On Friday morning, just as I was contemplating diving even deeper into the tedious topic of U.S. Labor Force evolution for this post, The U.S. Federal Reserve (Fed) highlighted their inadvertent release of data from the so-called Teal Book deep in the weeds on its website. Gasp!, I know. However, this little accident gave us a peek behind the curtain of recent Fed policy deliberations, which are ordinarily released on a five year lag. The logically-titled Teal Book, born of the merger of the Green Book and the Blue Book in 2010, contains the Fed staff’s economic forecasts and policy recommendations that are distributed to the FOMC prior to each policy meeting. The staffers are decent forecasters on a relative basis: a notable academic study in 2000 by Romer and Romer concluded that the Green Book forecasts were generally more accurate than those of private-sector economists. Researchers from the European Central bank went so far as to determine in 2014 that these forecast advantages were at least partially a result of the “Fed’s staff access to better information on the future fed funds rate…”.* So, where the Teal Book contents differ materially from those published contemporaneously by the FOMC in the Summary of Economic Projections (SEP), that should tell us something.
The most striking takeaway from the Teal Book release was the staff’s prediction for the future path of Fed policy rates. The FOMC release their rate forecasts via the “Dots” chart in the SEP, and by comparison the Teal Book forecasts were decidedly more dovish. The Dots from the June SEP indicated two rate hikes were on the table before the end of 2015, and the staff projection sat squarely at 35bps, or one hike. The forecasted paths diverged even further at longer time horizons. For year-end 2016, the Teal Book forecasted 1.26% (or about one hike every other meeting next year) versus 1.75% mean on the Dot plot, and for 2017, 2.12% versus 3%. Accompanying (and presumably fueling) these low-and-slow fed funds rate forecasts, the Fed staff projected Core PCE Inflation in-line with the lowest of all FOMC participants in the SEP, implying that inflation would not return to the 2% target at all through 2020. Their outlook for potential GDP was as reserved as mine has been in these pages in recent months: 1.61% this year, gradually rising to 1.83% by 2020, again in-line with the absolute low of the FOMC’s range of 1.8 to 2.5. If the Fed staff had a vote in the SEP, they would be outliers to the downside on most variables. Again, the Fed staff has a reputable forecasting track record, whereas the FOMC as a whole is perhaps a bit more doubtful. So why the wedge between SEP and Teal Book?
Colleague Brandon Merrill and I wrote about the concept of “Mandatory Bias” in FOMC communications back in February of 2014. Essentially the Fed has no choice but to reflect optimism in their published outlook for the economy and monetary policy, because their communication is part of the policy. The Teal Book forecast release in quasi-real time is an enlightening event suggesting that this bias is there. The FOMC clearly doesn’t feel comfortable publicly endorsing an outlook that isn’t optimistic, even if it might be more realistic. It’s as if they have politely read the staff projections and then applied a coating of sugar to let us down easy. The market sees through this on some level, with prices barely budging after the details of the leak were highlighted.
*Green Book / Teal Book absolute forecast accuracy in the post-crisis period is mostly untested because other than the recent accidental release, post-crisis forecasts are still embargoed. The latest one from 2009 contains some significant optimistic misses.
Romer & Romer: http://eml.berkeley.edu/wp/c+dromer_aer2000.pdf
Industrial metals prices have had a rough year, with copper down 17% and iron ore lower by close to 30%. What are industrial metals prices telling us about global growth and does one help to predict the other?
Figure 1: Industrial metals returns, indexed from November 2010
Booming emerging market infrastructure spending prior to the financial crisis and in the aftermath of China’s 2009-10 fiscal stimulus prompted the metal industry to invest in long term projects. Prices have been falling for several years and recently the rising USD has contributed. Lower prices have begun the painful supply rationalization needed to stabilize markets. However, projects started during the prior high price environment have continued to come online which add to supply. For instance, Australia is a major exporter of metals and although capital expenditures have recently followed prices lower, rising value added in the mining sector suggests production continues to rise.
Each metal has unique supply and demand drivers and requires investment spending in the long run to meet expected demand growth. In the near term, however, the industry is overproducing as high cost producers are reluctant to go offline and demand growth in China has surprised to the downside. China makes up nearly 50% of global consumption for copper, aluminum, nickel and zinc with the U.S. a distant second at between 6% and 10% (Source Bloomberg). Figure 3 shows decelerating investment spending in China on new construction.
Below we look at the relationship between industrial metal returns and measures of global growth. Over the study period, we note that developed market economic stats appear insignificant, suggesting metals prices are somewhat independent of developed market growth. On the other hand, emerging market industrial production shows a relatively strong current and possibly a leading relationship with metals. Metal returns are moderately correlated with and sometimes lead emerging market GDP. It seems to make sense that a decrease in China industrial production is negative for metals in the current period and potentially negative, for example, for the Chile mining industry in the future with knock on impacts to both economies.
Figure 4: Metals price changes versus EM and DM growth
Net speculative positioning is shorter than usual across metals. In particular, copper shorts are high suggesting market participants are confident that China policy makers will refrain from stronger forms of stimulus in the near term which would benefit metals prices. This could be due to increased government focus on economic reforms along with environmental and anti-corruption campaigns.
Figure 5: Copper non-commercial short contract position on Comex exchange
Recent declines in metals prices are consistent with acute weakness in industrial activity, particularly in China, despite improvement in the June official stats. Low prices are likely to persist in metals where high cost production is slow to shut down and demand from China remains weak. Simple regression analysis suggests emerging market GDP may weaken over the next several quarters as the impacts of metal weakness flow through to growth. Metals markets appear to be pricing continued weakness in China activity and prices would likely benefit substantially if China policy stimulus gains traction from here.
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