Wall Street's Economic Outlook Slipping Closer to Fed's Pessimism

Ben Bernanke
Ben Bernanke

Wall Street is not expecting additional quantitative easing from the Federal Reserve at its meeting this week but increasingly believes in the Fed’s promise to keep interest rates low until late 2014, according to the latest CNBC Fed Survey.

Just a third of the 53 economists, fund managers, and strategists who responded to the CNBC survey see additional QE from the Fed in the next 12 months, unchanged from the March survey. And just a quarter expect Operation Twist to be extended beyond its expiration in June.

“The window is closing on the Fed's flexibility to do something dramatic before the election,” John Kattar of Eastern Investment Advisors wrote in response to the survey. “I expect them to broadly hint at the possibility of QE at next week's meeting, just to keep options open. But it will probably require much worse news.”

"Bernanke has been vindicated on the Fed's forecast, with growth now giving back some of the seasonal strength we saw earlier in the year."" -Mesirow Financial, Diane Swonk

Several lackluster economic reports have moved market participants closer to the Fed’s view on the economy and the outlook for monetary policy. Asked their opinion of Fed policy, 51 percent of respondents say it’s “just right,” up from 38 percent in March; only 36 percent believe it’s “too accommodative,” down from 53 percent in March.

“Bernanke has been vindicated on the Fed's forecast, with growth now giving back some of the seasonal strength we saw earlier in the year,’’ said Diane Swonk of Mesirow Financial.

The survey found that 49 percent now believe the Fed will keep interest rates “exceptionally low” through late 2014, up from just 40 percent in March. The same percentage, however, disagree, showing that while there has been improvement, Fed Chairman Ben Bernanke has not yet made believers of all investors.

James Paulsen of Wells Capital Management called on the Fed “to move beyond its crisis mindset and appropriately normalize policy to reflect the maturation of the U.S. economic cycle from crisis to recovery. Failure to do so soon risks creating another crisis — an inflation crisis!"

In fact, 42 percent of respondents agreed with the statement that the Fed’s forecast that it will keep interest rates low through 2014 is a mistake that could undermine the Fed’s credibility; 38 percent said it’s a good decision that has helped drive down interest rates.

While Fed Chairman Ben Bernanke has two years remaining in his term, market participants have begun to think about his departure, especially since he has advocated policies that take him right up to the end of his current term in 2014. A sizable 55 percent of respondents do not expect Bernanke to be chairman after 2014. “I can't imagine he wants to stick around for another term of shenanigans by our political leadership,” wrote Swonk.

Only 2 percent believe Bernanke would be renominated by a Republican president; 35 percent say he would be renominated by only a Democratic president, and 35 percent say Bernanke would not be renominated by a president from either party.

The leading candidate to replace Bernanke by a Democratic president is Fed Vice Chair Janet Yellen, who was chosen by 43 percent of respondents, followed by former Treasury Secretary Larry Summers who was picked by 20 percent.

Stanford economist and former international Treasury official John Taylor is thought to be the top pick for a Republican president, followed by former CEA director and Columbia University Graduate School of Business Dean Glenn Hubbard.

Market participants came closer to the Fed on the policy outlook because they came closer to the Fed on the economic outlook, which is to say, they became more pessimistic. Market participants downgraded their outlook for year-over-year GDP growth to 2.39 percent from 2.46 percent. They took nearly a quarter point off the outlook for growth in 2013 and now see GDP rising just 2.55 percent. As a result, they downgraded already muted expectation for the stock market. Respondents on average forecast the S&P 500 stock index will be basically flat through June and rise just 2.9 percent by year-end.

“Inflation will be higher in 2013 than the Federal Reserve is forecasting, prompting a shift toward restraint,” wrote Hugh Johnson of Hugh Johnson Advisors. “Tax and spending policy should shift toward restraint (hopefully not aggressively) in 2013. This combination is likely to impede equity price moves in Q4 and 2013.”

Market participants also lowered their outlook for the yield on 10-year U.S. Treasury notes to 2.4 percent by year-end from 2.6 percent in the March survey.

However, the probability of a recession in the next 12 months rose a bit to around 21 percent from 19.6 percent in March. It remains well below the 36 percent probability from the September survey. The chance that high gasoline prices by themselves will cause a recession declined a bit to 21.8 percent from 23.8 percent. “Energy prices would have to rise significantly and stay at an elevated level for a couple of quarters in order for us to become more concerned about recession,’’ said Joe LaVorgna of Deutsche Bank. “In our view, north of $150 on WTI is the point at which recession risk rises materially."

There was a significant shift in the issue that is seen as the biggest threat to the recovery, with 37 percent choosing the European financial crisis, compared to just 17 percent in March. Tax and regulatory policy was seen as the biggest threat by 27 percent of respondents, down from 36 percent in March.