While our overall economic forecast for 2014 and 2015 GDP are little changed from our third-quarter update, some of the pieces have changed quite dramatically. Overall GDP growth is likely to remain in the 2.0%-2.5% range in 2015, as it has for the past three years. We stuck with our GDP forecast for the entire year and avoided the up-and-down adjustments that a lot of other forecasters have made.
Most forecasters were a lot more bullish on 2014 and then overreacted to weather-related issues early in the year. Though some year-end data, especially from the United States, looks stronger going into 2015, a weak world economy is likely to act as a brake on overall U.S. results.
Due to a year-end dive in gasoline prices, our December-to-December inflation forecast will come in wide of the mark for 2014, with inflation likely to be 1% or less compared with our previous forecast of 1.8%-2.0%. We are, however, sticking to that forecast for 2015, as gasoline prices are likely to be considerably higher a year from now.
Our interest rate forecast of 3.5% for the 10-year Treasury Bond for 2014 was particularly embarrassing, as Fed tightening and a stronger U.S. economy were offset by actions of other central banks loosening monetary policy. Money, being the ultimate fungible commodity, found its way into the U.S. with a truly depressing effect on U.S. interest rates. We still think rates at some point will have a quick bounce-back to 3.5% and then stabilize without much further change for a potentially long period of time.
Fed tightening, combined with our inflation expectations and normal spreads over inflation, suggest this higher rate. The slower long-term growth rates around the world and low inflation suggest that rates are not going massively higher over the near and intermediate term.
Though not visible in our summary forecasts, housing was also a disappointment that was offset by stronger-than-expected consumption data and auto sales. Housing was hurt by higher prices, student loan levels, and continued tight lending conditions. We were more pessimistic than most housing forecasters for 2014, but even our conservative forecast proved to be too aggressive. Next year should prove a little better for housing with the labour market looking up and interest rates remaining relatively low, though slightly higher by year-end 2015. Though again, I am more cautious than most on the housing industry because of demographics, changing tastes, and affordability issues. We did manage to get our home price estimate just about right.
As we close out the year, investors seem obsessed with falling oil prices and actions of the Federal Reserve. I don't think that anyone should fixate on either of these issues. With energy supply and demand in relatively close balance, recent price declines aren't likely to last all that long. In the short run, prices can move a lot because of energy placed in storage. But as we burn through those excess supplies, cost of production and longer-term supply and demand issues come into focus.
Therefore, while cheap prices sound good now, they aren't sustainable for long. Either producers will cut back or users will pick up the pace. And what is produced in a day isn't very far off what is used in a day. No one knows how long oil will stay cheap, but I wouldn't be changing a lot of forecasts assuming cheap oil forever. Likewise, I think most oil-producing countries have at least some staying power and I wouldn't expect cheap oil to wreck our whole financial system.
In terms of the Federal Reserve, you would think everyone would have learned their lesson in 2014. In general, forecasters were nearly perfect in their predictions of Fed actions for 2014; start tapering and end new bond purchases, talk more hawkishly about rate increases based on a stronger economy. The only problem was that even knowing that in advance, interest forecasts were exactly wrong. Instead of increasing more than a point, interest rates, at least on the 10-year bond, fell more than a point.
Rates depend more on economic activity and central bank actions, not just in the United States, but also around the world. Given open markets, the Fed often doesn't control rates. During much of the past half century the Fed was always behind the curve, fighting the last battle and raising or lowering rates well after markets had already moved rates based on economic activity and supply and demand.
Given that the consumer represents about 70% of the U.S. GDP, economists' time is better spent analysing what the consumer is doing versus navel-gazing about when the Fed will make its next move or worrying about which oil producer is going broke next. In this report, we take a closer look at what the consumer has been doing lately and what the outlook might be.
The quick answer is that the hourly wage rate is likely to go up, but the demographics of an aging population will limit employment growth, keeping consumption below its long-term trend of 3.6% but above the 1.9% rate of the past 10 years. Another hint, long-term demographics are going to be more important than temporarily cheap oil prices, which have turned everyone into consumer bulls. Cheap oil prices come and go quickly; demographic realities, not so much.
This article was originally published on Morningstar.com
