‘Quantitative failure’ pushes stock markets down

Stock markets swooned again last Friday, when the US jobs report showed the number of jobs created in January was well below expectations, at 151,000 compared with the 190,000 forecast by analysts.

Investors can no longer find comfort in turning bad news into good news, as they once did because any piece of bad economic news meant the Federal Reserve held interest rates rather than hike them.

If anything, Friday’s nonfarm payrolls report is rather alarming for markets in terms of the Fed’s future policy.

Analysts at Societe Generale point out that the 4.9% unemployment rate is “in line with the FOMC’s assessment of the longer-run natural rate. Moreover, the recent pickup in wage pressures, although modest, confirms that labour slack has largely been eroded.”

Of course, the Fed looks at other data besides unemployment, and if the recent market turmoil is any guide, investors anticipate recession. However, it doesn’t follow that the Fed can just stop raising interest rates or even, as some analysts have said, go back on its first hike.

One only needs to remember what happened back in September, when the Fed completely miscalculated what the markets wanted. Instead of implementing the first interest rate hike in almost a decade, as it had telegraphed before, the Fed preferred to stand and see how markets would react.

At the time, panic caused by the devaluation of the Chinese yuan and the Chinese stock market crash of August still haunted investors.

However, the fact that the Fed held interest rates instead of raising them exacerbated investors’ fears instead of calming them, and could be one of the reasons why the market turmoil has not died down even now.

Fighting for market control

But another reason, and a more serious one, is this: the free market is trying to take back control from the government. I wrote in a previous piece that the selloff marks the breakdown of trust, with “communism for the rich“, as Jim Rogers described the various bailouts and asset purchases, having prevented price discovery for a long time.

By selling off various over-valued shares and dumping the weakest bonds (the “high-yield” ones), investors are trying to re-price assets that have been supported by governments and central banks for too long.

Just look at momentum stocks: LinkedIn’s share price fell 44% on Friday, while Amazon fell by more than 6%; even mighty Facebook – ok, that’s not a momentum stock, it is supported by strong earnings, but still, it’s part of the high-growth, internet miracle — was down 5.8%.

Analysts at Bank of America Merrill Lynch have given this phenomenon a cute name: quantitative failure. They note that last year’s money printing by the Bank of Japan and the European Central Bank, instead of flaring inflation, caused US dollar strength, which in fact contributed to deflation.

This year’s implementation of even more monetary stimulus, as promised by ECB president Mario Draghi and as already carried out by the BoJ, “is no longer causing asset price inflation or currency depreciation.” Instead, they add, eurozone banks have lost 41% over the past six months, while Japanese banks lost 36%.

What do investors need in order to regain confidence? According to the analysts at Bank of America Merrill Lynch, they want a “Shanghai Accord” that would see a one-off devaluation of the Chinese renminbi, plus swap lines to China and other emerging markets from the Fed to help them deal with the pain of a stronger dollar, as well as fiscal stimulus from Germany, France and Britain to kick start growth.

But in fact, governments would do well to get out of the way and let the free markets work, for a change. After all, the point of price discovery is to reward success. It’s time politicians understood that.

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