The Federal Reserve told us in December last year that it would maintain its asset purchases until the outlook for the US labour market had improved substantially. Does Tuesday’s rather anaemic jobs data release meet this criterion any more than it did last month, when the Fed decided not to taper its asset purchases? Not really.
The underlying pace of job gains is certainly not rising, and may even have fallen slightly. But the unemployment rate dropped to 7.2 per cent, and the pace of decline suggests that the 6.5 per cent threshold for considering interest rate rises could be reached in mid-2014, ie before the balance sheet tapering has ended! This gives Janet Yellen, the incoming Fed chairman, an early problem: she will surely have to reduce that 6.5 per cent threshold soon.
In this blog, we use some statistical tools which have been developed by the regional districts of the Fed to frame a judgment about the underlying state of the labour market, updated to include this week’s new information . Read more
The award of the Nobel Prize last week to three academics who have specialized in the empirical modelling of asset prices has focused attention on what academic research can tell us about a highly topical question: could the US equity or credit markets currently be in a bubble? It goes without saying that this is of great interest to investors, who have seen the US equity market rise by 131 per cent since February 2009, and are asking when the bull market might end.
It is also of relevance to the likely next Chair of the Fed, Janet Yellen, who will be closely examined about bubbles in her confirmation process. In the past, she has strongly argued that the Fed should not use standard monetary policy to deal with bubbles . Read more
When Ben Bernanke became Fed Chairman in 2006, his collection of speeches and academic papers turned out to be extremely relevant to the decisions he would take in office, especially after 2008. The same is likely to be true of his nominated successor who, pending her confirmation by the Senate, has now become the de facto voice of the Fed.
Google Scholar lists dozens of entries under the name Janet L. Yellen. These citations outline an extremely well considered economic philosophy that has developed along a consistent path since the early 1980s. A 67-year old leopard is unlikely to change its spots. Read more
In the endless saga over US fiscal policy, attention has shifted from the closure of some parts of the government (which happened on Tuesday) to the possibility that the Treasury Department will reach the limit of its extraordinary measures to work around the debt ceiling on or around 17 October.
The negotiating tactics of the White House are now clear. They are painting the scenario in which the debt ceiling remains frozen as completely catastrophic, perhaps hoping that market disruptions will increase pressure on the Republicans to waive through the necessary legislation. Markets, however, have so far been reluctant to co-operate. (See this earlier blog.)
In a letter to Congress on 25 September, Treasury Secretary Jack Lew described the ensuing situation as “default by another name”, and Goldman Sachs CEO Lloyd Blankfein has said that “there is no precedent for a default”.
Investors hate the word “default” but they need to be careful about its exact meaning here. Most observers, including the major investment banks, think it very unlikely that the US would ever choose to default on any payments due on its sovereign debt, even if the debt ceiling is left permanently unchanged after 17 October.
The government could, however, go into arrears on many of its normal payments after that date. This would have serious contractionary effects on the economy, and might lead credit agencies to downgrade their ratings on US sovereign debt. Read more
Many people are asking why the financial markets have so far been unruffled by the political crisis which is playing itself out in Washington. That is a very good question. Yesterday was a case in point. The Financial Times website led with a story by Martin Wolf headlined “America is flirting with self destruction”. Yet equities were up on the day, and gold fell sharply.
The explanation for this conundrum, I believe, is twofold. Part of it is connected to the nature of markets, and part to the nature of this particular episode.
To start with the nature of markets, it has become very clear in recent years that asset prices are not necessarily very good at reacting in a smooth manner to changes in the perceived risk of extremely unlikely events taking place. For long periods, the markets do not react at all, and then they suddenly react in a discontinuous manner. The manner in which asset prices reacted to the risk of sovereign defaults in the euro area before and during the crisis of 2011-12 was a good example of this.
For many years, the markets acted as if there was no risk at all of default. Then, in the summer of 2011, they suddenly started to price a risk of 30 per cent or more that several sovereigns would default within the next 5 years, an assessment which now appears to have been a significant over-reaction. So the fact that markets do not price these risks for very long periods of deteriorating newsflow does not imply that the risks are in fact non existent, or that they will not suddenly appear in asset prices.
Why do markets behave in this way when, after all, the major participants are fairly rational, most of the time?
One of the main motors behind the growth of the world economy in recent decades, the expansion of world trade, seems to have entirely lost its mojo. In the next few weeks, there will be vital multilateral negotiations ahead of the WTO’s Ninth Ministerial Conference in Bali on 3-6 December, which will attempt to salvage something from the Doha Round. And there will be further negotiations towards the US-inspired Trans Pacific Partnership, which is still supposed to be completed this year. With protectionism now on the rise, it is crucial that something is salvaged from these talks.
World trade volume has been virtually stagnant in the 12 months ended mid 2013. Zero growth in world trade is normally a sign of impending global recession, not of a sluggish expansion. Furthermore, there are extremely strong reasons for believing that growth in trade is one of the principal contributors to supply-side gains in global GDP, so a slow-down in underlying trade growth involves permanent losses in welfare. What has gone wrong, and what does it mean for the future? Read more
The Fed’s actions last Wednesday created more outrage than usual from investors, some of whom clearly felt that they had been misled, inadvertently or not, by the FOMC’s botched attempts at forward guidance during the summer months.
Challenged at his press conference, Mr Bernanke said that he makes monetary policy for the good of the economy, not to ratify the expectations of investors. In this, he is fully justified. The fact that a minority of investors might have lost money as a result of the so-called “broken contract” should not concern the Fed one jot. Caveat emptor! Read more
The financial markets, after many months of forward guidance and supposedly “transparent” communication from the Fed, were very surprised by the FOMC’s latest decision to delay the start of tapering its asset purchases. This can be seen most clearly in the immediate 0.15 per cent drop in the yield on ten year treasuries, which reflects the extent of the lurch towards dovishness shown by the committee.
Prior to the announcements, the market thought that it knew two things with a high degree of confidence. First, the Fed chairman had said explicitly that the start of tapering was likely “in the next few meetings” and then clarified that this meant “before the end of the year”. Second, he had given explicit guidance that the end of tapering would occur around the middle of 2014, by which time the unemployment rate was expected to be below 7.0 per cent.
Given that the starting and ending dates for tapering were well pinned down, only the pace in between seemed to be up for debate. This left little room for manoeuvre on the final total for the Fed balance sheet, which was thought to be around $4.1 trillion (or 24 per cent of GDP).
All of this has now been thrown into considerable uncertainty following the chairman’s latest press conference. It is no longer as likely that the start of tapering will come this year, though December now seems to be the best single bet. Not can it be assumed that the 7 per cent unemployment rate is a good guide about the end point. Although the FOMC’s economic projections still show unemployment dropping below this rate somewhere around mid-2014, the chairman seemed to pour cold water on the importance of the 7 per cent figure, a consideration he himself had voluntarily introduced in the June press conference. Read more
“Not until after the German elections” became a very familiar refrain during the darkest hours of the euro crisis in 2012. Sometimes it meant that Greece could not be expelled from the single currency until then. More frequently, it implied that Germany would not be ready to make larger fiscal transfers to the deficit economies until Angela Merkel was safely installed in the Chancellery for four more years. There is still some optimism in eurozone political circles, and even in the financial markets, that the reform process, painfully slow even when the single currency looked like breaking up, will now accelerate.
In a week’s time, the polls will be closed, and Mrs Merkel will probably be embarking on her third and likely final term as Europe’s de facto leader. Like a second term American President, she might become hamstrung by her lame duck status. Alternatively, freed from the shackles of electoral politics, she might strike out in a bolder direction, driving banking union, fiscal union and structural reform towards the finishing line. Read more
The Fed has said that it will taper its asset purchases next week if it judges that the labour market outlook has improved “substantially”, and will consider interest rate rises when the unemployment rate falls below 6.5 per cent. Jan Hatzius of Goldman Sachs says that the Fed is suffering from “buyer’s remorse” over the 6.5 per cent threshold, and may reduce it next week. But are they right to use the unemployment rate as their key indicator of labour market conditions? The evidence on this is becoming increasingly murky.
The US unemployment rate has fallen from a peak of 10.0 per cent of the labour force in October 2009 to only 7.3 per cent today, an impressive rate of decline. Yet the employment/population ratio has hardly changed at all over the same period, implying that the whole of the decline in unemployment has been due to a decline in the participation ratio, as disillusioned job seekers have quit the labour force.
On this basis, many Keynesians have argued that the labour market has not improved at all, let alone substantially. The corollary is that the unemployment statistics are giving a seriously misleading indication of the scope for further action to stimulate demand.
This issue has been rumbling along for at least a couple of years, but it came to the fore last week with an important speech by John Williams, President of the San Francisco Fed. He said explicitly that “the preponderance of evidence indicates that the unemployment rate remains the best overall summary statistic”, while “the employment-to-population ratio blurs structural and cyclical influences”.
Mr Williams pointed out that the unemployment rate has consistently been the best single measure of slack in the labour market for many decades, and that it remains very closely correlated with alternative measures of slack derived from other sources. This is supported by the data. The unemployment rate is now about 0.7 standard deviations above its long term mean. The first graph shows three other measures of labour market slack derived from entirely different sources, and all of them are in the region of 0.0-1.0 standard deviations from normal, which substantiates the broad message from the unemployment data. Read more