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Originally published 8/19/2011 © 2021 Olson Research Associates, Inc.
Let’s travel back in time. Imagine it’s August 2009 and you’re approaching budgeting season. You are starting to prepare your projections for management and for use in your stress-testing. You’ve heard that the “best practice” is to prepare a two-year forecast. You ask yourself, “what could happen in the next two years that could have an impact on our performance?” Do you think you would have pondered any of these events:
December 2009 - Chinese economy overtakes Japan
March 2010 – Health Care Bill signed by President
April 2010 – Fed’s QE1 ends
April 2010 – BP Deepwater Horizon oil spill
July 2010 – Dodd-Frank Bill signed by President
November 2010 – Fed’s QE2 announced
November 2010 – Federal pay freeze announced
December 2010 – Bush tax cuts extended
February 2011 – Libyan civil war
March 2011 - Japanese Earthquake and Nuclear Crises
July 2011 – Chicago Fed reports a 17-20% increase in farmland values
August 2011 - US Government credit rating downgrade
I’m guessing you would have missed a few. I usually get a nod or two after someone reads this list. But most often people point out that prior to many of these events we did have some warnings from experts or talking heads. And while that may be true, I’m still quite skeptical of industry experts when they try to make predictions.
Probably a more relevant expert prediction you would pay attention to is a forecast of market rates. Undoubtedly that’s the type of variable you would want to build into your projection. So again, imagine it’s August 2009 and you are preparing your budget. What are the expert interest rate forecasts telling you? Take a look at the table and bar graph below.
Four out of the nine experts are predicting Fed Funds to remain unchanged, the other five predict that it will move higher. Which one do you believe? To play it safe you may choose the average. However, choosing the average means your rate forecast will be 80 basis points off…in just the first year! What are you going to do in the second year of your forecast? How much farther off will you be?
The purpose of this post is to reiterate my point that a two-year forecast is too long. Just looking over the list of events above I can tell you that for me the BP oil spill in the Gulf seems like ancient history. That’s why I’m really surprised the Fed communicated a specific time frame a few weeks ago. Trying to create a budget or forecast one-year into the future is hard enough; leave the two-year predictions to the fortune tellers.
(source data for the rate predictions can be found on the FHLB Seattle’s web site in their quarterly publication called “What Counts”)
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