Forecast of capital markets variables

Please develop capital market expectations, over the forecast horizon of the next 2 to 5 years for the following USA variables:

1. Real GDP –

a. Most Recent Observation - Real GDP growth last year was down 3.5%

b. Central Tendency of Forecast – The central tendency of the forecast is 2.5%

c. Range of Forecast – The range of the forecast is between 2% and 4%

d. Longer Run Forecast – The long run forecast is 2%

e. Methodology – The methodology for this forecast is based heavily on historical context. Here population growth average around .8% a year. In this instance we will round up to 1% for ease of calculation. In addition, total factor productivity gains typically amount to 1% to 1.5% per year. Therefore, on a real basis, accounting for population and productivity gains, GDP should rise around 2% to 2.5% per year (Blanchard, 1997)

2. Unemployment rate

a. Most Recent Observation – The most recent observation occurred in January 2022, with the unemployment rate being 4%

b. Central Tendency of Forecast – Unemployment has averaged 5.8% from 1948 to 2022. Currently, the United States is below its historical average

c. Range of Forecast – The range of unemployment varies dramatically due in part to underlying economic conditions. The lowest unemployment rate occurred in World War 1 at 1%. The highest unemployment rate occurred during the great depression and was 25%.

d. Longer Run Forecast – Over the long run, I would expect unemployment to normalize to around 6%, in line with the historical average.

e. Methodology – Currently, the employment statistics point to sustained low unemployment figures. As of February 2022, there are 10.9 million job openings with only 9.8 million available applicants. Over the long term, I expect this trend to reverse due to the overall business cycle turning more negative, additional layoffs and an overall normalization of business activity post the COVID-19 pandemic (Appleyard, 1992).

3. PCE Inflation

a. Most Recent Observation – The most recent observation occurred in January 2022, where inflation was 7%

b. Central Tendency of Forecast – The central tendency of inflation has been around 2% to 3% per year. Here, the federal reserve mandate has been long term inflation of 2% per year.

c. Range of Forecast - The range of inflation varies dramatically due in part to underlying economic conditions. The lowest inflation rate after the Great Recession and Housing Market collapse of 2008. Here inflation was roughly flat at -0.36%. The highest inflation rate occurred in 1980 and was 13%.

d. Longer Run Forecast – Due to the fed mandate, I anticipate the long run forecast for inflation to be in the range of 2%-3%

e. Methodology – Short term supply chain disruption, accommodative monetary policy, accommodative fiscal policy, and rapid demand from consumers after the COVID-19 pandemic has caused a rapid rise in inflation. This inflation was particularly acute in auto sales and other high-ticket items. However, the federal reserve has indicated that they anticipate raising interest rates throughout the year to help mitigate the impacts of inflation. Other governments around the world have also began to raise interest rates. As consumer purchasing behavior normalizes, supply chains become optimized, and demand starts to slow, I forecast inflation returning to its historical average of 2% to 3% (Cooper, 2001).

4. Core PCE Inflation

a. Most Recent Observation - The most recent observation occurred in January 2022, with an index observation of 120.47. Quarter over quarter PRE prices have risen 4.6%

b. Central Tendency of Forecast – The central tendency of the index has been around 110 over the last few years, with PCE inflation rate of roughly 3%

c. Range of Forecast – The range has been roughly 1% to 3%

d. Longer Run Forecast – The long run forecast is for PCE inflation between 2% and 3%

e. Methodology – The methodology of the forecast is related to historical variance analysis. As PCE inflation exclude food and energy, I expect the inflation rate to be in line with historical averages going long term. The methodology relies on the concept of “Reversion to the mean,” with expectations of normalizing market conditions going forward.

5. Fed Fund rate

a. Most Recent Observation – The most recent observation was 4-February where the fed funds rate was .25

b. Central Tendency of Forecast – The federal funds rate has average 4.5% since 1955

c. Range of Forecast – The federal funds rate has a very large range of forecasts . Currently, the fed funds rate is the lowest it has ever been in the past 6 decades. Likewise the highest period for the fed funds rates was in the 1980’s with rates around 17% to 20%.

d. Longer Run Forecast - The long-range forecast is roughly 1% to 2%

e. Methodology – The methodology behind this forecast a lower interest rate environment over the next 5 to 10-year period. Here, accommodative monetary and fiscal policy has created large demand for high yielding assets such as homes, apartments, real estate, and stocks. A rise in interest rates will dramatically decrease the value of these assets as has been seen in the recent “taper tantrum” that occurred a few years ago. Here, I anticipate a much more gradual approach to interest rate increases to minimize capital markets disruptions. Likewise interest rates are low around the world. If America has an interest rate far in excess of other nations, large amounts of capital seeking the higher yield could flood American markets, causing still further inflation.

6. US 10y Treasury Rate _Nominal

a. Most Recent Observation – 1.82% in February 2022

b. Central Tendency of Forecast – 4% over the last 4 decades

c. Range of Forecast – The 10-year treasury has a very large possible range of forecasts. It’s low point was 1.8% in 2022. Its high point was 14.94% in 1980