Markets & Economy

The Fed has misinterpreted the effect of falling oil prices and a strong dollar

Two aspects of Fed forecasting have failed: long term and short.

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The good news is very nice: mortgage rates are stable near 3.75 percent, sales of existing homes have risen 10.4 percent in the last year, and sales of new ones have soared 19 percent. Even the poor news is good: a softer-than-expected economy is holding the Fed at bay.

Forecasting the economy is not easy. I asked an exceedingly bright client, a super-computer wonk from our National Center for Atmospheric Research, to compare the difficulty of forecasting climate and the economy. His eyes shot up to the ceiling, then closed; he became silent, wrapped his arms around his sides; then some chanting noises and back-and-forth rocking, and at last fairly shouted: “Easy!” What…?

“Climate is easy! We have laws of thermodynamics, fluids, and gasses! Economy… we have no rules.”

Today, the Fed would second that motion. March orders for durable goods stripped of volatile transportation (airplanes and cars) were expected to rise .3 percent from February’s pit (-.6 percent) and instead fell .2 percent — down .5 percent if private-sector only, excluding military.

Wall Street houses are grudgingly backing down their estimates for first-quarter GDP to a 1 percent to 1.5 percent range. The Atlanta Fed’s GDPNow, a real-time tracker, is running 0.5 percent, and no better in April. The media chatter is embarrassing. “The economic weakness is all about bad weather.” Give that up, guys. Not everyone lives in New England or New York. And, oddly enough, weather is often lousy in winter.

The Fed, with the best of intentions, has painted itself into a corner, but at least it has the sense to put down the brush when it runs out of paint. All Fed speakers in the majority close to Yellen have become tentative, changed from “Hold us back” to “We must lift off … but not now.”

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Two aspects of Fed forecasting have failed: long term and short. Clean sweep. The Fed’s models assumed ever since 2009 that extraordinary measures would ignite the economy, but I thought then and since misunderstood what had gone wrong. The blown credit and housing bubbles did their damage, but a majority of Americans for 25 years have been undercut by foreign competition, and information technology has accelerated the affair.

In the last six months, the Fed’s estimates of the effects of falling oil and strong dollar have been embarrassing. Oil first. Oil began a violent ramp-up in 1973, again in 1979 — the two combined so extreme that long lead-time production and conservation held prices steady until 2005. Then the spike to $100 in 2005, all the way to $150/bbl in 2008, and holding $100 until the collapse last December.

In each of those jumps, fallbacks and plateaus, natural gas and coal (and therefore electricity) rose and fell together, a concerted drag, then stimulus. Not this time! Natural gas super-collapsed six years ago, same for coal. Gasoline had been so overpriced since 2008 that Americans limited their driving for the first time since World War II rationing.

Upper-crust economic pundita are out of touch with households, now burbling about a “temporary increase in the savings rate” to explain the absence of fallen-oil stimulus. Two-thirds of US households have been painfully overstretched, and $2.25 gas only eases a little strain — not a return to mindless consumption.

The dollar. Late last year the party line went: “We don’t export much, so losing some won’t hurt, and everything we import will get cheaper.” Uh-huh. You missed the globalized damage in the Great Recession, and you’re still missing it. Every competitor in the last year has chopped its currency value by an aggregate 15 percent (except China, which secures its competition by other means). Note that their devaluations do them no good at all versus each other, just with us. A desperate maneuver.

In a global market, wages paid by our competitors in dollar terms just fell 15 percent, and this new undercut follows 25 years of holding down US wages in global leveling.

Answers are not easy (how to teach kids to compete, and to pursue sound careers, and to run resilient households?). The Fed does need to lift off from 0 percent. But all of this would be easier if we acknowledged that this is not 1945, or 1965 or 1985. We had been lucky beyond imagining then, and now we need to use the ol’ thinking cap.

It’s hardly off a table edge, but 2015 is the worst reading in three years:

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This competitive devaluation is not doing anyone any good, except possibly Germany, and may be making it worse by undercutting the one outfit that’s supposed to buy everybody’s exports: the U.S. By the way: this unanimously poor first-quarter performance make the weather excuse all the sillier.

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Note production continuing despite drop in rigs. One theory: fracking is becoming more efficient and cheaper by the minute, and we don’t need as many rigs to continue to increase U.S. production — and at costs easily competitive, $60/bbl.

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That’s a lot of oil in storage here. Overseas oil consumers have ramped their imports to take advantage of possibly temporarily low prices, but even China has run out of storage. Truly confounding: many oil-consuming nations are also ramping their oil taxes (mostly to protect their currencies and revenue hunger, not climate altruism). Thus, overseas consumption is not likely to rise to soak up the U.S. fracking bonanza, and the sheikdoms cannot afford to cut their production.

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Love this chart. The only nations whose production costs put them in pumping trouble at $60/bbl: Britain and Brazil, followed by Canada and Australia. Of course, each nation’s internal costs are not as unifiorm as the chart appears, and expensive players will drop out. Still, low cost production is immense.

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Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.