Hope vs experience

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2 March 2016 Est. reading: 10 min read

The remarkable and persistent run of forecast errors since 2010 seems set to continue in 2016. Growth forecasts were too high; bond yield forecasts too bearish; policy rate forecasts too hawkish. Initially these errors were net-positive for investors who focused on low rates rather than weak growth. Now, rightly, investors worry that rates can’t go low enough to maintain growth.

Yes, it’s difficult to forecast, particularly the future. But it’s remarkable that since 2010 forecasts have not only been consistently wrong, but consistently wrong for the same reasons. This year seems no different: growth forecasts are falling (exhibit 1).

Chart showing consensus global GDP forecasts

Earnings forecasts are also falling. Earnings forecasts almost always fall, but recent downgrades are larger than usual. Forecast EPS for developed markets is lower now than in 2011 (exhibit 2).

Chart showing developed market MSCI consensus EPS forecasts over time

Forecasts of stronger growth went hand in hand with forecasts of rising bond yields. The yield forecasts have been (almost) as persistently wrong as the growth forecasts (exhibit 3).

Chart showing consensus forecast year-end 10 year US Treasury yield over time

Consensus persistently expected policy rates to start moving towards ‘normal’. Exhibit 4 shows forecasts for the average G10 policy rate. The return to normal policy rates hasn’t happened – or, where it started, hasn’t continued – because growth hasn’t returned to normal.

Chart showing consensus forecast year-end G10 policy rate over time

Policymakers and official forecasters have been no better than private forecasters. The Fed’s forecasts for Fed policy have been worse than the market’s. Both have been too hawkish, and have been consistently scaled back. That pattern is being repeated this year, with implied yields on short-rate futures falling sharply (exhibit 5).

Chart showing Fed Funds target, market and FOMC forecast over time

This history of mistakes is well-known. But note a few points:

  1. The fact that the history of errors is well-known didn’t stop the errors seemingly being repeated again this year.
  2. The errors suggest that the ‘new normal’ is not yet the consensus view, at least amongst the contributors to consensus forecast surveys or, it seems, amongst policymakers.
  3. The pattern of errors – growth consistently being weaker-than-expected despite monetary policy being looser-than-expected – suggests that the consensus has persistently over-rated the power of monetary policy. This applies to policy-makers as much, if not more, than to investors.
  4. Until mid-2015 markets seemingly put more weight on the surprise of looser-and-lower policy than on the weaker-and-lower growth surprise. This underpinned a global re-rating in risk assets, notably a 70% PE-driven gain in developed world equities (exhibit 6).

Chart showing MSCI World index over time

Now, however, it seems there’s more focus on the dark side: the fact that growth remains weak despite the persistent looser-than-expected monetary policy calls into question the ability of central banks to achieve their aims.

This shift is important. While ever the focus was on the positive of easy policy, the resultant re-rating of risky assets compressed risk spreads which in turn effectively loosened financial conditions. With the focus now increasingly on weak growth the resultant widening of risk spreads tightens financial conditions. It’s clear what this means in interest rate markets: despite central banks keeping the rates they can directly control low, or pushing them lower, rates elsewhere are rising (exhibit 7). In short, central banks’ influence over broad financial conditions is becoming weaker.

Chart showing long-dated bond yields over time

I think this is permanent. I do not think, say, that the Fed reversing its one rate increase, or resorting to another round of QE, would restore the faith in central banks. Such a reversal would highlight the persistent over-estimation of central banks’ power. Investors have seen behind the curtain and realise central bankers are not wizards. It still requires bad news to push markets sharply lower, but I think it’s increasingly clear is that when that news comes central banks will not be able to provide an offset.

Gerard Minack has been analysing, forecasting and advising on financial markets since 1987. He focuses on the fundamental factors that usually drive investment performance: valuation, currency, monetary policy and the economic cycle, all with a focus on the medium-to-long-term outlook. Gerard retired from Morgan Stanley in May 2013, where he had served as global cross-asset strategist and before that global developed market equity strategist. Gerard has stopped working at big banks, and started Minack Advisors in 2013, providing independent fundamentally-based research on financial markets for institutional investors around the world.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address: 27 Old Gloucester Street, London, WC1N 3AX.

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