Sept. 22--What does the Federal Reserve know that we don't know?
That question drove the plunge in stock prices last week after the Fed's decision to keep near-zero interest rates intact, and will continue to paralyze investors in the weeks ahead.
"The Fed effectively moved the goal posts, indicating that the labor market and economy still aren't strong enough to justify even a single rate increase," stock market strategist Robert Doll, of Nuveen Asset Management, wrote in a note to clients Monday. The ongoing concerns, he wrote, will continue to be a "net negative for risk assets."
In other words, people will be hesitant about buying stocks, high-yield bonds, commodities or anything that will get pummeled if it turns out that troubles in overseas economies will drag down a still vulnerable U.S. economy. The risk to the U.S. economy, of course, would come if recessions overseas strain U.S. businesses so much that they start cutting back spending again and start hacking away at their workforces.
Expect stocks to be yanked up and down as data released on China and emerging markets are examined for clues about the impact in the U.S., and as analysts debate the Fed's next move.
Analysts are scouring overseas data more closely for risks. For example, J.P. Morgan analyst Nikolaos Panigirtzoglou wrote to clients this week that auto production and rail freight volumes related to China are the weakest since the Lehman crisis in 2008 infected banks worldwide. He estimated that claims foreign banks have on Chinese entities totaled $1.1 trillion in the first quarter of this year.
With large debts that need to be paid back in dollars, emerging markets could be vulnerable. And if they can't pay their debts, their lenders could be hurt.
Capital Economics economist Paul Ashworth said in a recent report that the buildup of dollar debt is "worrisome." The foreign debt-to-GDP ratio has risen from 11 percent in 2009 to 17 percent now, which he said is "equivalent to more than $3 trillion."
Currently, large U.S. companies depend on overseas markets for about half of their sales so even without inflicting injury on the banking system, recessions in emerging markets could hurt U.S. employment.
"Elevated financial market volatility and the subpar growth rates of business sales and core profits should prompt a downsizing of business spending plans," said economist John Lonski, of Moody's Analytics. He expects businesses to add fewer workers than they've been adding and also expects pay to remain sluggish.
The popular belief on Wall Street recently has been that the U.S. workforce has recovered from the 2008 recession and that the U.S. is strong enough to endure the strains from overseas markets. But last week's Federal Reserve announcement reopened questions about how strong the U.S. labor market has become. Fed Chairman Janet Yellen said she isn't satisfied that employment has rebounded adequately.
It's true that unemployment, at just 5.1 percent, is almost at the level the Fed wants to see. But unemployment numbers merely show how many people who are looking for work haven't been able to find jobs. Millions aren't looking, and so they don't get counted. With people dropping out of the workforce since the recession, the percentage of Americans participating in the workforce is near an all-time low. Only 62.6 percent of working-age people are participating in the workforce. If you look at the figures that way, a 5.1 percent unemployment rate gives a more glamorous view of employment than the reality. Yellen has continually emphasized that she thinks more people would be participating in the workforce, and earning higher pay, if the job market was, indeed, strong.
What has to be tormenting the Fed is that their models keep showing employment should be better, inflation should be stronger, and the U.S. economy should be more vigorous than it is. Since the recession, the Fed's models keep pointing to the economy on its way to a more brisk recovery than ever happens. Last week the Fed lowered expectations again.
So perhaps the eerie question isn't just: What does the Fed know that we don't know? Rather, it is: What does the Fed not know that they sense they should know? Or: What does the bond market know that the Fed doesn't know?
Even when the Fed was expected to raise rates, 10-year U.S. Treasury bond yields stayed at ultra-low levels below 2.5 percent -- an indication that bond investors don't see a vibrant economy and see plenty of reason to take shelter in low-yielding bonds.
Given their uncertainties, it's not surprising that the Fed would wonder what the fragility of China's and emerging markets' economies might do to the United States' so-so economy in the months ahead.
gmarksjarvis@tribpub.com
