Last week’s market turmoil – dubbed the Wall Street Bloodbath was triggered by the latest US Jobs report. According to the January data released last Friday, nonfarm payrolls grew by 200,000 in January and the unemployment rate was 4.1 percent.
So what is wrong with that you may ask? It is all good news right?
Most Americans would struggle to work out why this would cause share prices to plunge. After all, unemployment has been coming down steadily for years, during whichtime US workers have struggled to make ends meet. Annual earnings growth is still running below 3%.
However, the moment the jobs report came out it was as though a switch had been flipped. Markets now viewed stronger US growth with trepidation because they thought it would result in higher inflation and tougher action from the US central bank, the Federal Reserve.
Donald Trump’s package of tax cuts, finally pushed through Congress at the end of last year, ceased to be the growth-boosting, productivity enhancing benefit to the economy it had been in 2017 and suddenly became a means of overheating the economy and driving up the US budget deficit.
From the perspective of Wall Street, these are seen as unwelcome developments. In 2017, the financial markets bought shares because they thought the US was in for a prolonged period of strong growth, weak inflation and low interest rates.
The long period of low interest rates have led to a buildup of potentially serious financial sector vulnerabilities.”
Stock-market stability is not one of the Federal Reserve’s mandates from Congress, although the central bank is of course interested because of the interconnectedness of the financial system.
The game changer is inflation because it pushes up the risk-free rate, and a higher risk-free rate makes risky assets such as stocks relatively less attractive.
The improving world economy means rising employment and pay – and thus rising inflation and interest rates.