Bad data but at least we’ve got the Fed: James Saft

October 2, 2015

Oct 2 (Reuters) – The U.S. jobs data were a bust, China
remains a threat, the Fed won’t hike until, well, don’t ask, and
bad news is good news for the stock market once again.

Stocks plunged and then rallied back to gains on Friday
after payrolls data showed not just declining momentum in job
creation, but static wage gains and the lowest labor
participation rate since 1977.

The reaction is likely more a function of the conviction
that distress in markets will be met with tender care by the Fed
than anything else.

The data certainly wasn’t much to celebrate.

“From (an) economic viewpoint as bad as bad can be,”
Citigroup strategist Steven Englander wrote of the data in a
note to clients.

“Great for bonds as it raises the possibility that U.S.
recovery is losing steam – slower jobs, low inflation. Data are
weak from both a demand side and supply side perspective. It is
premature to declare recovery dead, but nothing in data to
suggest otherwise.”

The one clear market reaction to the not-dead economy was in
interest rate futures markets, which now show a 30 percent
probability of a rate hike in December, down from slightly less
than half before the data was released. Expectations now center
around March for a first increase in interest rates. The S&P 500
fell sharply, only to storm back to a gain of 1.4 percent
in the afternoon, a swing of nearly 3 percent.

The data arguably helps to vindicate the Fed’s decision to
remain on hold at its September meeting, though whether we
should expect it to react to developments in China or those in
the U.S. remains unclear.

Whatever might be driving the Fed, investors appear to feel
it has their best interests at heart, though combined with a
disquieting feeling that “benign” and “in control” are two
different things.

Perhaps investors took heart from Fed Vice Chairman Stanley
Fischer, who, in a speech which did not touch on monetary
policy, made the case for not bursting bubbles with the hammer
of monetary policy, citing the “significant costs”.

Instead Fischer argued for better “macroprudential” tools,
essentially regulatory interventions like lending curbs which
seek to cut systemic risk.

“The limited macroprudential toolkit in the United States
leads me to conclude that there may be times when adjustments in
monetary policy should be discussed as a means to curb risks to
financial stability,” he said at a Boston Federal Reserve Bank
conference. “A more restrictive monetary policy would, all else
being equal, lead to deviations from price stability and full
employment.”

That sounds very much like a policy maker keen not to drop
all the eggs, even if willing to admit that sometimes eggs rot.

A STOOL WITH THREE LEGS

Boston Fed president Eric Rosengren argues that Fed policy
is consistent with the idea that it has a third mandate,
financial stability, to go along with the traditional ones of
managing inflation and employment.

A paper released at the same conference and authored by
Rosengren and colleagues from the Boston Fed illustrates how big
a role the fear of financial instability plays in setting
policy.

They counted up the times the Fed, between 1987 and 2009,
used financial instability terms like “bust” and “crisis” in the
transcript of policy-setting meetings. Believe it or not, but
every 100 times such terms, which they call “moaning,” are used
can account for a 45-basis-point drop in interest rates.

That’s a more powerful predictor than a 1 percent move in
unemployment rate forecasts, and nearly double the move in rates
prompted by a 1 percent move in inflation. (here)

Financial stability isn’t the third mandate, it’s the first.
Some of the words on the list are good for a laugh; “lending
standards,” “price-to-earnings” and “supervision” are all
indicators that we need easier policy, it seems.

When credit spreads are tight, “moaning” is an even more
potent predictor of easing, with every 100 times negative words
are used accounting for a 67-basis-point drop in interest rates.

Unsurprisingly to observers of the Fed’s ‘tails you win,
heads I lose’ approach to investors and markets, the central
bank doesn’t behave the same way when credit conditions are
loose, perhaps indicating a bubble or similar risks. For every
“100 words of moaning” during boom periods we only get 36 basis
points of tightening.

So, bad news truly is good news if you have risk assets at
stake, the only question being what form the easing will take if
the bad news (good news) keeps coming.
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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