The Federal Reserve released its monthly minutes yesterday, and for the first time in recent memory, some parts of the outlook were fairly chipper. “Financial market conditions,” it states, have “generally strengthened, and surveys and anecdotal reports pointed to a pickup in household and business confidence.”
One piece of data that caught my attention was the Fed’s unemployment expectations. In an upward revision from its last meeting, the Fed now expects the jobless rate to be between 9.2% and 9.6% by late this year.
These are interesting numbers when compared with the Treasury’s recently completed stress test. That test which was used to determine whether banks were adequately capitalized under a worst-case scenario assumed that 2009 unemployment would fall between 8.4% in a baseline scenario and 8.9% in the worst-case scenario.
In other words, the Fed’s baseline outlook is grimmer than the Treasury’s worst-case outlook. These funny inconsistencies remind us why economics is an art, not a science.
Why fret over a handful of basis points, you say? Simple: According to some Fitch Ratings analysis, there’s a historical one-to-one correlation between unemployment and prime credit card charge-offs. That is, if the unemployment rate doubles, so does the credit card charge-off rate. It’s even worse for lower-quality cards.
When you’re talking about numbers this big, an increase in the charge-off rate of a few dozen basis points is nothing to sneeze at. And since the stress test’s goal was to adequately capitalize banks, the thought that more money may need to be raised in the future doesn’t seem far-fetched.
Will it be the end of the world for banks? For most, no. But when the Federal Reserve’s own projections challenge the Treasury’s stress test by what could equal billions of dollars of losses for several banks, there’s yet more reason to wonder whether the test was more of a confidence campaign than an objective and realistic analysis.