Comment On The Federal Reserve Forecast

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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Federal Reserve forecast of April 25, 2012 is sending mixed signals to the markets.

While the numbers for Gross Domestic Product (GDP), unemployment and inflation are as expected in the immediate term, the 2014 growth and inflation projections are unrealistic if not appearing to be incorrect because they are highly improbable.

GDP growth rate is projected by the Fed to be between 3.1 and 3.6, reduced from the Fed’s January high of 4.0 and inflation between 1.6 and 2.0 per cent.

For US growth rate to nearly double from the current value by 2014 as a result of higher domestic investment and/or exports, and for inflation to remain where it is or lower, world oil and food prices must go down despite US growth.

For contributing variables of headline inflation – food and energy – to come down in value, expectations of European and Chinese growth, about 1/2 of the global economy on a purchasing power parity (PPP) basis, must be bleak.

For US growth to double from the 2012 value, the scenario of increase in US exports is inconsistent with the expectation of inflation.

Capital inflows and return of US capital back into US financial markets because of weak economic conditions in Europe and China could produce a wealth effect by inflating US equities in newer generation information technologies (IT) such as social media and in life sciences without structurally impacting the US economy to raise its potential growth rate but maintaining upward pressure on inflation – core (the Fed’s preferred measure) and headline using the 1990s inflation as a benchmark for explaining our inflation forecast under wealth effect.

Wealth effect should raise consumption, if the Fed growth forecast is to be explained, through a combination of higher domestic investment in IT and life sciences and consumption, while keeping employment growth on track at the current pace.

At Transformations we forecast with 80% probability that US, Latin America, Africa and India will remain at status quo because of EU stability and 50% probability for a China slowdown which is largely predicated on geopolitics.

Ceteris paribus, however, 2014 will experience food and energy inflation as in 2007 because of the global bias for recovery, followed by another US/EU crisis soon thereafter, before 2016, with a rising probability between 50 and 80 per cent from now, as domestic Chinese consumption rises and should China embracing a multiparty democracy by 2014 not materialize.

2014 to 2016 will see, with a probability greater than 50 per cent, rising US and eurozone yields on government debt because of a Chinese pullback from US and eurozone government bond markets while gradually increasing their yuan presence in the form of foreign direct investment (FDI) in the West.

2014 and beyond, structural change to lower the cost of energy and natural resource factor inputs and free trade in food is imperative, independent of the geopolitics, for global economic stability.

In this context, it is important for investors everywhere to note that interest rates for central bank funds will not return to the higher 1990s levels anytime soon if structural change is to be facilitated globally.


About Chandrashekar (Chandra) Tamirisa
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