uploads///Fed  GDP forecast

Why has the recovery taken so long to arrive?

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Dec. 4 2020, Updated 10:52 a.m. ET

Decreasing GDP growth estimates for 2015

As you can see in the following chart, since its December 2012 meeting, the Fed has been lowering its estimates for 2015 gross domestic product, or GDP, growth. At the March 2013 meeting, the Fed was forecasting that the 2015 GDP growth would be 3%–3.6%. At the last meeting, that dropped to 2.6%–3%.

Ever since the financial 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.

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Most recessions over the past 50 years have followed the same pattern. Once the economy starts to take off, inflationary pressures emerge. Then, the Fed raises interest rates. This slows the economy and causes a buildup of inventory. Firms lay off production employees while the inventory is worked off. Then, the expansion begins again. This is the classic garden-variety recession.

These recessions are usually short lived. The recoveries are swift. This is why the Fed has been forecasting 3% or higher growth since 2009.

The financial crisis was fundamentally different. It wasn’t caused by the Fed’s tightening. It was caused by an asset bubble that burst. The problem here isn’t a buildup of inventory—it’s a buildup of bad debt. These types of recessions generate slow, halting recoveries with a lot of backsliding. Japan has been working through the aftermath of its real estate bubble. The bubble burst in 1989.

Also, when consumption is 70% of the economy and it’s depressed by consumer deleveraging, you don’t get the spending that’s needed to pull the economy out of its slow growth pattern. This explains why the recovery hasn’t been satisfying.

Implications for mortgage REITs

For mortgage REITs, economic growth cuts two ways. For the agency REITs—like Annaly (NLY) and American Capital Agency (AGNC)—improved growth can actually be bearish for these stocks. It signals an increase in interest rates.

In contrast, non-agency REITs—like NewCastle (NCT), PennyMac (PMT), and Redwood Trust (RWT)—take credit risk. An improving economy means lower delinquencies and better MBS (mortgage-backed securities) performance.

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