The Federal Reserve’s Falling Growth Forecasts

Seemingly overlooked in all of the hubbub about a possible rate hike occurring at the December Federal Open Market Committee (FOMC) meeting is the longer-term trend of falling growth forecasts. FOMC members have collectively reduced their real (“inflation-adjusted”) long-run GDP growth forecasts for at least five consecutive years. The current long-run forecast calls for 1.80% economic growth; in 2011, the midpoint of the forecast range was 2.55%.

At the same time, expectations for long-run inflation essentially have not budged. Since the September 2012 meeting, FOMC members have forecast an increase in personal consumption expenditures (PCE) of 2.0%. (It was slightly lower in 2011, with a midpoint of 1.85% for the typical range of forecasts.) Reported PCE has been staying below the committee’s target, hence allowing interest rates to stay at low levels.

Some of the reasons influencing the downward trend in forecasts are obvious. Job creation has not been strong even though nonfarm payrolls have been increasing and the unemployment rate is at low levels. Wage growth has been disappointing for many workers. Quarterly productivity has worsened eight times since 2011. Budget bickering in Washington has capped fiscal stimulus and many state governments are strapped. The economy in other developed countries has been in a funk. Yesterday, the International Monetary Fund’s managing director, Christine Lagarde, said the overall growth outlook for developed economies “remains subdued.”

From an investment perspective, the falling forecasts are yet another sign that the calls for a bond armageddon occurring are the dog that didn’t bark. Given the ongoing trend in long-run economic forecasts, it’s hard to envision the Fed aggressively raising interesting rates in the foreseeable future. A 25-basis point (0.25%) increase at the December meeting would not change this view. What matters with interest rates is often not the timing of the next rate hike (presuming that it’s small and expected), but rather the perceived magnitude and frequency of the rate hikes that follow it. The CME’s FedWatch Tool currently places a greater than 90% chance on the FOMC’s federal fund’s target rate not being above 1% a year from now.

Forecasts are always subject to change. Plus, my crystal ball remains cracked. Nonetheless, without a change in the economic climate or some other change, long-term interest rates will remain on track to stay low. Such an environment should continue to provide stability for prices of longer-term, high-quality bonds. It would not be favorable to those seeking higher interest on cash savings or higher yields from fixed-income investments. It also means that annuity purchases should continue to be staggered over a period of time. For stocks, low interest rates help companies finance expansion, but slow economic growth hurts revenue and thereby earnings growth.

There are other potential implications of continued slow growth. To the extent that inflation (and inflation expectations) remains low, purchasing power will be better preserved, or at least eroded by a lesser amount. Tax-related limits will rise more slowly, which keeps the ceiling for inflation-adjusted credits and deductions from changing much, if at all. For example, 401kHelpCenter.com recently predicted that the annual limits for 401(k) deferrals and catch-up contributions will stay at $18,000 and $6,000, respectively, in 2017. Similarly, low inflation could mean a small increase in Social Security benefits. The Social Security Board of Trustees projected a 0.2% cost-of-living adjustment for 2017. The actual numbers for 2017 have not been released.

For those of you who remain frustrated, there are few things you can do. Avoid the temptation to take on more risk in an effort to get higher rates of return or higher yield. Such strategies can backfire in a painful way. Save more if possible. Most importantly, stay disciplined and think long-term. Economic and market conditions change over time, often without much warning and in ways we don’t anticipate.

SEC Proposes Two-Day Trade Settlements

Yesterday, the Securities and Exchange Commission (SEC) proposed a rule shortening the amount of time it takes to settle a trade from three days to two days. Currently, when you sell a stock or security, the cash from the transaction is not available for three days. Brokers will allow you to use the proceeds to buy another security immediately, but the funds are not available for withdrawal until three trading days afterward.

A fact sheet about the rule change is on the SEC’s website. A link to the proposed rule is on the right-hand side of the page, under “Related Materials.” (It’s easy to overlook the link.) Public comments on the rule will be sought for 60 days following the publication of the rule in the Federal Register.