Thu, 21 Mar 2013
Morningstar's Bob Johnson assesses the impact of the FOMC's stimulus program so far and stacks up the Fed's growth and employment expectations against his own.
Jason Stipp: I am Jason Stipp for Morningstar. The Federal Open Market Committee's statement on Wednesday showed more of the same when it comes to the stimulus efforts and a bit of a change on their economic outlook. Here to offer his take on the Fed statements and compare it to his own view of the economy is Morningstar's Bob Johnson, our director of economic analysis. Thanks for joining me, Bob.
Bob Johnson: Great to be here.
Stipp: So, when we looked over that Fed statement, on the policy front, on the interest rate front it was essentially more of the same. So what does that mean? What is more of the same? What activities will they be continuing?
Johnson: Well, the first is the short-term interest rate, which they've always controlled, the so-called federal-funds rate, and they've vowed to keep that rate in the 0%-0.25% range, and that determines the amount of money at what people borrow at and what the certificate of deposit rates are. So unfortunately those numbers for CD buyers are still going to be pretty dismal.
Then the second big part of it is that they've vowed to continue their mortgage and Treasury security buying program. People were a little bit fearful that might be withdrawn or tempered a little bit, but they offered to continue to buy the $40 billion worth of mortgage-backed securities and the $45 billion of Treasury securities per month as long as the economy remained weak.
Stipp: And how long are they going to continue to do that? What are their target points?
Johnson: Well, the target point is 6.5% unemployment and 2.5% inflation. And you get either one of those and they'll probably have to think about tempering their buyback programs.
Stipp: What happens if inflation hits that target before unemployment?
Johnson: Chances are they'll have to evaluate what caused it, whether it's short-term or long-term. If we had a quick spike in oil prices because of some dislocation in the Middle East, I doubt that they would change much. If on the other hand it was because of stronger-than-expected U.S. wage growth or prices for consumer goods, then they'd be all over it.
Stipp: The Fed also talked about economic forecasts, so where they are seeing the economy moving on three different measures: gross domestic product, inflation and unemployment. Let's talk about GDP first. What is the Fed now expecting for GDP and how does that match up with what your expectations are?
Johnson: They're now using 2.3% to 2.7% for 2013, which would be an uptick from what we had in 2012, and that's just a little bit lower than their previous forecast, but that's still kind of above what consensus is of most economists and above what I'm thinking. I'm thinking kind of 2.0% to 2.5%; they are thinking 2.3% to 2.7%, which is a pretty good number.
I think that it may be a stretch to get there. It is actually a little bit higher than what's it's in some of the budget numbers, so that would actually help to improve the fiscal deficit more than people expect if we really do grow that fast. But I think that number will probably sneak down a little bit over time. I think 2.0% to 2.5% is a more reasonable range to use.
Stipp: And they're expecting even higher in 2014?
Johnson: Yeah. I think they're expecting just around 3% for both 2014 and 2015, and some are a little bit higher than that forecast even on an individual basis. So that's certainly some more good growth, and again that's probably a little bit higher than what I am thinking, probably not a lot. My big theme is we're kind of maybe stuck in this 2% to 2.5% range, maybe a little bit better, but not much for some time, and that's going to make for a lengthy, lengthy recovery. And the reason it's not going to be as dramatic as the Fed thinks it might be, in my opinion, is we can't get all the cylinders hitting at one time, which is a good and a bad thing.
Right now housing is coming on strong, but we're losing a little bit out of exports. Manufacturing growth, which had been so strong early in the recovery, is beginning to slow a little bit. Government has been like an anchor for the last couple years, and I'll tell you what, it looks like to me, at least on the federal side, we've probably got another year or two of that anchor around our neck in terms of government spending. So, the issue why the number is slower than we'd all like to see is we're not getting all things going at once, but the good part of that is that this could be one of those big 10-year recovery periods and not one of these 12-month wonders.
Stipp: All right. So, your GDP expectation is coming in a little bit lower than the Fed's, but you do think that we'll be able to sustain that GDP for a while into the future.
Let's talk about inflation, the Fed's expectations and your expectations?
Johnson: They're saying inflation looks like under 2% to them, and I'd have to agree with them, which would be good. The long-term average is pretty close to 3.8%-3.9%. The median number is 3.1% over the last 70 or so years. So 2% is clearly way below the longer-term norm.
Stipp: What's driving that? Why is it lower than the norm?
Johnson: Well, part and parcel it's probably the slow economic growth that we're seeing isn't kind of pushing up and making all the dislocations that make prices go up so much. And I think the bubble has burst a little bit on the commodities front. I think China is trying to be a little bit more internally focused a little less, externally focused and a little less "let's import tons of copper and make lots of excess steel and whatever." I think a lot of that commodity boom is probably over, and that's part of what's behind us. I think that drove a lot of the number when it got so close to that danger point of 4%. There was a lot of the foreign demand and even stockpiling, and I think some of that's behind us.
Stipp: And the Fed is aiming with its stimulus measures to get to a 6.5% unemployment rate, but what are they expecting in the shorter term? What's their forecast there?
Johnson: I think they think we'll probably be between 7.3% and 7.5%, which is down from their previous forecast in terms of an unemployment rate...
Stipp: For 2013?
Johnson: By the end of 2013, which is getting closer to my range, but I am still a little bit off consensus. I still think we'll be under 7% by the end of the year.
Stipp: And what will drive that?
Johnson: I think that that's going to be driven by job growth of about 2%, which averages out to about 180,000 jobs a month. And I think the number of (participants) in the economy will go up, but maybe by a couple million at the most.
Stipp: And let's talk a little bit about the stimulus measures that are happening. This is, you said, the 51st month of zero interest rates. So, the Fed has had its hand in the stimulus measures for quite a long time. Has it done any good in your opinion?
Johnson: As you know, Jason, and our long-term readers will know, I've been relatively negative on the programs, but probably about a year or two ago when the housing market finally started, I said that maybe they had the right idea after all. Kind of couple of things happened, maybe a couple more out of their control, that helped.
I was certainly very fearful about speculation in commodity prices. I was fearful with all this money being stuffed into the economy, so to speak, with all this bond-buying, that we'd have some real speculation because you couldn't really invest in the housing because the houses wouldn't appraise, and you couldn't borrow money from the bank if you had bad employment history. So it really kind of limited that money, it just kind of left it open to lot of speculative vehicles. And I was afraid commodity prices would go way up, and that would hurt the U.S. consumers. And for a while that did happen. But frankly as China's growth and Europe's growth slowed, some of the bloom came off the commodity rose and that brought commodity prices down, so we didn't get the negative effect that I expected from quantitative easing.
On the other hand, it seemed to have some effect on both the stock market and the housing market. Now both were kind of undervalued on their own and were due for what I'll call a reversion to mean, that is to do better to just even get to the long-term averages. But it was maybe the psychology and the shot at putting little extra money behind the bets that made it effective. And lo and behold, they've got to be saying that did work. The stock market is now up 133% off the bottom. Most markets are now at all-time highs. The housing prices are still long ways from the top but are up 10% from a year ago.
So from that way, it's worked. Whether that was the whole reason it worked, no. Kind of like Cash for Clunkers, you know. It got the automobile thing moving, but if you look back at it, you'll say well, that wasn't the real reason. It was because the cars were getting old and everybody needed new cars.
Stipp: How much of the current stock market right now at the level that it's at do you think is underpinned by these stimulus measures? If the Fed started to remove some of those, do you think the stock market is going to crumble because it just needed that to reach the level that it is at now?
Johnson: I don't think so. I mean I'd be lying if I didn't say it helped. I know at Morningstar we use discounted cash flows to value companies and we really haven't changed the long-term interest rates that we're using to do that discounting in there. So, if rates go up, we're not changing our discount rate here at Morningstar. That doesn't appear to be the most likely case.
Also, I would add that operating earnings, or earnings in general at S&P 500 companies, even though the S&P is just about where it was last time around, earnings are considerably a step above that and inflation is lower, and everybody's balance sheets are better, we're a little bit less leveraged than we all were. So, it's hard to make the case that we're drastically overvalued in the market right now because last time we were at this level, valuations were heck of a lot higher.
Stipp: So, then the last question for you, if we say that some of the stimulus measures did do some good or at least had the intended effects that the Fed wanted them to have, do we need more? So the Fed is doing more of the same, as you said. Is it necessary at this point now?
Johnson: You know what, I've always said that maybe we need to stand on our own two feet, and I've always been probably a little bit premature on that. I still think that we need to be thinking about slowly withdrawing some of that support. On the other hand I think that we're all beginning to come around to the case that the Fed may do some of this bond buying, but they're never going to sell what there are buying. They're just going to let those bonds mature and just not buy them again. Now, keep in mind for right now in [Wednesday's] statement they are very explicit. We are going to keep rolling over bonds and buy more bonds when the old ones expire. But the first way to kind of ease out of this will be stopping some of the bonds that are rolling over.
Stipp: So we've got more of the same from the Fed, but there's certainly still a lot to talk about the Fed's activities and those activities into the future. Thanks for joining me and helping to clarify your perspective on the economy versus the Fed's.
Johnson: Thank you.
Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.