MUNIX COMMENTARY – 11th November
Are forecasts useful?
I start this article with a quote from the famous investor Warren Buffet “Forecasts usually tell us more of the forecaster than of the forecast”.
Central bankers regularly give public speeches, hoping to explain the latest developments in the economy and the likely future path of monetary policy. A common feature is outlining the latest official forecasts, and sometimes their personal outlook which might help explain their own voting pattern. Two recent statements show how some statements go with the flow of the market, others work against.
Whilst European inflation is at its highest levels in 15-20 years, the ECB continues to place significant emphasis on its forecasts that it will come down. Indeed, its Chief Economist Philip Lane recently argued that “An abrupt tightening of monetary policy today would not lower the currently high inflation rates but would serve to slow down the economy and reduce employment over the next couple of years and thereby reduce medium term inflation pressure. Given our assessment that the medium-term inflationary trajectory remains below our 2% target, it would be counter-productive to tighten monetary policy at the current juncture”. Sadly for Mr Lane, the markets were not convinced about the accuracy of such forecasts, and still expect a first rate move in Q4 2022.
In the USA, Fed Governor Richard Clarida also gave his thoughts about the outlook for the economy. If his forecast proves correct, the “necessary conditions for raising the target range for the federal funds rate will have been met by year end 2022”. Inflation to date presents “much more than a moderate overshoot of our 2% longer run inflation objective, and I would not consider a repeat performance next year a policy success”. He expects economic growth to drive the unemployment rate down to 3.8% by the end of next year and “eliminate the 4.2m employment gap relative to” the months before the pandemic. At that point, an interest rate path similar to that laid out by Fed officials in September would “be entirely consistent” with the framework of hitting 2% inflation and reaching “maximum employment”.
Of course such a forecast has to be refreshed as and when new data appears. On that basis, the latest announcement that US Consumer Price Inflation has exceeded 6% year on year is a concern. To put such a figure into perspective, this is the highest 12-month inflation rate since the early 1990s, which for economic historians or those old enough to have lived through it was the end of the Reagan boom and the surge in the oil price after the Iraqi invasion of Kuwait. Unlike recent months where a single factor, such as energy, was the prime mover, on this occasion the gains were widespread. Wall Street economists put the figures into their models and produced a peak inflation rate of 7% pa within a few months.
Markets usually, although not always, react to hard data more than reassuring speeches. The US CPI report triggered a sharp rise in 2, 5 and 10 year bond yields, with the latter now approaching 1.6% again. Three rate rises are widely expected next year. To quote one commentator “In a nutshell, the market has swung strongly against the notion that the Fed can stay patient and is betting that it has already left it too late”. UK gilt yields were not caught up in the sell-off, hovering about 1%, partly because the latest GDP report was a little weaker than expected but mainly because investors await next week’s labour market data. As economists put that into their models, they will revise their estimates for the next rate move.
I end this article with another quote, this time from Peter Lynch “If you spend more than 13 minutes analysing economic and market forecasts, you’ve wasted 10 minutes!” A useful exercise then but remember the provisos.
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making