy requires more than $5 of debt to provide $1 of economic growth – the engine of growth is broken.

As of the latest Fed meeting the forecast for 2014 and 2015 economic growth has been revised down to just 2.9% and 2.8% respectively as the realization of a slow-growth economy is recognized. However, the current annualized trend of GDP suggests growth rates in the next two years could likely be lower than that.

With more than 48 months of economic expansion behind us; this current expansion is longer than the historical average. Economic data continues to show signs of weakness, despite intermittent pops of activity, and the global economy remains drag on domestic exports. With higher taxes, government spending cuts and the debt ceiling debate looming the fiscal drag on the economy could be larger than expected.

What is very important is the long run outlook of 2.15% economic growth. That rate of growth is not strong enough to achieve the "escape velocity" required to substantially improve the level of incomes and employment that were enjoyed in previous decades.

Unemployment

The Fed's new goal of targeting a specific unemployment level to monetary policy could potentially put the Fed into a box. Currently, the Fed sees 2014 unemployment falling to 6.45% and ultimately returning to a 5.6% "full employment" rate in the long run. That long run rate was adjusted higher from the June meeting. The issue with this "full employment" prediction really becomes what the definition of "reality" is.

Today, average Americans have begun to question the credibility of the BLS employment reports. Even Congress has made an inquiry into the data collection and analysis methods used to determine employment reports. Since the end of the last recession employment has improved modestly. However, that improvement, as shown in full-time employment to population ratio chart below, has primarily due to increases in temporary and lower wage paying positions. More importantly, where the Fed is concerned, the drop in the unemployment rate has been due to a shrinkage of the labor pool rather than an increase in employment.

While the unemployment "rate" is declining, it is a very poor measure from which to benchmark the health of the economy. The drop in unemployment is primarily due to temporary hires, labor hoarding and falling labor participation rates. Real full-time employment as a percentage of the working population shows that employment has only marginally increased since the financial crisis. The drop in jobless claims does not necessarily represent an increasing employment picture but rather labor hoarding by companies after deep levels of employment reductions over the past 4 years.

Inflation

When it comes to inflation, and the Fed's outlook, the debate comes down to what type of inflation you are actually talking about. The table and chart below show the actual versus projected levels of inflation.

The Fed significantly underestimated official rates of inflation in 2011. However, in 2012 and 2013 their projections and reality became much more aligned. Unfortunately, inflation has fallen well below target levels of 2% which is weighing on economic growth. The Fed's greatest economic fear is deflation and the current drop in annual rates of inflation will keep pressure on the Fed to continue to accommodative policy active for longer than most expect.

However, for the average American the inflation story is entirely different. Reported inflation has little meaning to the consumer as the real cost of living has risen sharply in recent years. Whether it has been the cost of health insurance, school tuition, food, gas or energy – these everyday costs have continued to rise substantially faster than their incomes. This is why personal savings rates continue to fall, and consumer credit has risen, as incomes remain stagnant or weaken. It is the rising "cost of living" that is weighing on the American psyche, and ultimately, on economic growth.

Wishful Thinking

While the FOMC is vastly hopeful that the current economic improvement will be sustained; rising deflationary pressures, weak global growth rates and stagnant wages pose major headwinds. The problem is that the current proposed policy is an exercise in wishful thinking. While the Fed blames fiscal policy out of Washington; the reality is that monetary policy does not work in reducing real unemployment or interest rates. However, what monetary policy does do is promote asset bubbles that are dangerous; particularly when they are concentrated in the riskiest of assets from stocks to junk bonds.

The problem that the Fed will eventually face, with respect to their monetary policy decisions, is that effectively the economy could be running at "full rates" of employment but with a very large pool of individuals excluded from the labor force. Of course, this also explains the continued rise in the number of individuals claiming disability and participating in the nutritional assistance programs. While the Fed could very well achieve its goal of fostering a "full employment" rate of 6.5%, it certainly does not mean that 93.5% of working age Americans will be gainfully employed. It could well just be a victory in name only

With the Fed committed to continuing its Large Scale Asset Purchase program (Quantitative Easing or Q.E.), and deploying specific performance targets, the question of effectiveness looms large. Bernanke has been quite vocal in his testimonies over the last year that monetary stimulus is not a panacea. In his most recently statement, Bernanke specifically stated that "fiscal policy is restraining economic growth."

However, the recent improvements in employment and economic activity allowed the FOMC to begin "tapering" their current rate of asset purchases from $85 to $75 billion per month.

"…the Committee sees the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases."

The problem for the Federal Reserve currently is that there are very few policy tools left, and the economic effectiveness of continued artificial stimulation is clearly waning. Lower mortgages rates, interest rates and excess liquidity served well in priming the pumps of the real estate and financial markets when valuations were extremely depressed. However, four years later, stock valuations are no longer low, earnings are no longer depressed and the majority of real estate related activity has likely been completed. More importantly, the recent surge in leverage and asset prices smacks of an asset bubble in the making.

Reminiscent of the choices of Goldilocks – the reality is that the Fed's estimates for economic growth in 2013 was too hot, employment was too cold and inflation estimates were just about right. The real unspoken concern should be the continued threat of deflation and what actions will be available when the next recession eventually comes.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Wg-f98O2mIg/story01.htm Tyler Durden

Steve Chapman on Excusing Abuses of Power

If you’re part of the U.S. national security apparatus and you
torture someone to death during an interrogation, you can rest
easy. Two administrations have furnished get-out-of-jail-free cards
absolving you of responsibility for your crime. But if you’re part
of that same U.S. national security apparatus and divulge to the
American people information about government activities that are
unauthorized, illegal, and quite possibly unconstitutional, you
should expect no such mercy. Commit crimes on behalf of the
government? OK. Reveal secret abuses committed by the government?
You must be joking. Steve Chapman says the government’s reaction to
Snowden’s revelations perfectly demonstrates the Washington rule:
Abuse power, and you’ll be protected by those with power. Expose
abuse, and you’re on your own.

View this article.

from Hit & Run http://reason.com/blog/2013/12/19/steve-chapman-on-excusing-abuses-of-powe
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Los Angeles Gets Gun Grabby in Domestic Violence Cases

"Question No. 4: Have you stopped beating your wife?" At a press conference
yesterday, Los Angeles city officials announced that they’re going
to get grabby about guns owned by defendants in domestic violence
cases. Or rather, as grabby as the law apparently already allows
them to be.

Here’s how the Los Angeles Daily News
described it:

A new way to deal with those accused of domestic violence was
unveiled Wednesday, with the City Attorney’s Office and Los Angeles
Police Department seeking to remove guns from those accused of
abuse.

“Once someone is arrested for domestic abuse, the LAPD will
inform my office, and we will take steps to remove their guns,”
City Attorney Mike Feuer said at a City Hall news conference. “Each
week in the United States, nine women are killed by handguns. We
can do better than that.”

Feuer said the new prosecution protocol developed by his office
with advocacy groups over the past six months is designed to reduce
the possibility of further violence.

Under current law, those accused of domestic violence are
prohibited from owning a weapon. Violators could face additional
criminal charges.

There’s some awkwardness in the newspaper’s reporting. This
isn’t actually a new way of dealing with domestic violence and the
description of “current law” is a bit misleading. The story gives
readers the impression that simply being accused of domestic
violence is enough to get your guns taken away. Here’s how the Los
Angeles Police Department lists the regulations
connected to gun possession and domestic violence cases:

12028.5 PC Family Violence/Firearms Seizure

The police at the scene of family violence, involving a threat
to human life or physical assault, may take temporary custody of
any firearm or deadly weapon in plain sight or by consensual search
for the protection of the peace officer or other persons present.
The police may retain the weapons up to 72 hours unless the weapons
were seized as evidence or for an additional crime.

12021(g) PC Restrictions on Firearm
Possession

Persons subject to a restraining order may not obtain, receive,
purchase or otherwise acquire a firearm.

The person must know they are subject to the restraining order
and the restraining order must contain in bold print that they are
prohibited from receiving or purchasing or attempting to receive or
purchase a firearm, and the penalties. (This does not apply if a
firearm is received as part of a community property
settlement).

6389 PC Relinquishment Of Firearms

Prohibits person subject to a Domestic Violence protective order
from owning or possessing a firearm while protective order is in
effect.

Exemption may be granted if a firearm is a necessary condition
of employment. A person may possess only during scheduled work
hours and during travel to and from work.

So, the gun grabbing only applies if a judge rules that a
protective order is justified and only lasts for the duration of
the order. The Daily News reporting makes it appear like
the city attorney’s office is going beyond the bounds of the law
and snatching guns on the basis of just accusations, but the Los
Angeles affiliate of CBS is a little bit
more specific in their reporting. What the city says will
happen is that the city attorney’s office and the LAPD are going to
communicate better on domestic violence cases, so that if a judge
does issue a protective order, the city will respond and actually
enforce the existing laws and prosecute those who try to bypass
it.

Obviously “Wait, this isn’t as bad as you think it is!” should
not be taken as an endorsement of these laws. The discussion of the
abuse of women seems to conflate the use of a weapon with the
existence of the abuse itself, like the gun is somehow a factor in
causing the violence and not a tool the abuser selects. Even as the
city announces this effort to step up enforcement of these laws,
they also noted that domestic violence cases in Los Angeles are
actually down.

from Hit & Run http://reason.com/blog/2013/12/19/los-angeles-gets-gun-grabby-in-domestic
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The Legend of the Chicago Welfare Queen

In “stump speech after stump speech,” Josh Levin
writes in Slate, Ronald Reagan “regaled his supporters
with the story of an Illinois woman whose feats of deception were
too amazing to be believed.”

“In Chicago, they found a woman who
holds the record,” the former California governor declared at a
campaign rally in January 1976. “She used 80 names, 30 addresses,
15 telephone numbers to collect food stamps, Social Security,
veterans’ benefits for four nonexistent deceased veteran husbands,
as well as welfare. Her tax-free cash income alone has been running
$150,000 a year.” As soon as he quoted that dollar amount, the
crowd gasped.

Four decades later, Reagan’s soliloquies on welfare fraud are often
remembered as shameless demagoguery. Many accounts report that
Reagan coined the term “welfare queen,” and that this woman in
Chicago was a fictional character. In 2007, the New York Times’
Paul Krugman wrote that “the bogus story of the Cadillac-driving
welfare queen [was] a gross exaggeration of a minor case of welfare
fraud.”

But the woman did exist, Levin writes, and while she certainly
wasn’t a typical welfare chisler‎, let alone a typical welfare
client, Reagan’s descriptions of her scams were mostly accurate
accounts of her activities. Yet there was much more to her criminal
career than the case that made her infamous in the ’70s:
kidnappings, con games, maybe murder. Levin’s
story about her life reads like an epic Gothic saga in which
half a dozen villains turn out to be the same shape-shifting
monster; every time you think it couldn’t possibly get weirder, it
does.

from Hit & Run http://reason.com/blog/2013/12/19/the-legend-of-the-chicago-welfare-queen
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The MinotEur Labyrinth: What Europe's "Bank Resolution" Looks Like In One Chart

Late last night, European Union finance ministers agreed on a new system to centralize control of failing euro-zone lenders – a so-called “bank resolution mechanism” – in the hope that it will stop expensive banking crises from ruining the finances of entire countries.As WSJ reports, “”Taxpayers will no longer foot the bill when banks make mistakes and face crises, ending the era of massive bailouts,” according to Michel Barnier, the EU’s internal market commissioner.” Sadly, Mr. Barnier is incorrect, for two main reasons.

First, in Europe the link between a bank and its sovereign has never been tighter courtesy of ever rising holdings of host sovereign debt by a bank in question (subsequently repoed with the ECB for cash) currently at recordh high levels across the periphery, which means a major bank failure will always result in taxpayer impairment.

Second… well, instead of describing it, we will instead simply show graphically courtesy of the FT just what the “streamlined” bureaucratic process for achieve bank “resolution” in Europe looks like.

In a word (or two) – good luck.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/e7QSYy-1QIk/story01.htm Tyler Durden

The MinotEur Labyrinth: What Europe’s “Bank Resolution” Looks Like In One Chart

In a word (or two) – good luck.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/e7QSYy-1QIk/story01.htm Tyler Durden

China Also Tapers, Forced To Promptly Bail Out Money Markets

Overnight we warned that short-to-medium-term money market rates had spiked to record highs (1-Year rate-swaps over 5.06%) and that the PBOC was bravely standing firm on its (lack of) liquidity injections… that didn’t last long. Despite the PBOC’s veiled ongoing attempts to ‘taper’ its own liquidity provisions, as MNI noted, echoes of the June liquidity crunch were heard again in the Chinese money market Thursday and authorities moved to extend trading amid a surge in rates which quiet injections of funding by the People’s Bank of China failed to stem. Jitters in the Chinese interbank market since the PBOC tried to force deleveraging in June highlights the nervousness of an overstretched banking system that is reliant on the central bank’s largesse to ensure stable operations.

Via MNI,

Trading in the interbank market was extended by a half hour, traders said, citing a notice from the China Foreign Exchange Trade System, something which hasn’t happened since money market rates hit record levels back in June.

The PBOC admitted after the close, via its official microblog, that it used Short-term Liquidity Obligations (SLO) to add funding to the market. The bank didn’t specify when it added the funds but, in another direct echo of the June panic, the PBOC said it is prepared to add more.

“We will continue to provide liquidity support via SLOs to qualified financial institutions if necessary, depending on the progress of fiscal spending,” the bank said, adding that liquidity conditions are volatile because of seasonal factors.

…

Some traders expect a degree of calm to return once Christmas and the January 1 holiday have passed and liquidity returns to the system.

But the Chinese New Year comes soon after that, beginning at the end of the month, and the authorities have signaled they intend to wean China’s notoriously mismatched financial system off its addiction to credit creation over the longer-term, indicating that rates will remain volatile in the weeks and months ahead.

This is a problem – and this is why the banks are terrified – Goldman’s projection of Chinese debt to GDP through 2014 and 2015 is incredible…

and problematic as corporate bond yields surge higher… (with repo only maintained by government largesse)

It seems clear that the Chinese banks’ PBOC taper tantrum will not allow the central bank to withdraw painlessly.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/3BEmmarm57c/story01.htm Tyler Durden

What do People do with Means-Tested Assistance ?

There is a ideological caricature of Americans who are aided by public assistance. There claims of fraud and waste are rampant, but the actual evidence is sorely lacking. It is not that there is no fraud or waste, but that it is grossly exaggerated. The caricature tends to be part of a political agenda that wants to reduce the assistance.

This Great Graphic was posted on Atlantic by Jordan Weissmann. It shows the consumption patterns of those receiving assistance (red) and those that do not (blue). The data comes from the Bureau of Labor Statistics.

Families receiving assistance spend about half as much as families drawing on assistance. They spend a third less on food, 50% less on housing and 60% less on entertainment. That said, the data does not capture the non-cash assistance that some households receive.

Some research (see Henry Farrell’s review of a new study on the Washington Post’s Monkey Cage blog) indicates that people tend to be more supportive of transfer payments and assistance if they believed the recipients are in genuine need and not gaming the system. We suspect, then, that if there was a greater understanding of what the assistance is being spent on, there may be less political resistance to it.

Of course, it is not simply a marketing challenge. It is ultimately a political question. How should the social product be divided ? What do social classes owe each other? In that debate, those receiving assistance are often demonized for political and ideological reasons that often bear little relation to the facts.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/HQJEi2dlkX4/story01.htm Marc To Market

These EM Currencies Did Not Get The "Taper Is Priced In" Memo

As equity markets around the world try valiantly to hold on to yesterday’s manufactured gains that ‘proved’ the Taper is a good thing, few have commented on the consequences that are already being felt. Emerging Market currencies were broadly pummeled overnight with Indonesia’s Rupiah tumbling to 5 years lows and the Turkish Lira collapsing 1.9% in the last 2 days (its biggest drop in 4 months) to an all-time low.