A review of the Federal Reserve’s June meeting indicates expectations for economic growth, unemployment and inflation have changed rather dramatically. In addition, a growing divergence between the forecasts of individual committee members suggests discussion concerning the direction of future policy may become more contentious.
The Federal Reserve Open Market Committee, who shares the responsibility of setting the nation’s monetary policy, last met on June 21st and 22nd. As is traditionally the case, a statement was released following the meeting to communicate the presumed consensus of the committee members and outline future policies.
This afternoon the minutes of June’s two-day meeting were released. In addition to providing more insight into the frustratingly slow pace of economic recovery and stubbornly high unemployment rate, the minutes also offer two additional revelations:
- A significant change in expectation relative to the April meeting is apparent.
- A clear divergence of opinion among individual committee members is emerging.
Both of these findings offer very important insights into the future of monetary policy, a key factor in the direction of stock and bond markets alike.
While the Fed’s statement may suggest the committee shares a single economic forecast, one particular exercise offers quantifiable insight into both a shift in general expectations and a clear variance between the expectations of individual committee members. This exercise requested the five members of the Board of Governors along with the twelve Federal Reserve Bank Presidents to indicate their personal expectation for economic growth (GDP), unemployment and inflation for the 2011, 2012 and 2013 calendar years. The same exercise was conducted during the April meeting, thus making any change in expectations easily discernible.
For those who are interested, this is best shown on the following graph released by the Federal Reserve available on their website.
There are three significant findings:
- In two months since the last meeting, expectations for GDP growth have decreased substantially. When asked in April, ten members expected GDP growth in the range of 3.2-3.3% this year. In June, the consensus was closer to 2.75%, a reduction of approximately 11%.
- Visions of lower employment appear to be fading quickly. Most members now expect an unemployment rate in excess of 8% for 2011 and 2012.
- Inflation expectations are higher as well, but not as dramatically. One individual clearly has higher expectations than the others.
In addition to a shift in the consensus view, the disparity in expectations between the individual committee members varies wildly. One member forecasts unemployment of 6.5% in 2013. Another expects 8.3%. That’s not only a wide disparity, but it has far reaching consequences for tax revenues, state budgets and a host of other variables. The forecasts for next year’s economic growth are similarly extreme. One member calls for a 2.2-2.3% increase. Another expects growth in the 4.0-4.1% range. The former would be problematic, the latter is rather robust.
Economists have never enjoyed a reputation as an agreeable lot, but the variance of these expectations suggests that the Fed’s ability to agree on the nation’s monetary policy may become increasingly difficult. In fact, after reading the minutes, the only point of clear agreement appears to be that economic growth will be slower than expected and “the outlook for both employment and inflation (is) unusually uncertain.”¹ I’m not sure that sets the stage for harmonious policy discussions.
This dissension between participants is precisely why Granada changed its investment theme on May 2nd from “Kicking the Can” to “Tug of War.” It was clear to us that a continuation of accommodative fiscal and monetary policy with little, if any regard for the consequences was being threatened. In addition, we expected that any discussion to modify the overly accommodative economic policies would be controversial.
Granada’s long-standing position is that in the absence of fiscal and monetary assistance, GDP growth will suffer and unemployment will remain stubbornly high. Collectively, the Federal Reserve’s Open Market Committee members appear to be adopting a similar stance.
In the face of high unemployment and low economic growth, the cry for assistance will only grow louder. The hands of Congress, once generous to a fault, are now sufficiently tied by Tea Party activists and the credit rating agencies alike. The plea for additional stimulus will thus be made directly to the Federal Reserve. Their response is critical to determining the direction of stocks, bonds and commodities in particular. The prudent investor is thus well-served monitoring the expectations of both the stated consensus and the individual committee members to evaluate the propensity for additional stimulus.