Comstock Partners, Inc.November 03, 2011
Fed's Outlook Nothing To Cheer About
In our view the FOMC statement and Chairman Bernanke's follow-up press conference presented a bleak take on the economy. The market cheered the virtual assurance that the funds rate would remain near zero until at least mid-2013 and the strong hints that further stimulus including QE3 was on the table. To us, however, this was far more of a forecast of economic weakness rather than strength. Importantly, they slashed growth estimates significantly for 2011, 2012 and 2013 while making steep upward revisions in the unemployment rate for all three years..
Although the Fed acknowledged that the economy improved in the third quarter it attributed much of the better results to temporary factors that inhibited growth in the first half. They stated that "recent indications point to continued weakness in overall labor market conditions... the unemployment rate will decline only gradually" over the next few years. The Fed noted a recent pickup in household spending, but failed to point out that income had lagged behind and that only a decrease in the savings rates allowed spending to improve. It is notable that the FOMC Central Tendency Forecasts slashed GDP growth by 1.1% in 2011, 0.8% in 2012 and 0.6% in 2013. It also raised its estimates for the unemployment rate by 0.3% in 2011, 0.6% in 2012 and 0.7% for 2013. These are highly significant revisions from the prior forecast. Even as late as 2014 the Fed estimated the unemployment rate at 6.8%-to-7.7%.
In line with its pessimistic outlook the Fed said it would continue operation twist and repeated its intention to maintain "extremely low levels of the federal funds rate at least to mid-2013." Bernanke also mentioned additional means of stimulus including QE3 if needed. Since the Fed did not increase the stimulus now, presumably the economic growth and unemployment outlook would have to be worse than the forecast in order for this to happen.
It is significant that the Fed felt the need to point out that, "Moreover there are significant downside risks to the economic outlook including strains in global financial markets." Observers of the Fed will remember that not so long ago Fed forecasts were usually considered to be the mid-point between potential upside surprises and downside risk. There was no such balance in the current statement or in Bernanke's press conference. In fact most of the discussion is centered on what further stimulus measures are possible. Even the previously dissenting "hawks" on the committee----Fisher, Plosser and Kocherlakota---- went along with the majority.
The markets took the Fed's hints of further stimulus as an excuse to rally. In our view the promise of exceptionally low interest rates to at least 2013 and talk of additional stimulus are signs of weakness. In a real economic recovery the discussion would be about when to raise rates and how to reduce the Fed's bloated balance sheet. Such considerations are notably absent today. When we also take into account that any settlement of the European sovereign debt problem will likely result in recession and that Japan has entered what could be its third "lost decade" the global outlook could turn downright ugly. If that is the case, who will be buying all of the goods being produced in China?
The bulls assert that the market is already discounting major risk and is reflecting widespread fear that may prove unfounded. That might be true if the market had collapsed as in 2000-2002 or 2008-2009. However, the current market is more of an extremely volatile trading range with wide swings in both directions. In fact the huge daily swings to the upside on any hints of favorable news indicate that investors are every bit as fearful of missing the next bull market as they are of getting caught in a free-fall. That is not the kind of action seen at major bottoms. In our view the 2011 lows are likely to be tested and breached with a test of the 2009 lows to follow.