Macro Signposts | 30 April 2024

This week, during our annual Secular Forum, I asked Anastasia Buyalskaya to guest author Macro Signposts. Dr. Buyalskaya, a behavioral science advisor to PIMCO, integrates behavioral insights and methodologies into our investment process.

Unless explicitly stated, views expressed do not constitute official PIMCO views.

Can Macro Forecasting Be More Scientific?

By Anastasia Buyalskaya, Ph.D. – advisor to PIMCO on behavioral science

PIMCO investment professionals have gathered this week for the annual Secular Forum. Informed by presentations from guest experts in geopolitics, economics, and technology, forum participants debate the state of global markets and economies and identify trends likely to affect portfolios. The objective of the Secular Forum is to step back from the noise of daily market movements (which tempt our "availability" and "recency" biases) and reflect on the trends likely to affect markets over a five-year horizon, and beyond. I wrote about the Secular Forum process – and how PIMCO structures it with an understanding of our behavioral biases in mind – in the 16 May 2023 edition of Macro Signposts.

During Secular Forum and in the weeks following, these expert insights and internal discussions will coalesce into a set of general predictions about macroeconomic outcomes. But how do we turn a broad prediction into a quantifiable macro forecast that in turn informs investment strategy? In other words, how can we ensure our forecasts are as scientific as possible – meaning they can be measured, utilized, analyzed, and (hopefully) improved?

Basic reasoning: structure and precise probability
Two researchers and professors at the University of Pennsylvania, Philip Tetlock and Barbara Mellers, have focused for over a decade on these questions. Tired of television pundits making forecasts so vague they were useless, Tetlock and Mellers developed and launched the Good Judgment Project to see whether macro forecasting (of economic, geopolitical, and social trends and outcomes) is a skill that could be measured and improved over time.

The researchers found that some individuals were more skilled at forecasting than others. But they also found ways for just about anyone to increase forecasting accuracy – for some, it just takes some basic training in probabilistic reasoning. Tetlock discussed their findings in the book, "Superforecasting: The Art and Science of Prediction."

One element of probabilistic reasoning is ensuring that a forecast is structured and quantifiable. A forecast should avoid vague verbiage in favor of more concrete terms (e.g., predicting a specific number of central bank rate cuts, or a quantity of basis points, rather than "being dovish"). Similarly, a forecast should be explicit in its time horizon (e.g., between now and 31 December 2024 rather than "in the near future"). This turns a fuzzy statement into a quantifiable forecast that can be evaluated for accuracy.

Ideally, a forecast incorporates a confidence (or probability) estimate, such that similar forecasts can be grouped and assessed for accuracy. For the best forecasters, for example, 70% of their rate cut forecasts to which they had assigned a 70% probability would turn out to be correct. Using precise numbers enables more accurate analysis than using words that may mean different things to each of us – perhaps my use of "likely" implies I see a 52% chance, but your use of the same word implies 80%, for example.

Applying a more scientific approach to macro forecasting
Several PIMCO teams have taken note of these approaches. In early 2023, one of the regional portfolio committees (which inform and provide input to the global Investment Committee) introduced a more structured process to collect forecasts from its members (economists and portfolio managers covering a range of asset classes). Each week, committee members input point forecasts on a range of economic indicators and asset price levels into a central record. An automated weekly prompt reminds each forecaster to revisit their set of projections and ensure none are stale in light of new or evolving information.

By quantifying and documenting these forecasts, the regional portfolio committee could track them over time and evaluate them against actual outcomes – and against other forecasts. Although it's a small sample (just over a year), members have noted some intriguing findings that in turn have helped hone their processes:

• Looking at the committee's 2023 forecasts for the fed funds rate, it is interesting to see how they coalesced to a "higher for longer" view as the year progressed. We can also identify discrete jumps in the forecasts – such as a universal mark-up in March 2023 following the regional banking crisis.
• While individual members' forecasts typically have moved together, there also have been periods of significant dispersion. Since the full range of forecasts was documented and quantified, the committee was able to engage in a more structured and informed debate in which opposing views, and not merely extroverted views, could be voiced.
• Committee members each offer a range of expertise, and may be particularly skilled in forecasting trends in specific areas or asset classes. Looking across individual and collective forecasts over time has helped the committee ensure a balance of well-informed views for every economic and market indicator measured.

While macro forecasting is both art and science, PIMCO is taking an increasingly scientific approach. Already we've found how more precise macro forecasts enable rigorous and thoughtful debate as we develop the top-down views that inform high-level investment strategy. Over time we'll continue to refine our processes from a behavioral lens, measuring impact and offering key takeaways for investors.

Read the previous edition of Macro Signposts, where we analyzed the impact of China's industrial growth on global manufacturing trends.

We welcome your questions about the global macro landscape. Don't hesitate to suggest themes or data for us to analyze and discuss: Please email [email protected].

For regular insights on U.S. policy via email, please write to [email protected] and ask to receive the Washington Watch.

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