Fed doubles down on forecasting

Financial market leaders never cease to amaze. Today the CNBC headline is that the US Federal Reserve will introduce a new quarterly forecast on interest rates. Historically the Fed would set interest rates and give vague guidance on future policies precisely to avoid committing to actions they may need to adjust as market conditions change. Forecasting GDP growth was already tough enough that most forecasts turned out to be wrong. It is precisely this reliance on forecasts that encouraged financial markets to leverage and invest in exotic financial products nobody understood and that almost destroyed the entire system in 2008. Now, instead of accepting the harmful effect of forecasts the Fed is doubling down with more forecasts. In my view this could not be more misguided.

A business that produces and sells products or services needs to make forecasts. The business doesn’t do 10:1 leverage the way a bank or hedge fund does. If the business goes bankrupt the ripple effects are small on the overall system. The problem is that hedge funds, banks and investors at large don’t function the same way. If you tell the general population that real estate can only go up, people will go and buy houses at any price, leveraging themselves to the maximum with debt multiple times their annual earnings. Some used the “interest only” mortgages to buy even more expensive houses and make profit from appreciation. Until prices went down and losses multiplied to the downside. All this because of future expectations and people optimizing on them. All this because of forecasts from presumably reliable sources.

The world has too much debt and we are trying to solve the problem by issuing more debt. If this was not enough, the financial world suffers from excess reliance on forecasts that often turn out to be wrong. And we issue more forecasts as a result. How insane is this?

Sometimes we need crises as wake-up calls, so I’m optimistic that some day the leaders will make our world more robust and accepting to the nature of life: uncertainty.

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