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).
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).
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).
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.
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).
This history of mistakes is well-known. But note a few points:
- The fact that the history of errors is well-known didn’t stop the errors seemingly being repeated again this year.
- 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.
- 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.
- 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).
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.
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.