Friday, October 2, 2015

Today's bond reaction to the employment report is not as optimistic as it first appears

At first glance, today's movement in bond markets along with the buoyancy of equities looks like one of those instances where an indicator that the Fed keys off of is enough of a negative surprise that the positive trigger of monetary offset overwhelms the negative information.  This would not be the case if the Fed wasn't persistently positioned outside the range of optimal policy.  It is only the case because monetary policy is tight enough that loosening will benefit the real economy.

In any case, on closer inspection, I don't think the bond markets did react today with an expectation of a delayed rate hike.  In my Eurodollar futures indicator, the expected date of liftoff didn't change a single day today.  It was January 2 at the beginning of the day and it was still January 2 at the end of the day.  What changed was an increase of uncertainty about the date of the first hike and a sharp decline in the expected rate of hikes once they begin.  This is now all the way down to only 50 basis points per year.  That is very flat.  I don't think the yield curve has been this flat since the crisis.  It's a new low.

I think this is more evidence that the current natural rate is not appreciably above zero, and any rate hike is expected to reverse fairly quickly.

But, why would equities rise?  My best guess is that the lack of wage gains gives hope that the downward pressure we have seen on profits over the past couple of years will lighten up.  I'm not completely satisfied with that answer.  This is not the only indicator that is beginning to show early signs of potential cyclical peaks in equity and labor markets, so if bond markets don't expect a Fed reaction here, I would think that recession fears would dominate.

On the other hand, far forward rates only fell a few basis points today and have held fairly steady, albeit low, for most of the year.  So, maybe markets expect the Fed to stick to its current plan for the first rate hike and then to be extremely careful about doing anything else after that.  Is it possible that we can thread the needle and continue down a path of very low inflation without triggering a liquidity problem?  Or, is the buoyancy of the far forward rates due to the asymmetrical effect of uncertainty at the zero lower bound, and what we are seeing is something close to a flat yield curve with ZLB distortions?


  1. You're thinking too hard. The path of short-term rates is considerably lower. Long-term inflation expectations went up (would not be the case if your labor theory were true). Emerging markets outperformed domestic markets (again, wouldn't be the case if this were about US labor pressure). Discount rate down, stocks up.

  2. I agree with Scott Sumner and others that markets tell us a lot. On the other hand, maybe not every day, in every hour.

    I believe in efficient markets---but there are undervalued stocks due to information gaps, for example, or occasional market fads that can waylay market results. I supple even political upheavals could play a role (Russia in Syria?).

    In general, interest rates are very low (in terms of recent history) a sign the market expects little inflation, and also that capital is abundant.

    Another thought: Supplies of capital are entering the market in huge dollops, perhaps irregularly, thanks to sovereign wealth funds and other huge institutions (for that matter, the People's Bank of China has been buying gold).

    If there is "too much" capital ("too much money chasing too few deals") then we can expect low interest rates, even as central banks jigger things around.

    So, to sum up, I think it takes a few days, or even more, of the dust to settle sometimes.

    Besides, this view allows one to cite the market when it agrees with our position, and then to cite imponderables when it doesn't. The most important thing in macroeconomic discourse is to never change your mind.

    1. You're right, Benjamin. I thought it was interesting that the expected date of the first hike didn't move. But the rest of the post is weak.

  3. I was not criticizing your post. All of your posts are extremely intelligent, moreover you "pioneered" the right way to look at housing costs.