Listening to the markets (plus no more zero bound)
No one likes to be contradicted. But I must admit that the markets are increasingly pointing to the likelihood that I’ve been too pessimistic about both the prospects for growth, and the likelihood that ultra-low interest rates would persist for longer than most people assumed. What do they see that I don’t?
We know that the recent spike in US 10 year bond yields occurred after the strong jobs report this morning. But the upside surprise seemed rather modest, and the headline unemployment rate (which figures into the Evans Rule) stayed at 7.6%. Also note that the recent move toward easier (or less tight) policy in Japan, Britain and the eurozone would tend to raise global growth, putting upward pressure on global real yields.
One possibility is that the jobs data is somehow flawed. In my post this morning there was a story about a dealership in Denver that couldn’t find sales people. I tend to discount those anecdotal stories, preferring aggregate data. But there is always the possibility that lots of people who are on disability/UI/food stamps, etc., are actually working in the underground economy. Some economists claim the retail sales data are too strong relative to the official unemployment data. On the other hand, that explanation would create an even bigger mystery, why has RGDP lagged the jobs data? I suppose the argument would be that RGDP is also understating actual growth, as lots of goods and services are not being measured by the government.
Note that changes in the underground economy tend to occur fairly gradually over time, so if this is an issue (and I still have my doubts), it’s a far bigger problem for monetary policy regimes like the Taylor Rule, which depend on accurate measures of the output gap, than a policy like NGDPLT, which doesn’t require any estimate of the output gap.
Also note that nominal hourly wage growth was also quite strong in June (suggesting a tightening labor market), but on the other hand that’s only one month.
EMH fans like myself can’t get too depressed about being wrong in market forecasts, as we are ALWAYS WRONG when any asset price changes significantly in a short period of time. That’s because in most asset markets the current price is quite close to the expected future price 6 or 12 months forward. All big changes are unexpected. I get a little more uneasy, however, when I can’t quite see the reason for the change, even after it has occurred. I’d guess that in a few years this will all become clear.
My best guess is that two things have happened in recent months:
1. Growth is stronger than the markets (or I) expected.
2. The Fed will respond to any given level of growth with more aggressive “tapering” than expected.
That one-two punch seems to have driven 5 and 10 year bond yields much higher than I expected.
I use the term “tapering” because I don’t mean to suggest than monetary policy will gradually become more contractionary, indeed I expect just the opposite. But it will look more contractionary to most people.
Also note that the idea we are in a liquidity trap, which never made any sense to me, has now become completely laughable by any standard. If 5 and 10 year bond yields recently rose by 100 basis points, then there’s clearly that much room for the “liquidity effect” to reduce them again. If people keep talking about a liquidity trap, then you should just laugh in their face. (Not really; one should always be polite—but at least chuckle to yourself.)
PS. Just to be clear, I’m not claiming that the Fed could definitely cut 10 year bond yields by 100 basis points, I don’t know that. What I do know is that if they failed it would obviously be because of the income and inflation effects, which of course means there’d be no liquidity trap. So let’s PLEASE stop talking about the “zero bound.”
PS. Mark Sadowski really needs to get his own blog. Here’s an excerpt from a great comment:
Assuming the major model type estimates are correct, then in the absence of the tax increase and the sequestration 2.144 million jobs would have been created which is over 50% more than in any other two quarter period this recovery and over double what was created in the previous two quarters. It would also have been the most jobs created in any two quarter period since the 2.251 million created in 1984Q1/1984Q2.