There Is No Crystal Ball

February 03, 2022

Four combination column/marker charts showing projected and actual economic metrics. Chart subtitle: Under normal economic conditions, the Fed is fairly accurate at predicting economic metrics, except the number of rate hikes. General description: Charts are arranged 2x2, with upper row showing GDP (blue) and Inflation (purple) and lower row showing Unemployment (tan) and No. 25bp Rate Hikes (green). Legends are shown at left of each chart, with projections displayed as lighter columns and actual numbers in darker circle marker overlaid by year. X-axis of each chart shows years from 2014 through 2021. GDP chart description: Y-axis spans -7% to +7%, hovering between 2-3% for the years shown. Generally the Fed projections historically were only off by less than 0.5% until 2020, with a projection of -6.5% and actual at -3.4% and 2021, with a projection of 6.5% and actual at 5.7%. Inflation chart description: Y-axis spans 0% to 6%, hovering between 1% and 2% for the years shown. Generally projections historically were only off by less than 0.2% until 2021, with a projection 2.2% and actual at 4.85%. Unemployment chart description: Y-axis spans 0 to 10%, hovering between 3% and 6% for the years shown, though it had steadily declined since 2014. Generally projections historically were off by only 0.1% until 2020, with a projection of 9.3% and actual at 6.8. 2021 was back to historical norms with a projection of 4.5% and actual at 4.2%. No. 25bps Rate Hiks chart description: Y-axis space -5 to +5. These projections and actual data are very inconsistent; the Fed was only correct one year out of the years shown (2017) and otherwise both under- and overestimates relatively frequently. Chart source: Federal Reserve Summary of Economic Projections, Bloomberg. End chart description.

The Federal Reserve is arguably the most influential financial institution in the world. Their eight meetings a year are highly anticipated, their policy decisions are highly scrutinized, and their economic projections and commentary can move markets. Last month the Nasdaq sold off nearly 9% on concerns of heightened inflation and expected rate hikes by the central bank. The market reversed sharply after the January FOMC meeting on Chair Jerome Powell’s comments about rising inflation and monetary tightening. There are even trading strategies built on predicting market movements after the Fed’s comments and monetary policy surprises. While the monetary policy decisions made by the Fed have a material impact on the economy, their projections are not always accurate, especially when it comes to rate hikes.

Our chart of the week examines the summary of economic projections of GDP, unemployment, inflation, and the number of 25 basis point rate hikes projected for the year over the last eight years. Prior to the COVID pandemic in 2020, the Fed had fairly accurately predicted GDP, inflation, and unemployment, more often than not coming within 0.2% of actual full-year numbers. Ironically, when it comes to interest rate changes — the metric most directly controlled by the Federal Reserve — predictions worsen. While the Fed accurately foresaw no movement in 2014 and 2021 and were on the mark with three rate hikes in 2017, they greatly overestimated hikes in 2015 and 2016 and underestimated rate cuts in 2019 and 2020. Following four rate hikes in 2018, after starting the year predicting three, the Fed quickly reversed course in 2019, cutting rates three times, a sharp contrast to initial expectations for one additional rate increase.

This year the members of the FOMC are predicting three rate hikes, though history has shown us actual results could differ greatly. Monetary policy and economics are never an exact science, and the continually evolving supply and demand dynamics behind inflation make this year all the more challenging. There are simply variables that cannot be predicted. In other words, there is no crystal ball. As the year unfolds, we will continue to keep our clients abreast of policy updates out of the Fed as well as any other developments that could impact the course of rates.

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