- THE MAGAZINE
The U.S. Federal Reserve’s central tendency projections for GDP growth in 2013 and 2014 (excluding the three highest and lowest numbers) were lowered. For 2013, the Fed now expects 2.0 percent to2.3 percent year-on-year GDP growth in the fourth quarter, compared to 2.3 percent to 2.6 percent in its June forecasts.
The Fed still anticipates GDP growth accelerating in 2014, but to 2.9 percent to-3.1 percent year-on-year in the fourth quarter instead of 3.0 percent to 3.5 percent as in June. Given the Fed statement and Chairman Ben Bernanke’s remarks, higher mortgage rates and potential fiscal contraction later in 2013 are the culprits.
Paul Edelstein, director of financial economics, IHS Global Insight, says headline personal consumption expenditures (PCE) inflation projections were raised for 2013, but lowered for 2014, likely reflecting expectations for oil prices due to the Syria crisis. Core PCE inflation projections were little changed. The Fed still doesn’t expect to hit the 2% target until late-2015.
The Fed’s unemployment projections were also left largely intact. Instead of the June forecast of 7.2 percent to 7.3 percent unemployment in the fourth quarter of 2013, the Fed now sees 7.1 percent to 7.3 percent, reflecting recent months’ declines. Unemployment will end 2014 at 6.4 percent to 6.8 percent instead of the previously projected 6.5 percent to 6.8 percent.
It is probably a good thing for bond markets that the Fed’s unemployment forecasts were largely unchanged, said Edelstein. Stock and bond markets rallied on the news that the Fed deferred a decision to taper. Had the Fed upgraded its unemployment projections, market expectations for the Fed’s first rate hike could have moved up, causing bond yields to rise at some point in the near future.
In his press conference after the Fed meeting, Ben Bernanke stressed the committee’s concerns about the economy’s response to recent financial tightening and the potential for further fiscal cuts. The Fed has plenty of reason to worry.
The preceding couple of months had been disappointing for the housing market recovery. After a 100 basis point jump in mortgage rates, credit demand, home sales, and new construction plans had all suffered. Hopefully mortgage rates will retreat with the Fed’s decision not to taper. But they won’t go back to where they were in April before taper talk heated up, suggests Edelstein.
Meanwhile, some nasty fiscal fights are brewing in Washington. A continuing resolution is needed in the next couple of weeks to fund government operations and avoid a shutdown. Soon after, the debt ceiling needs to be raised to prevent the government from prioritizing obligations. And the sequester needs to be dealt with or further government spending cuts are in store for 2014. Congressional Republican leaders announced their intensions to tie the continuing resolution to a defunding of the Affordable Care Act. President Obama and Senate Democrats aren’t expected to agree to this, setting the stage for a showdown.
For these reasons, the roadmap that Bernanke laid out in June for the taper process was upended. In June, Bernanke said that the Fed could begin tapering later in the year if economic conditions were sufficiently strong, and end bond buying entirely by mid-2014 at which point the unemployment rate would likely be 7 percent. In his statement, Bernanke said that the taper isn’t preset, and that the 7 percent unemployment marker isn’t set in stone.
For now, we maintain the view that the Fed will taper in December, commented Edelstein. But much depends on developments in Washington and in the housing market. The possibility that bond buying could be maintained at its current pace into 2014 is somewhat higher.