BofA Lowers Its GDP Forecast, As Goldman Stops Short Of Calling FOMC Bunch Of Liars, Sees QE2 In As Little As Three Weeks
A month ago, we took aim at Bank of America economist Neil Dutta, whose consistently bullish exhortations were starting to sound far too hollow in light of the prevalent, and all too obvious, economic deterioration. Today, the second most bullish bank on Wall Street (after Morgan Stanley) has finally relented and cut its 2011 GDP forecast from 2.3% to 1.8%, raised its unemployment expectations, and is now firmly in the "bad news is better news" camp, expecting the launch of QE2 in Q1 of 2011. Elsewhere, Goldman's Jan Hatzius took offense to the FOMC minutes, and stopped just short of calling the Fed a bunch of myopic liars What seems to have angered Hatzius is the Fed's "bald statement"(sic... or Freudian slip?) that “no member saw an appreciable risk of deflation.” Hatzius goes all out: "This seems surprising given (1) the recent data on economic activity, wages, and prices, (2) the decline in breakeven measures of inflation expectations, (3) a recent article suggesting that at least one FOMC member (President Bullard of St. Louis) is indeed quite worried about deflation, and (4) the observation by an unnamed meeting participant that “…survey measures of longer-run inflation expectations had remained positive in Japan throughout that country's bout of deflation." As a result, Goldman has now revised its call for no action from the Fed until the mid-term election, and anticipates a new round of QE to come as soon as the Fed's next meeting in three weeks. Is Jan finally starting to call the Fed on its bullshit?
From Bank of America:
The growth recession is here
After salami-slicing our forecast in recent months, we are ready to make a deeper cut. We now expect a growth recession: we think the economy will manage to post positive headline GDP numbers, but this growth will not be fast enough to keep the unemployment rate from drifting higher. We expect below-trend GDP growth in each of the next four quarters, and with a gradual rise in the unemployment rate above 10%. With the weaker growth, we believe the Fed will launch QE2—a new asset buying program—in Q1 of next year. Our interest rate team expects this to push 10-year yields below 2% in the early part of the year.
Recent data show a steady deceleration in growth. After surging in the first few months of the year, the two most important monthly indicators—private payrolls and core retail sales—have stalled (Chart 1). At the same time the post-tax-credit housing hangover has been worse than expected, and even the business equipment recovery shows signs of faltering. Our sense is that the growth recession is already here and it is likely to linger through the first half of next year.
- For 2010, our full-year GDP forecast has been sliced 0.3ppts to just 2.6%.
- For 2011, we have shaved growth 0.5ppts to just 1.8%.
- The downward revision comes from weaker anticipated spending from both consumers and businesses. With business confidence weakening and the economy slowing, we took our 2011 capex forecast down to 7.0% from 12.0%.
- And, given the protracted inventory overhang in residential real estate and weaker labor market, we assume a long, even more painful, U-shaped
Yet far more curious was Jan Hatzius' note from yesterday in which he openly casts doubt on the Fed's predictive skills, and their constant inability to see deflation even where it is now prevalent. We present the full note with highlights:
How “Appreciable” Is the Risk of Deflation? (Hatzius)
• The minutes of the August 10 FOMC contain the bald statement that “no member saw an appreciable risk of deflation.” This seems surprising given (1) the recent data on economic activity, wages, and prices, (2) the decline in breakeven measures of inflation expectations, (3) a recent article suggesting that at least one FOMC member (President Bullard of St. Louis) is indeed quite worried about deflation, and (4) the observation by an unnamed meeting participant that “…survey measures of longer-run inflation expectations had remained positive in Japan throughout that country's bout of deflation.”
• Further signs of economic weakness and/or disinflation over the next few months would likely increase the perceived risk of deflation, and persuade the committee to address these risks via renewed quantitative easing. Our best guess is that this will happen in late 2010 or early 2011, but if the economic activity data are very weak and/or breakeven inflation falls quickly, we would not rule out a move at the September 21 FOMC meeting.
The most surprising aspect of the August 10 FOMC minutes was the highlighted part of the following sentence (near the start of the discussion of the committee’s policy action): “While no member saw an appreciable risk of deflation, some judged that the risk of further near-term disinflation had increased somewhat.” The “members” in this sentence are the five current Fed governors, including Chairman Bernanke, as well as the presidents of the Federal Reserve Banks of Boston, Cleveland, Kansas City, New York, and St. Louis. This is a stronger version of Chairman Bernanke’s assessment in his speech last Friday that “falling into deflation is not a significant risk for the United States at this time…” (emphasis added).
We don’t know exactly what the term “appreciable” means in terms of probabilities, but our interpretation is that the threshold would be no higher than 20%. Moreover, we don’t know exactly what the term “deflation” means in terms of the measure used or the time period, but our interpretation is a negative year-on-year reading for the core PCE price index over the next 2-3 years—i.e., roughly through the end of the Fed’s formal forecast horizon.
We are surprised by this statement, for several reasons.
First, it seems to be at odds with the recent economic data. While we are still some distance from outright core deflation, and while it is not our central expectation, the PCE price index excluding food and energy currently stands at 1.4% year-on-year, and the Dallas Fed’s trimmed-mean PCE index—which may well be a better measure of underlying inflation trends than the ex-food and energy index—stands at 1.0%. These numbers are clearly below the Fed’s implicit targets, as Chairman Bernanke noted in his speech on Friday. Moreover, this is at a time when the output/employment gap is at its largest since at least the early 1980s, and may be starting to widen once again given the economy’s transition to below-trend growth.
Second, the confidence that deflation will be avoided is at odds with the recent moves in some measures of inflation expectations. Survey expectations have not changed much, but the decline in forward measures of breakeven inflation is noticeable. The 5-year 5-year forward breakeven inflation rate calculated from on-the-run Treasury securities stood at 1.87% in the latest week, down from a high of 2.77% in late April 2010, and it is now at its lowest level since April 2009. Other measures of breakeven inflation have also been declining. A further substantial decline—say by another 30-40 basis points—would likely make Fed officials quite nervous.
Third, the statement seems to be at odds with a recent article by President Bullard of St. Louis suggesting that a continuation of the Fed’s current stance on short-term interest rates could result in deflation (see “Seven Faces of ‘The Peril’”, July 28, 2010). The first sentence of the abstract reads: “In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years.” Moreover, the article suggests that this is indeed a significant risk, at least if the FOMC maintains the current low-interest rate policy. (We do not agree with President Bullard’s view that low interest rates increase the risk of deflation, but that is a separate issue.)
Fourth, the statement about the risk of deflation follows the observation a few paragraphs earlier that “[o]ne [participant] noted that survey measures of longer-run inflation expectations had remained positive in Japan throughout that country's bout of deflation.” This is at least noteworthy because Fed officials have frequently pointed to the stability of inflation expectations as a reason to downplay deflation concerns.
Ultimately, the FOMC’s views and policy will evolve with the data. Further signs of economic weakness and/or disinflation over the next few months would likely increase the perceived risk of deflation, and persuade the committee to address these risks via renewed quantitative easing. Our best guess is that this will happen in late 2010 or early 2011. However, if the data on economic activity—especially Friday’s employment report—surprise sharply on the downside and/or breakeven inflation falls quickly, we would not rule out a move at the September 21 FOMC meeting.
Full BofA note