Friday, June 7, 2013

Jobs, Interest Rates, and the Summer Swoon

The stock market has been drifting down over the past few weeks, almost entirely due to the concern that the Fed may start "tapering" or reducing QE3 from $85 billion monthly to something lower, like maybe even $84 billion.  The stock market is afraid of this!  And, because the Fed has said they will begin this when unemployment hits 6.5%, the monthly Jobs Report this morning took on a surprisingly cosmic importance.

Waiting for the release at 8:30 AM, the futures market indicated the Dow would open slightly down.  By 8:45 AM, futures indicated it would jump 60 points.  What happened during the interim was that we learned the economy produced 178 thousand private sector jobs last month, when most predictions were about 130-140 thousand.

That's the good news, i.e., news for Democratic boosters.  The unemployment jumped from 7.5% to 7.6%, which is good news for Republican critics.  The work force increased by 420 thousand, which is good news for both partisans.

The futures market jumped simply because the uncertainty -- of having an important number unknown -- was reduced.  Reducing uncertainty almost always boosts the market.

I don't expect a decisive move in the market for the next month or so, as we consolidate some of its recent gains.  During that time, we will continue to fret about how QE ends.  Former Fed head Alan Greenspan calls it the "terminal rate problem."  As soon as the Fed allows rates to move up a little, the bond market will immediately assume rates will go up a great deal, and bonds will therefore lose a great deal immediately.  So, how can the Fed prevent this?  My guess is that the Fed will take the long-term view and spank the bond market in the short-term.  They will announce a quarter-point increase, knowing the market will assume a much larger increase, pushing down the market value of bonds terribly.  Then, the Fed will hold rates steady with only a quarter-point increase, creating huge profits in the bond market.  That is the only way the Fed can take control again.

With respect to selling all the mortgage bonds on the Fed's balance sheet, overwhelming the bond market and driving down prices, remember this:  the Fed doesn't have to do anything.  They can simply hold the bonds, which are amortizing every month.  Time will solve that problem.

It is time to enjoy the summer.  Go to the beach.  Cook a few steaks on the backyard grill.  Wander around some part of this wonderful country you've never seen.  Don't worry about the stock market.  After all, it doesn't worry about you.