In the last several years the Fed has been overly
optimistic about economic growth prospects. Fed officials have had to
repeatedly mark down their forecast and then revise down the initial and
subsequent readings. In fact, yesterday
the real GDP for the first quarter of 2014 was revised down to -2.9% from -1.8%
recently, and -1.0% in April of this year.
This is the lowest real GDP
reading in 5 years. The consumption segment (by far the largest) was reduced
from the original forecast of 3.1% to just 1% yesterday. This latest release lacked both consumption
and capital expenditures
Moreover, with the release of the report for 1st
quarter GDP, the Fed’s new downwardly revised forecast for the year, issued
only last week, is already badly out of date.
The latest Fed GDP forecast for 2014 is for a central tendency of
+2.1% to +2.3% growth. However, given the
1st quarter growth, a simple arithmetical calculation shows that GDP
would have to grow at an annualized rate of about 4.4% for each of the next
three quarters to reach its new projection.
We regard this as highly improbable, and are surprised that we have not
seen or heard anyone comment on this.
To get significant growth we need more consumer spending in order to offset the weak capital
expenditures by most of corporate America.
We have discussed the consumption problem in many of our comments. The largest problem with consumer spending is
the enormous debt taken on by the household sector during the period of the
mid-1980s to 2007 when the “great recession” hit. The percentage of household debt as a
percentage of both GDP and personal disposable income more than doubled over
that period of time. Since 2007 the
consumer has been paying down the debt and deleveraging. To get good growth we need the deleveraging
to end or wages to rise in order to turn around the weakness in consumption.
After 5 years into a recovery real consumption has been
growing at only 2% in real terms while the long-term average is closer to
3.5%. If the deleveraging slows down it
will all come down to wages increasing.
While job growth has been barely satisfactory over the past 5 months,
and the unemployment rate has declined, the lack of wage growth and a declining
Labor Force Participation Rate to multi
decade lows (back to1978 levels), have reinforced the fact that there is still a lot of spare
capacity. We believe, the continued
household leverage and spare job capacity will continue to disappoint the Fed
and probably force them to reinstate the QE-3 before the tapering ends.
In fact, last week’s comment summarizes our QE point of
view with the following statement-- “However,
we believe the market will correct significantly before the Fed ends the
tapering of the bond purchases and this will result in a delay of further
tapering, and maybe even reverse the tapering altogether, and actually increase the amount
of bond purchases made each month. What
will be interesting is how the markets handle it. Will investors continue to believe the Fed
will bail the markets out again by buying more bonds? And will investors go back to the buying of
risky assets on the news of more QE purchases, or will they start losing
confidence in these policies?
Eventually, we believe it will be the latter”.
