Should You Trust the Fed’s Forecast? Insights into Their Unreliable Track Record

On Wednesday, the Federal Reserve will publish its latest economic forecasts. There will be a strong focus on the Summary of Economic Projections, which consists of the Fed’s own estimates for GDP growth, unemployment rate, inflation, and the appropriate policy interest rate.

The summary will be released as an addendum to the statement following Wednesday’s Federal Open Market Committee meeting.

Investors will closely analyze these projections, and they are likely to impact the market.

However, should you make changes to your investment portfolio based on the Fed’s projections? It’s probably best not to.

The Fed’s History of Poor Forecasting: An Example

Larry Swedroe, Head of Financial and Economic Research at Buckingham Strategic Wealth, has spent years studying economic forecasts from various sources, including the Federal Reserve.

He offers this piece of advice: Don’t make investment decisions solely based on what the Fed or anyone else says.

In a recent article, Swedroe examined a single metric: the Fed’s attempts to project interest rate increases for 2022.

He found that at the end of 2021, the Federal Reserve predicted three rate hikes and an end-of-year policy target rate below 1%.

What actually happened? In 2022, the Fed raised the Fed funds rate seven times, resulting in a target rate of 4.25%-4.50%.

Federal Reserve: 2022 Meetings

(rate hike each meeting, in basis points)

• Dec. 14 — 50 bp
• Nov. 2 — 75 bp
• Sept. 21 — 75 bp
• July 27 — 75 bp
• June 16 — 75 bp
• May 5 — 50 bp
• March 17 — 25 bp

How did this happen? The Fed simply miscalculated the rate of inflation.

“One of the surprises, at least to the Fed, was that inflation turned out to be much higher than its forecast,” Swedroe wrote. “Its December 2021 forecast for 2022 inflation was for the core CPI to be between 2.5% and 3.0%. Inflation turned out to be more than double that.”

If the Fed Can’t Get It Right, What Hope Do We Have?

This has broader implications for forecasting. Swedroe, along with many others, has long noted the poor track record of stock market forecasters. However, the Federal Reserve is a special case: “One would assume that if anyone could accurately predict the path of short-term interest rates, it would be the Federal Reserve — not only are they professional economists with access to a tremendous amount of economic data, but they set the Fed funds rate.”

Yet, the Fed has consistently failed to accurately predict not only interest rates but also other economic factors like GDP growth. In my book, “Shut Up and Keep Talking: Lessons on Life and Investing from the Floor of the New York Stock Exchange”, I discuss the Fed’s own research, which found that their economic forecasts from 1997 to 2008 were no better than average benchmark predictions.

So, why does this happen? There are two main problems:

1) Predictions from the Fed and others are influenced by bias and noise, which diminishes their accuracy;

2) Lack of complete information, as unforeseen events can influence outcomes.

All of this should make us all more humble about forecasting and less inclined to make sudden changes to our investments. The key to investing is knowing our risk tolerance, having a long-term plan, staying invested, and avoiding market timing.

Swedroe’s conclusion is clear: “If the Federal Reserve, which sets the Fed funds rate, can be so wrong in its forecast, it isn’t likely that professional forecasters will be accurate in theirs.”