At the December 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 this series, we’ll look at its GDP (gross domestic product) forecast for 2013, 2014, 2015, and 2016, and also at how its forecast for 2014 GDP growth has changed over the past few meetings.
The Fed had 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 2013 GDP growth would range from 3.0% to 3.5%. At the last meeting, that dropped to between 2.8% and 3.2%. Ever since the crisis, the Fed has been consistently high in its GDP forecasts. In many ways, the Fed has been modeling this recession like 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
- Inflation starts to be felt
- The Fed raises interest rates
- Consumers stop spending
- Inventory builds
- Companies lay off workers
- Inventory works off
- Companies re-hire workers
- The cycle begins again
The net effect of these types of recession 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 Fed tightening—it was caused by a burst asset bubble. And these recessions are much more intractable and impervious to government stimulus. In these recessions, 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 de-leveraging, 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 mortgage REITs
The agency REIT ETF (MORT) was up on the FOMC statement, but it underperformed the market. The agency REITs like Annaly (NLY) and American Capital Agency (AGNC) benefit most from Fed stimulus. It lowers their cost of funds and boosts the value of their holdings. If you think we’ll be in a slow growth environment, where the Fed will have to increase asset purchases to stimulate the economy, the long-duration agency REITs are where you want to be. If you think the economy will slowly improve but do nothing spectacular and that interest rates will slowly increase, you probably want to be in adjustable-rate agency REITs like MFA Financial (MFA) and Hatteras (HTS), as you get the upside of higher rates in your portfolio and lower duration. If you think the economy is about to take off, then you want non-agency REITs like Two Harbors (TWO), so you get the benefit of improving credit exposure.