Wednesday and Friday of last week where crucial. Why? Wednesday was Fed rate-decision meeting day and Friday was the jobless rate announcement day. How did it go? Well the Fed decided to keep rates at the current 0-0.25% range and most importantly maintained their commitment to these rates for an “extended” period. This was good news for equity markets especially as rate hikes started to surface around the globe starting with Australia followed by Norway. Then, Friday came and the unemployment figure officially broke 10%. The number of unemployed increased by 175K; 45K more than consensus estimates. This was bad news. Equity markets generally are around 6-months ahead of the economy. Since equities bottomed in March, one would expect unemployment to peak in September, but it didn’t even October. This raises a serious question: are we really done with this crisis? I may not have a clear-cut answer, but the S&P 500 attempted to answer that question with confidence: it shrugged-off the news and closed up on Friday.
I guess the Fed maintaining their rates at these virtually free levels could buoy markets for a while. Banks can make easy money: borrow from the Fed and buy 30-yr Treasuries making an easy 3% spread. Leverage that spread and it turns into hefty profits. These low rates also help squeezed homeowners refinance their mortgages at lower rates. I guess the market is more interested in this fact than in unemployment going up. However, I think the market should start to become concerned with the unemployment level. What I think is especially peculiar is whether we will simply go back to usual full employment levels (3-4% unemployment) or we will have a “new normal” unemployment level (say 7%) way higher that than “old normal” for a sustained period of time.
How will the economy change if such a thing happens. More importantly, what will drive growth going forward? With a cash strapped US consumer base looking to start paying down their years of leverage and even start saving, I don’t see that sector driving growth. Another concern I have is when will the Fed raise rates? Mind you, I’m not really worried about inflation since most of the money is going/went to filling holes rather than flooding accounts. What I’m concerned about is the presence of an interest rate buffer the Fed will need for the next downturn. In the 80s, interest rates reached unprecedented levels and nearly touched 20%. From then we had a valuable buffer of interest rate cuts to spur growth in downturns. With rates at 0-0.25% for an “extended” period, what will drive growth and make it digestible to raise rates to have ammo of rate cuts for the next downturn?
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I’m more interested in the possibility that the Central Banking paradigm will disappear and rates would be left to the market. Of course if QE and low rates actually work in resuscitating the global economy and bringing unemployment down then that would be a moot point.
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