Back in 2008, Queen Elizabeth was clearly not amused when she asked about the financial crisis, "Why did nobody notice it?" Unfortunately, this is a not so simple question to answer given how quickly things change, a lack of transparency worldwide into markets and players and a system that rewards high leverage until it eventually doesn't.
For community bankers struggling to figure out when the Fed will raise rates and what impact it will have you are not alone. For eons economists have tried to predict recessions and rate movement using models more sophisticated than perhaps those that sent us to the moon and beyond. Yet, their ability to see into the future remains weak.
Consider for instance research released in 2001 by an IMF economist. He looked at the accuracy of economic forecasts worldwide during the 1990s and found it to be absolutely horrible. In fact, this was so much the case that he even quipped, "The record of failure to predict recessions is virtually unblemished."
Next, consider that the same IMF economist then convinced a college of his to work with him to update the research following the biggest economic crisis in our lifetimes. While 49 countries worldwide had fallen into recession by 2009, economists had not called a single one of those as late as Apr 2008. That is staggering in its shock value.
This problem has been going on for a long time. For instance, consider Fed research back in the mid 1980s that found commercial rate forecasters that were allowed to be within 2 percentage points of the actual rate could only reasonably predict the 3 month Treasury rate 6 months into the future with 67% accuracy. We have been out of school for awhile now, but the last we looked that was a grade of "D." Further, the Fed also quoted other studies at the time that even found "error statistics often double in size when the forecast horizon is extended to as little as from one to two quarters ahead."
Maybe you are thinking that is such an old data point, how accurate can it be? After all, the 80s are over and pastels aren't even in fashion anymore. Well, for an update around this issue we look to work done by North Carolina State University researchers from 2005. They used economist forecasts of interest rates and exchange rates that appeared in the Wall Street Journal's survey. Keep in mind that these blue chip economists were only forecasting 6 months ahead. Nonetheless, the researchers found that "none predicted directions of changes more accurately than chance" and the forecasted accuracy of most of the economists "is statistically indistinguishable from that of the random walk model when forecasting the Treasury bill rate" and was "significantly worse for many of the forecasters for predictions of the Treasury bond rate and the exchange rate."
Finally, we leave you with just a bit more to chew on as your team tries to predict where interest rates will go. First, know that most economists didn't predict the three most recent recessions (1990, 2001 and 2007) even after they had begun. Next, understand that as late as Nov 2007, economists saw only a 3% chance of a recession. Third, since 1990, economists have forecasted only 2 of the 60 recessions that have occurred around the world a year in advance or about 3%. Put another way, 97% of economic projections of recessions are wrong since 1990. Now we really know the Queen is not amused!