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Tapering and Treasury yields: Important takeaways

Part 3
Tapering and Treasury yields: Important takeaways (Part 3 of 4)

Inflation remains unbroken; a downward revision for unemployment

A downward revision

The Fed releases economic projections four times a year (March, June, September, and December). As the FOMC officials’ expectations for inflation, GDP, unemployment rate, and growth change, they revise and adjust policy to their changing view of the economy. However, the Fed chairwoman clearly indicated in her speech, held on March 19, 2014, “the downward revision in the guidance does not reflect a change in policy intentions.”

Economic ProjectionsEnlarge Graph

Traditionally, the Fed economic forecasts covered GDP, the PCE price index, and the unemployment rate for the next three years. The projections also provide the Fed’s long-run stand on various indicators.

Change in gross domestic product (or GDP)

The FOMC revised their expectations for 2014 GDP growth to a central tendency of 2.8% to 3.0% in March, down slightly from the 2.8% to 3.2% discussed in the December meeting. The downward revision is likely on the grounds of weaker than expected first quarter economic data— which was highly impacted by the poor weather.

The fourth quarter 2013 data was also below expectations; GDP fell sharply to 2.4%, after increasing 4.1% in third quarter 2013. There were number of headwinds for the decline including the unusual cold winters and a 16-day shutdown of the government.

Change in unemployment rate

The economic forecast report released estimates a decline in 2014 unemployment rate from a central tendency of 6.6% in December meeting to 6.3% in March. At present the unemployment rate is 6.7%.

The expected unemployment rate at the end of 2015 was revised down, to a central tendency of 5.6% to 5.9% in March meeting, from 5.8% to 6.1% in the December one. The Fed’s chairwoman Janet Yellen added that the “continued weakness in the labor market was driven by harsh weather conditions. However, financial crisis has taken an exceptional toll on the economy, which includes restrictive fiscal policy not just at the federal level but also at the state and local level.”

Meanwhile expectations for personal consumption expenditure (or PCE) and Core PCE inflation in 2014 and 2015 remained mostly in line with December’s projections.

GDP and personal consumption are highly correlated. An increase in GDP implies economic expansion, which is usually accompanied by an increase in consumption expenditure. Other things being constant, higher GDP translates into healthier corporate profits, as demand for product and services spur. This may lead to rise in the inflation, which directly impacts the market interest rates. Other things being constant, higher interest leads to decline in the bond prices (BND). Stock market (SPY) tends to grow with high GDP, however, if inflation goes overboard, it may impact the profitability of the major mortgage lender and consumer companies such as AG Mortgage Investment Trust Inc. (MITT), Annaly Capital Management Inc. (NLY).

Some of the major ETFs that gauge consumer spending patterns includes The State Street SPDR S&P Retail ETF (XRT) tracks the S&P Retail Select Industry Index (an equal-weighted market cap index), composed of the retail sub-industry portion of the S&P TMI.

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