The Short View

February 11, 2014 10:13 pm

Foreboding sense of US economic consensus

Markets hit harder than usual when expectations are confounded

Janet Yellen did nothing to shock markets on Tuesday. In her first Congressional appearance as the new Federal Reserve chair, Ms Yellen confirmed what everyone thought: she is dovish on interest rates, will continue to taper off the Fed’s bond purchases unless something goes badly wrong, and does not see emerging market turmoil as the Fed’s responsibility.

Still, her shift of focus away from headline unemployment – now just above the 6.5 per cent threshold set for reconsidering rates – reassured markets that she is as much of a dove as expected, and shares jumped. Equally, the commitment to tapering saw 10-year Treasury yields rise 6 basis points towards the end of her testimony, the most in a day this year.

Investors are hoping for a Goldilocks outcome for the US economy, with growth forecast to be solid, at close to 3 per cent this year, but inflation predicted to be just 1.6 per cent, according to the Consensus Economics survey. Investors think low inflation means Ms Yellen can stay dovish even as economic growth delivers higher earnings and keeps the bears away.

This may happen. But the consensus is dangerously, well, consensual. The gap between the highest and lowest growth forecasts is down to levels last seen at the height of the credit bubble in 2007, and before that at the end of the dotcom boom. It almost exactly matches the Fed’s own forecasts, too.

The danger is that investors, economists and the Fed turn out to be wrong. When everyone agrees, any upset disturbs markets far more than when there is a wide range of views, as all will want to change their position at once.

The forecasts are likely to be wrong, too. I say this not because I see something economists have missed, but simply because economic star gazing is closer to astrology than astronomy. Non-inflationary growth may be the outcome. But if it is not, markets will be hit much harder than they usually are when expectations are confounded.

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