Fra Moodys:
Fed’s Diminished Expectations Warn Credit Household spending is growing strongly and business capital spending sags, according to the policy statement of the FOMC’s September 21 meeting. The risks to business activity were seen as balanced, with strong household expenditures and solid job gains offsetting softness elsewhere. Nevertheless, the Fed’s release of near- and long-term projections of US economic activity contained some notable downward revisions.
For example, the Fed lowered its projected year-to-year increase for Q4-2016’s US real GDP from a June 2016 projection of 2.0% to September’s 1.8%. For both the final quarters of 2017 and 2018, the Fed expects yearly gains of 2.0% for real GDP, both unchanged from June’s projections. The Fed also supplied its initial forecast for the yearly increase of Q4-2018’s real GDP, which was 1.8%.
And for the first time ever, the Fed lowered its forecast of long-run real GDP growth to a pace under 2%, or 1.8% to be exact. In June, the Fed projected a long-run growth rate of 2% for the US economy. We do not know of a single consensus forecast that puts the long-term growth rate for the US economy under 2%. Still, a pronounced deceleration of US economic growth has been unmistakable.
The average annualized growth rate of US real GDP plunged from the 3.3% of the 10-years ended June 2006 to the 1.3% of the 10-years-ended June 2016. Similarly, real GDP’s 20-year average annualized growth rate has eased from the 3.2% of the span-ended June 1996 to the 2.5% of the span-ended June 2016. Apparently, the median US economic growth forecasts of Federal Reserve governors and District Bank presidents effectively looks for an extended downshifting of US economic activity, which some refer to as “secular stagnation”.
The days of viewing the long-term rate of US real GDP growth as at least 3% are from a bygone era. As inferred from the Fed’s long-term forecast of a 2% underlying rate of PCE price index inflation, the accompanying long-run rate of growth for nominal GDP is less than 4%. The slower implied long-term growth rates for real and nominal GDP signal lower real rates of interest and a downshifting of corporate earnings growth. In addition, the long-term rates of growth for private-sector debt will need to slow if excessive leveraging is to be avoided.
The nominal GDP outlook suggests operating profits might do well to grow by 3.5% annually, on average, during the next 10 years. For balance sheet leveraging not to endanger corporate credit quality, the outstanding debt of US nonfinancial corporations may be limited to an average annual growth rate no faster than 3.5%. Nonfinancial-corporate debt’s average annual increase has already decelerated from the 5.5% of the 10- years-ended June 2006 to the 4.4% of the 10-years-ended June 2016.
Consensus growth outlook implies limited scope for thinner spreads The Blue Chip consensus expects real GDP to grow by 1.8% yearly in Q4-2016 and by 2.2% annually for yearlong 2017. The yearlong 2017 projection includes a 2.2% year-to-year increase for Q4-2017’s real GDP, which is slightly faster than the accompanying 2.0% median forecast of high-ranking Fed officials. The high-yield bond spread shows a relatively strong correlation of 0.70 with real GDP’s year-to-year growth rate.
According to a regression equation that analyzes data from Q4-1985 through Q2-2016, the Blue Chip consensus projection for yearlong 2017’s real GDP growth has been associated with a 580 bp midpoint for the high-yield bond spread, which is somewhat wider than the recent 530 bp band. (Figure 1.)
However, real GDP’s ability to explain the high-yield spread is far from perfect. Regarding the current and previous recoveries, sluggish real GDP growth has significantly overestimated the high-yield spread for at least a two-year span on two occasions. The latest pertains to the two-years-ended September 2014, or when the average 607 bp midpoint predicted by real GDP growth was much wider than the span’s actual average spread of 433 bp.
