By: Soumya Kanti Ghosh : ET :18 July 2013
The market can remain irrational longer than you can remain solvent — John Maynard Keynes
The trends in rupee value and general trends in financial market over the past one and a half months remind me of this famous quote by Keynes. It is believed that, after a series of highly leveraged trades, when Keynes was humbled by the market, he made this observation. Though I am not a trader, I am constrained to make the same observation, even as a spate of irrational exuberance has kept the markets dodgy since Fed ChairmanBen Bernanke apparently made a point regarding QE scaledown. I will make a couple of points regarding the market meltdown, with reference to the US economic recovery that, I believe, is still a myth.
Myth 1
Are you aware of the correlation between Fed monthly asset purchases and the USunemployment rate? Look at the chart below. Ever since the beginning of financial crisis, the Fed has expanded its balance sheet significantly. However, the bad thing about such an asset purchase is that whenever it has tried to scale it down (for example, beginning of 2009 and end of 2011), US unemployment rate has jumped significantly. Interestingly, perhaps looking at this trend, the Fed has scaled up the size of the balance sheet since the beginning of 2013, and this may have had a sobering impact on the US unemployment rate that was somehow sticky at 8% during mid-2012. Thus, can we unwind QE so quickly, as markets perceive, if we go purely by trends? Think again!
Myth 2
Payroll additions at 1,95,000 in June 2013 indicate a buoyant job market! As per trends, the US economy lost 90 lakh jobs since 2008 and has till now (June 2013) added close to 69 lakh jobs, so there is still a gap of 21 lakh jobs lost. Additionally, payroll job additions in November 2012 was 2,47,000, in December 2012 it was 2,19,000 and in February 2013 it was at an all-time high of 3,32,000. Thus, it may be a little premature to say that the US unemployment will decline rapidly to 6.5%, when the US interest rates may see an upturn, as per Fed.
Myth 3
The US unemployment rate at 7.6% is a sign of an improving job market. Yes, it is true, but if we look at the difference between the US unemployment rate at 7.6% and the overall US unemployment rate (that includes marginally attached, discouraged and part-time workers), that gap is still at about 7%, much higher than the 4.5% in the years prior to the crisis. Also, the youth unemployment rate in the US (between 16 and 24 years) was 16% in June 2013 (that was on an average 12% before the crisis). Thus, clearly new jobs that are being created are not able to absorb the growing labour force. There are several other reasons to believe that the US economic recovery will take longer than we currently envisage. The recent downward revisions in US GDP data and US retail sales foretell a delayed recovery. My estimate is that if we go at the current rate, all other conditions remaining unchanged, the US unemployment rate may hit 6.5% only towards the end of 2014.
Alternatively, the US economy may touch inflation rate of 2.5% by November 2015, the other condition for Fed for keeping interest rates at low levels. But I am not a trader, and my guess may be as good as yours. The bottom line is that market reaction is not supported by hard data, and this needs to be clearly understood. This piece is not to argue for continued Fed accommodation, since there has to be a life after QE, but to make the record straight about the false market inhibitions. Finally, a word on rupee movements, for the curiosity of the readers. Even as the rupee continues to trade around 59.2/$, a simple back of the envelope calculation suggests that based on the REER (real effective exchange rate) trends, the rupee may be currently undervalued! But pardon the brevity for any rupee prognosis at this point!
(The author is chief economic advisor, State Bank of India. Views are personal)
The trends in rupee value and general trends in financial market over the past one and a half months remind me of this famous quote by Keynes. It is believed that, after a series of highly leveraged trades, when Keynes was humbled by the market, he made this observation. Though I am not a trader, I am constrained to make the same observation, even as a spate of irrational exuberance has kept the markets dodgy since Fed ChairmanBen Bernanke apparently made a point regarding QE scaledown. I will make a couple of points regarding the market meltdown, with reference to the US economic recovery that, I believe, is still a myth.
Myth 1
Are you aware of the correlation between Fed monthly asset purchases and the USunemployment rate? Look at the chart below. Ever since the beginning of financial crisis, the Fed has expanded its balance sheet significantly. However, the bad thing about such an asset purchase is that whenever it has tried to scale it down (for example, beginning of 2009 and end of 2011), US unemployment rate has jumped significantly. Interestingly, perhaps looking at this trend, the Fed has scaled up the size of the balance sheet since the beginning of 2013, and this may have had a sobering impact on the US unemployment rate that was somehow sticky at 8% during mid-2012. Thus, can we unwind QE so quickly, as markets perceive, if we go purely by trends? Think again!
Myth 2
Payroll additions at 1,95,000 in June 2013 indicate a buoyant job market! As per trends, the US economy lost 90 lakh jobs since 2008 and has till now (June 2013) added close to 69 lakh jobs, so there is still a gap of 21 lakh jobs lost. Additionally, payroll job additions in November 2012 was 2,47,000, in December 2012 it was 2,19,000 and in February 2013 it was at an all-time high of 3,32,000. Thus, it may be a little premature to say that the US unemployment will decline rapidly to 6.5%, when the US interest rates may see an upturn, as per Fed.
Myth 3
The US unemployment rate at 7.6% is a sign of an improving job market. Yes, it is true, but if we look at the difference between the US unemployment rate at 7.6% and the overall US unemployment rate (that includes marginally attached, discouraged and part-time workers), that gap is still at about 7%, much higher than the 4.5% in the years prior to the crisis. Also, the youth unemployment rate in the US (between 16 and 24 years) was 16% in June 2013 (that was on an average 12% before the crisis). Thus, clearly new jobs that are being created are not able to absorb the growing labour force. There are several other reasons to believe that the US economic recovery will take longer than we currently envisage. The recent downward revisions in US GDP data and US retail sales foretell a delayed recovery. My estimate is that if we go at the current rate, all other conditions remaining unchanged, the US unemployment rate may hit 6.5% only towards the end of 2014.
Alternatively, the US economy may touch inflation rate of 2.5% by November 2015, the other condition for Fed for keeping interest rates at low levels. But I am not a trader, and my guess may be as good as yours. The bottom line is that market reaction is not supported by hard data, and this needs to be clearly understood. This piece is not to argue for continued Fed accommodation, since there has to be a life after QE, but to make the record straight about the false market inhibitions. Finally, a word on rupee movements, for the curiosity of the readers. Even as the rupee continues to trade around 59.2/$, a simple back of the envelope calculation suggests that based on the REER (real effective exchange rate) trends, the rupee may be currently undervalued! But pardon the brevity for any rupee prognosis at this point!
(The author is chief economic advisor, State Bank of India. Views are personal)
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