"It's tough to make predictions, especially about the future," is a quote attributed to Yogi Berra (who died not three months ago). He's wasn't wrong, I'd add that it's tougher still when you're making economic predictions. Here are three predictions for 2015 regarding interest rates and oil that left Wall Street with egg on its collective face (and who can say they don't enjoy that spectacle once in a while?).
First, a point of methodology: how am I defining "Wall Street"? I looked at the forecasts of forty banks, investment banks, and research firms for December 2015 made by Jan. 1, and took the median value. The raw data was collected for the Wall Street Journal's monthly Economic Forecasting Survey.
Oil: Brent crude (global benchmark)
|
Actual |
Wall Street consensus forecast (median) |
Wall Street forecast range | |
|---|---|---|---|
|
Barrel of oil (Brent crude) |
$40.67* |
$65 |
$50-$85 |
*Ice Jan 2016 futures contract on Dec. 7. Source: Author's calculations, Wall Street Journal, ICE
When it comes to the price of oil, the current consensus view is summed up with three words: "lower for longer." No wonder: once bitten, twice shy.
At the end of Dec. 2014, the price of oil had fallen by more than half compared to its 2014 high, hitting $55. Surely, that sort of decline could only be followed by a rebound, an upside correction as it were? And a rebound did occur -- during the first half of the year: on Jul. 1, the price stood at $61.65, not far from the $65 consensus forecast.
However, that number was incinerated in an oil fire during the second half of the year, with the price of a barrel having fallen by roughly a third to around $40 (see graph below). On Tuesday, the prices of Brent crude and U.S. oil futures broke below the $40 floor on an intraday basis, plumbing their lowest levels since Feb, 2009.
What is striking here is not the magnitude of the "miss", but the fact that the current price is below every single one of the forty forecasts in my sample. Was it really so difficult to conceive that, starting the year at $55, the price of oil could end 2015 below $50 (the low estimate)? This looks like a distinct failure of imagination.
Where will the price of oil be in 2016? The current consensus forecast for the end of next year is $55 per barrel, but some analysts are a bit more imaginative this year: in September, Goldman Sachs reduced its 2016 forecast for West Texas Intermediate to $45 from $57, but said that the price could dip as low as $20 per barrel!
Short-term interest rates: the Federal funds rate
|
Actual* |
Wall Street consensus forecast (median) |
Wall Street forecast range | |
|---|---|---|---|
|
Fed funds rate |
0.25%-0.50% |
1.00% |
0.13%-1.75% |
*Rate implied by the December 2015 Fed Fund futures price on Dec. 7, with a 79% probability. Author's calculations, Wall Street Journal, CME Group.
I can't think of any topic -- ever -- that has mobilized more time, energy and (well-paid) resources on Wall Street than anticipating the timing of the Federal Reserve's first post-crisis interest rate hike. Despite those efforts, Wall Street was off the mark here, getting well ahead of policymakers.
The consensus forecast called for a 1% funds rate in December, which would have necessitated several rate increases, but it turns out that the Fed funds futures market is currently pricing in the Fed's first rate hike in nearly a decade for next week's Federal Open Market Committee (FOMC) meeting, with odds of roughly 4 out of 5.
The market anticipates a quarter of a percentage point rise, which would lift the effective Fed funds rate to a range of 0.25% to 0.50% from 0% to 0.25% (the FOMC won't meet again until the end of January.)
Where did Wall Street go wrong? It seems the Street's collective mind had a decent read on the labor market (with a forecast for the unemployment rate in December 2015 of 5.1%, versus an actual rate of 5% in November), but was too aggressive in terms of their expectations for economic growth: They were looking for 2.8% to 3%; the year-on-year growth rate at the end of the third quarter was just 2.2%.
(They weren't expecting the extent of the rout in commodities prices and emerging markets, or China's summer market meltdown.)
Long-term interest rates: the 10-year Treasury note yield
|
Actual |
Wall Street consensus forecast (median) |
Wall Street forecast range | |
|---|---|---|---|
|
10-year Treasury note yield |
2.24% |
2.75% |
1.80%-3.75% |
Source: Author's calculations, Wall Street Journal, Bloomberg
The yield on the 10-year Treasury note is a global benchmark: it's the first building block in determining the appropriate discount rate for risk assets.
With the 10-year yield at 2.17% last New Year's eve, Wall Street went into 2015 confident that long-term rates would have to rise back up toward 3% -- this was the overwhelmingly popular view. The consensus forecast called for a 2.75% yield in December 2015.
But the market has a way of confounding oracles and making confetti of received wisdom. Only a month into the new year, those predictions looked wrongheaded, as the yield had plummeted to 1.64% (which turned out to be the low for the year).
As the following graph shows, the yield never broke 2.5% in 2015 (the red line represents the consensus forecast of 2.75%). As of Monday's close of trading, it was 2.24% -- essentially unchanged on the year.
(In case you're wondering, the current consensus forecast for next December is 2.70%.)
The wisdom of crowds?
I would never expect an economist to nail forecasts of economic indicators, but even aggregating the predictions of forty of them produced a mediocre result in these instances. Perhaps forty is too small a sample to achieve the "wisdom of crowds".
There is another possible explanation: Recall that The Wisdom of Crowds' author and former Fool writer James Surowiecki postulated four necessary conditions for that wisdom to emerge, including diversity of thought, independence, and decentralization. Wall Street falls pretty far short on all three criteria. To borrow Harold Rosenberg's wonderful expression, Wall Street economists are a "herd of independent minds".
