The biggest risk to the U.S. economy isn't overheating but overshooting, says economist Peter Morici, the winner of the Forecaster of the Month contest for September. The Federal Reserve will probably raise interest rates too much, he fears.
"We can do another year of 3% [growth] if the Fed doesn't spoil it," Morici said in an interview.
The economy is in great shape right now, with companies finally investing in productivity-enhancing skills, Morici said. A seven-time winner of MarketWatch's contest, Morici is professor emeritus at the Smith School of Business at the University of Maryland and a regular columnist for MarketWatch.
"The biggest question is, will the Fed overshoot?" he said. By that he means, will the Fed push interest rates up so high that they'll be a headwind to growth, rather than the tailwind they've been for a decade? No one knows exactly where that point will be, but Fed officials have put a lot of thought into the question of where the equilibrium, or neutral, rate lies.
They call it R* - or R Star. It's the rate that neither stimulates nor retards growth. According to the infamous "dot plot," Fed officials seem to think it's around 3%, much lower than it used to be. But lately, they've become "agnostic" about where R Star is.
The Fed needs to stop at 3%, Morici said. The federal funds rate is now in a range between 2% and 2.25%.
These same officials seem intent on pushing short-term interest rates higher than that, maybe to 3.4% by 2021. Morici thinks restrictive interest rates would be a problem. "The difference between 3% and 3.4% is a lot," he said.
"It's not their business to prop up the stock market," he said. "But it's not their business to deflate it either."
"Their compass is broken," he said of the Fed. The yield curve is no longer a reliable guidepost for policy, because so many Treasurys are owned by foreign governments and central banks as part of their massive holdings of dollars.
Higher U.S. rates "always create problems in emerging markets," Morici said. That's where the dangers from overshooting are concentrated.
Emerging-market economies "overborrow to fund schemes that don't pan out and to build excess capacity," he said. When rates rise, they can't meet their payments. The effect on countries such as Turkey, Argentina and Pakistan is large.
The technocrats at the International Monetary Fund are warning of a global growth slowdown, but point the finger at trade wars instead of a good, old-fashioned debt overhang. "It's the debt cycle, not protectionism," Morici said.
Our forecasting contest tracks 10 indicators, and on four of them - nonfarm payrolls, the consumer price index, new home sales and the trade deficit - Morici's estimates were the most accurate among the 42 teams in our contest. His forecast for housing starts was in the top 10.
Number as reported*
Consumer price index
Durable goods orders
New home sales
* Subject to revision
The runners-up in the September contest were Spencer Staples of EconAlpha, Gus Faucher at PNC Financial, Brian Wesbury and Rob Stein at First Trust, and Christophe Barraud of Market Securities. All five teams are in our elite group of forecasters.
The MarketWatch median consensus published in our Economic Calendar includes the predictions of the 15 forecasters who have earned the most points in our contest over the past 12 months, plus the forecast of the most recent winner of the monthly contest. When they differed, the MarketWatch consensus was more accurate than the closely followed Bloomberg consensus 65% of the time in 2017.
The top forecasters over the past year are Jim O'Sullivan of High Frequency Economics, Christophe Barraud of Market Securities, Joerg Angelé of Raiffeisen Bank International, Ryan Sweet of Moody's Analytics, Peter Morici of the University of Maryland, Brian Wesbury and Bob Stein of First Trust, Pat O'Hare of Briefing.com, Richard Moody of Regions Financial, Avery Shenfeld's team at CIBC, Spencer Staples of EconAlpha, Ian Shepherdson of Pantheon Macro, Jan Hatzius's team at Goldman Sachs, Michelle Girard's team at NatWest Markets, Michael Feroli at J.P. Morgan Chase, and Gus Faucher of PNC Financial.