Seeing our future through the eyes of the Federal Reserve…
In early November, I had the pleasure of having lunch with Bill Strauss, the Senior Economist and Economic Advisor at the Federal Reserve Bank of Chicago. As the lead economist in Chicago, Bill shares research with the other 11 Federal Reserve Banks which collectively comprise our Federal Reserve System (the Fed). Their consensus thinking drives policy creation.
While I place little importance on predictions from “experts” given their track record of being inaccurate as often as they are on target, I am paying attention to Bill’s comments. The difference between the “experts” and the Fed is that the former tries to influence actions while the latter takes action to implement their beliefs. All of their data leads the Fed to the following conclusions:
1. Our expansion out of the 2007-2009 recession will continue to be slow.
2. Employment is expected to rise moderately in 2012.
3. Slack in the economy will keep the inflation rate low for the near future.
4. Vehicle sales are a bright spot and are anticipated to rise at a good pace.
5. Growth in all manufacturing should be solid in 2012.
The summation of his views is that a double-dip recession or other similar significant economic decline in the next 12-24 months is highly unlikely. However, the Fed is seeing enough headwinds to temper its expectations and shape its views that the recovery will be modest and prolonged.
The Fed’s views are aligned with Oak Wealth Advisors’ approach of staying broadly diversified, not taking excess risk, and tempering return expectations. Generating positive returns in portfolios should be feasible but they will likely be single digit returns for at least the next year or two. Investment market volatility will surely persist as uncertainty will not be eliminated from the world economy anytime soon.
More details of the Fed’s research and forecasts are follow below and continue in the next column for those who are interested.
- Banks are holding historically high levels of excess cash.
–Economic growth has been slowed by the decrease in lending.
–Business owners have not been aggressive in borrowing or investing to expand as they are not inclined to take risks in periods of heightened uncertainty.
–Consumer debt levels have declined from 24% to 21% of income. The decline has occurred over the past two years after the rate held at 24% from 2001 through 2009.
- Consumers seem to be in a better place financially than they have been for many years.
–Personal savings rates have stabilized around 4% of income after being close to zero prior to the recession and spiking to 8% during the recession.
- Gross Domestic Product (GDP) growth is forecast to be significantly lower than it has been coming out of prior recessions when it averaged 5.2% to 5.5%.
1.6% - 1.7% for 2011
2.5% - 2.9% for 2012
3.0% - 3.5% for 2013
3.0% - 3.9% for 2014
2.4% - 2.7% thereafter for the long-term
- Unemployment has only fallen from a high of 10.1% in October of 2009 to 9.1% two years later. It is anticipated to remain between 8.5% - 9.0% over the next 18 months.
–Historically, “full employment” has been accepted as an unemployment level of 5% to 6%.
–Between 2008 and 2009, the unemployment rate jumped from just below 5% to 10%.
- Core inflation (which excludes food and energy) is expected to stay between 1.5% - 2.0% for the near future. While it is understood that we are all affected by energy and food costs, they are highly volatile indicators over short periods of time and have not grown much in inflation adjusted terms over the last thirty years.
- New home construction is anticipated to continue to rise modestly.
- The Federal Funds rate, which is the interest rate at which the banks can borrow short-term funds from each other, is expected to stay between 0.0% and 0.25% through 2012.
–The continuation of these historically low Federal Funds rates suggests both a lack of demand for the cash and a lack of inflation pressure.