–Leading Bank Economists Don’t See Fed Tightening Until Q2 2012>}
–US ABA Projects US GDP +2.4% 2011, +3.2% 2012
–Unemployment Rate Seen 8.8% By Year-End, 7.9% End-2012
–Expect Meaningful Downpayment on US Debt; No Full Resolution Pre-2012
By Brai Odion-Esene
WASHINGTON (MNI) – A group of leading U.S. bank economists Tuesday
predicted that when the Federal Reserve begins the process of trimming
its swollen balance sheet, the asset sales will not be limited to just
its massive holdings of mortgage-backed securities.
The Economic Advisory Committee of the American Bankers Association
forecast the Fed will not raise the federal funds target rate from the
current 0.25% until the second quarter of next year, with the target
rate moving above 1% by year-end 2012.
“If we see the Fed beginning to raise rates by the beginning of
next year, we expect that to be preceded by an announcement that they
would stop their reinvestment program,” Peter Hooper, Deutsche Bank
chief economist and the committee’s chair, told reporters. “We expect
that probably to occur by sometime next spring.”
That will have an impact on the markets, Hooper said, with some
estimates suggesting that running down the Fed’s balance sheet — with
the $1.5 trillion excess holdings of securities built up — could raise
long-term Treasury yields by about 50 basis points.
Hooper said it his sense that the Fed would not limit sales to its
holdings of mortgage-backed securities, as “it would not want the
composition of its holdings to move towards increasingly toward
long-term.” This would be the case if they did not start to sell some of
their Treasury securities.
As for what would move the Fed to begin tightening monetary policy
by the second quarter of next year, Hooper said the Fed has indicated
all along that it predicates policy on where it sees the economy going
in the future.
There is less uncertainty on the growth front, he said. “The
feeling is that the economy is still in expansion mode although not
quite as robust.
“If we see several quarters of good payroll employment growth,
unemployment steadily coming lower and core inflation trending up — in
the vicinity of 1.5% — and expected to continue on those trajectories,
that would be a time for the Fed … to begin to remove some of the
stimulus,” Hooper said.
And as the economic data comes in, Hooper said there will be
increasing pressure on the Fed from the markets, which will be expecting
the central bank to act.
“They don’t want to fall behind the curve, when the time comes, in
letting inflation expectations begin to get away from them,” he said.
The EAC’s latest report expects economic activity will pick up in
the second half of this year from the current “soft patch,” predicting
real GDP to grow by 2.4% this year and 3.2% in 2012.
Leading the way on the EAC’s list of downside risks to their
outlook is a possible further rise in oil and gasoline prices. Currently
the committee projects WTI to average $99 per barrel this year and $98
Hooper noted that oil prices are “levelling off,” with no further
increases in oil price levels expected this year.
However, George Mokrzan, committee member and chief economist at
Huntington Bank, told Market News International following the press
conference that he is worried about oil price increases and the negative
impact on discretionary spending.
“That’s a restraining force, and I think that is a bit of a concern
… I think that would be a negative for the economy, that’s my number
one concern, or you could say risk, going forward,” Mokrzan said, citing
the ability of higher oil prices to fan general uncertainty and act as a
slowing force on growth.
The bank economists see high unemployment “lingering yet trending
down,” with the group forecast for the national unemployment rate to
decline from 9.1% in May to 8.8% by the end of 2011 and 7.9% by the end
of next year.
The expectation that the Fed would begin tightening monetary policy
by late this year “is out of the picture now,” Hooper said. But there
may be more uncertainty on prices, with headline inflation above the
Fed’s desired level and the core measure has also moved up.
“The expectation is inflation will recede from here and take some
pressure off the Fed,” he said.
The EAC forecasts consumer prices to grow at a rate of 3.2% this
year, before slowing to a 1.9% rate in 2012.
“Some members of the committee felt that inflation could be more of
a problem, which would say they should be tightening by very early in
the year,” Hooper said. “Others felt that inflation was not going to be
a problem … and they wouldn’t need to tighten until the end of the
Low inflation and Fed restraint will keep interest rates down in
general, according to the committee. The forecast for 3-month Treasury
bills is to hold near 0.1% through this year. The 10-year Treasury note
and 30-year mortgage rates are expected to rise to 3.6% and 5.1%,
respectively, by year-end.
As the Fed begins to tighten monetary policy, their forecast is for
Treasury bills to rise to 1.3%, 10-year Treasuries will rise to 4.3%,
and 30-year mortgages will rise to 5.8% by year-end 2012.
In his opening remarks, Hooper warned that the U.S. economy could
see a “significant” fiscal drag of about 1% of GDP.
He also warned that “failure to raise the debt ceiling … would be
catastrophic in terms of its impact on financial markets.”
However, “as a committee we are not expecting a full resolution of
the U.S. debt problem, that’s probably going to wait until after the
election (in 2012),” he said. “But there will be some meaningful
downpayment on that … through the process of the debt ceiling raises.”
The progress is beginning to be made the negotiations between the
administration and members of Congress, and an extension of the debt
ceiling will occur, he said.
“How large, how long will be a function of where they are at the
time in the negotiations, how much they’ve agreed to in terms of
spending cuts,” Hooper said. “If they haven’t agreed to a lot it will be
a short extension.”
There will have to be a meaningful cut in spending, Hooper said,
but it is likely to be spread out over time. This means the impact on
growth in 2012 “could be relatively limited.”
Hooper said he would not be surprised if the Fed had not already
factored in an expectation of a 1% of GDP fiscal drag, with the view
that there is ample room in private spending to offset that.
The EAC projects business inventories to grow by $46 billion this
year, and $51.3 billion in 2012.
“So you have a lot of potential on the private side to offset the
fiscal drag this coming year,” Hooper said.
The EAC predicted that personal consumption would grow by 2.4% this
year and 2.6% in 2012. When asked by Market News International if he
expects consumer spending to make a meaningful contribution to growth
given high unemployment levels, Hooper said household spending will
“neither be a strong driver of growth nor a significant drag.”
The saving rate will stay “pretty stable,” Hooper said, allowing
households to rundown their debt while allowing consumer spending to
grow with income. However, “we do see the tax burden increasing,” once
payroll tax breaks expire, he warned.
** Market News International Washington Bureau: 202-371-2121 **