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March 21, 5:00 pm EST Stocks came back strong today as the market has had a little more time to digest what the Fed signaled yesterday. As we discussed yesterday, the Fed has effectively eased monetary policy since the December stock market rout, by slamming the breaks on their “rate normalization” plan. They’ve gone to great lengths to communicate to markets that they willnot kill the economic recovery. Moreover, they’ve told us that they will do whatever it takes to keep the economc recovery going. Now, let’s talk about the signal they gave in the economic projections they released yesterday. They dialed down what they call their “terminal” or “neutral rate.” In the long run, this is benchmark interest rate that they believe is neither contractionary nor expansionary for the economy. When the Fed started the rate normalization process, they thought the terminal rate was 3.5%. Now they think its 2.78%. Does this imply they think the economy is in a new normal of lower growth and lower inflation? Probably not. First, the Fed has had an abysmal record of predicting rates, inflation and growth in the post-crisis era. Throughout, they have been way overly optimistic. And as markets have taken cues from the Fed, their bad predictions have bitten them. Arguably, they mis-set expectations and that led to negative surprises, which ultimately forced the Fed to keep emergency level policies maybe lower and longer than what would have been necessary had they guided expectations better. Jeff Gundlach, one of the world’s best bond fund managers, made this comment today regarding the Fed’s forecasts …
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I agree. But if we look at the forecasts the Fed published yesterday, I suspect there may be a new motivation for these projections. Instead of using this document as a way for Fed members to pontificate on the future of the economy, I think they are using it as a way to manage down expectations, just as a company sets a low bar on earnings expectations — so that they can beat them.
Maybe a lesson learned from the mistakes of the past 10 years — set the expectations bar too low, not too high.
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