By Dan Kervick
The government released a disappointing August jobs report today. And unfortunately, the hype and misinformation surrounding the Fed’s quantitative easing program has created a perverse situation in the capital markets which may contribute to sustaining that job market stagnation for some time.
For several months now, we have seen the establishment of an entrenched pattern in which investors routinely respond to a bad jobs reports with bullish behavior and respond to a good jobs reports with bearish behavior. Bad jobs news is treated as good news for investors; good jobs news is treated as bad news for investors. Why in the world would they respond in this way? Because in a classic case of the madness of crowds driven by misinformation and disinformation, the markets have convinced themselves that the fate of the world now depends on whether or not the Fed will choose either to continue or “taper” its quantitative easing program in the near term.
The negative economic consequences of such an entrenched pattern should be obvious: We now have a clumsy capital market that is systemically programmed to step on its own feet. If investors are buying, that should stimulate investment and hiring. The result will be an uptick in the employment picture presented in the succeeding jobs report. And that uptick will then be treated as bad news, and a reason to pull back on the buying! So good jobs news is treated by the markets as a reason to counteract its own earlier bullishness and worsen the prospects for the jobless. Clearly this isn’t the way we want our economy to work. Good news about jobs should be treated as … good news! … which will help drive a virtuous cycle and a self-sustaining recovery.
First, today’s job report was rightly received as disappointing by most reporters and analysts. The Wall Street Journal’s Phil Izzo sums it up well:
The U.S. unemployment rate dropped 0.1 percentage point to 7.3% in August and a broader measure of unemployment fell to 13.7% from 14%, but the declines came from the wrong reasons.
The drop in the main unemployment rate was driven almost totally by negative factors. The number of people employed fell by about 115,000. The only reason the rate declined is that the overall labor force dropped by a larger 312,000, a possible sign of discouraged long-term jobless dropping out.
The labor force participation rate, which is the percent of the population either working or looking to work, took a tumble to 63.2% — its lowest level since 1978.
So how did investors respond to the bad report? Well they think it’s great news! So they bought more stocks and bonds and pushed up their prices:
Investors had been eagerly awaiting the jobs report, as it is the last major piece of economic data leading up to the Fed’s next meeting in less than two weeks.
U.S. stock futures ticked higher after the release of the report, a sign that investors think that the economy is still to fragile to support the Fed’s plan to begin winding down its stimulus support for the economy as early as this month.
Bond prices rose and Treasury yields fell sharply following the jobs report, with the 10-year yield dipping to 2.88% from nearly 3%. (Bond prices and yields move in opposite directions.) Investors may be betting that the Fed will continue to buy $85 billion in bonds a month as opposed to tapering these purchases.
And I think we can safely predict that if their had been a good jobs report, investors would have turned sour and panicked about a Fed “Septaper.” They would have rushed to sell rather than buy.
Note that the Federal Reserve’s quantitative easing program has two dimensions. On the one hand there are the direct, primary effects due to the Fed’s participation in the markets for Treasury securities and mortgage-backed securities. As would be the case if any large buyer entered those markets and consistently spent many tens of billions each month, the result of such participation is to raise bond prices and push down yields. The later iterations of QE have focused on long term securities, and so long-term interest rates have fallen.
So much for the primary effects. But then there are all of the secondary effects of quantitative easing based not on the primary impact, but on market perceptions of what quantitative easing is, and how it does or doesn’t work. There is no science to these effects, since they all depend on the crazy psychological vicissitudes of whatever investors think is real, not what is real. But once a pattern of perceptions is established, it tends to be self sustaining, because investors come to expect that other investors will act in consistent ways in response to certain kinds of news, and they conform their own behavior to those expectations. The result can be that Fed actions, and perceptions of Fed actions, can take on the role of a mere signal that is wholly unrelated to the primary effects of those actions.
As I wrote in an earlier post, there now seem to be a not-insignificant number of people who believe:
1. The Fed has been “keeping the economy afloat” by its asset purchases which “pour money into the economy.”
2. The future volume of Fed asset purchases depends inversely on its perception of the health of the private sector economy.
The second claim is no doubt true at this point, but the first is based on misinformation. The actual nature of QE was clarified, yet again, by Warren Mosler in this recent interview with Stephanie Kelton. When the Fed buys Treasury securities from private sector financial institutions, the effect is to shift funds from those institutions’ securities accounts at the Fed to their dollar accounts. It’s the Big Bank equivalent of moving money from savings to checking. Also, if the Fed buys agency securities, part of the result is to drain interest income from the private sector as cash flows that once went to the private sector holders of the securities are now absorbed by the Fed. QE is an open market trade between two parties in which one kind of financial asset is swapped for another kind of financial asset of roughly equal value, but with differing yields and maturities. The swap does not “pour money into the economy”.
The Fed’s QE program has both enthusiastic fanboys and pessimistic fearmongers. But what both the fanboys and the fearmongers seem to agree on is the idea that QE pumps money into the economy, and as a result is inflationary and highly stimulatory. The fanboys crave these supposedly inflationary and economy-juicing outcomes. The fearmongers dread them, and recommend bunkering yourself behind gold and other non-dollar-denominated assets to prepare for the coming Armageddon of bubbles and hyperinflation. Unfortunately, there is widespread confusion about all of this. (Note Kelton’s anecdote about her airplane conversation with an experienced investor who foolishly put his money into overpriced gold because he mistakenly believed QE pumps oodles of inflationary dollars into the economy.)
The Fed hasn’t itself done that much to boost the QE hype, and they have been reasonably clear about what primary effects they are trying to achieve. But pundits have a responsibility to educate themselves, because their misinformation and distorted pictures about the role of Fed asset purchases are creating a bad situation in the markets, and stiffer headwinds for the nation’s jobless.
Perhaps a first step in unwinding the perverse market pattern would be for people to accept that the fate of galaxies does not hinge on whether or not the Fed tapers later this month, or the month after that, or the month after that. Much more depends on whether Congress and the President reverse their misguided program of fiscal contraction and sequestration, because deficit expansion does pump financial assets into the economy.
Cross-posted from Rugged Egalitarianism