Why the Fed took down its economic forecast substantially
At the June FOMC meeting, the Fed released its economic forecasts
Usually, at the March, June, September, and December FOMC (Federal Open Market Committee) meetings, the Fed releases its economic forecast for the current year and the upcoming two years. One of the nice things about this is that you can see how its forecast has changed over time. In this part of the series, we’ll look at the Fed’s GDP (gross domestic product) forecast for 2014 how it has changed over the past few meetings.
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The Fed has been taking down its GDP growth estimates for 2014
As you can see from the chart above, since its December 2012 meeting, the Fed has been lowering its estimates for 2014 GDP growth. At the December 2012 meeting, the Fed was forecasting that the 2013 GDP growth would range from 3.0% to 3.5%. At the last meeting, that dropped to between 2.1% and 2.3%. Ever since the crisis, the Fed has been consistently high in its GDP forecasts. In many ways, the Fed has been modeling this recession as a garden-variety recession driven by high inventory. Most recessions over the past 50 years have been inventory-driven and have been caused by Fed tightening. Usually, the sequence goes like this.
- The economy expands.
- The Fed senses the beginning of inflation.
- The Fed raises interest rates.
- Consumers stop spending.
- Inventory builds.
- Companies lay off workers.
- Inventory works off.
- Companies rehire workers.
- The cycle begins again.
The net effect of these types of recessions is that they’re usually short-lived and the recoveries from them are swift. This is why the Fed has been forecasting 3%-plus growth since 2009. This recession was fundamentally different in that it’s similar to the Great Depression because it wasn’t caused by the Fed’s tightening—it was caused by an asset bubble burst. These types of recession are much more intractable and impervious to government stimulus. In these, the buildup is not of inventory, but of debt. And debt takes a lot longer to work off than inventory. Also, when consumption is 70% of the economy and it’s depressed by consumer deleveraging, you don’t get the spending needed to pull the economy out of its slow growth pattern. This is why this recovery has been so unsatisfying.
Implications for commercial REITs
First quarter GDP was dismal, and we’ll get the third revision next week. Wall Street is forecasting that the final number will come in at -1.8%, which is a drop from the second revision, which came in at -1%. While the Fed is being guided by unemployment, GDP growth is also influencing the policy, although it may a while before we see any increase in short-term interest rates.
Interest rates are an important input for the commercial REIT sector, as commercial REITs tend to be leveraged and will also trade based on their dividend yields. While increases in interest rates may not necessarily be welcome news for office REITs like Brookfield Office Properties (BPO), SL Green (SLG), Vornado (VNO), Kilroy (KRC), or Highwoods (HIW), the reason for the increase is good news—economic growth is an important driver of rental income and vacancy rates.