Vivek Kaul
The Bombay Stock Exchange (BSE) Sensex, India’s premier stock market index, rose by 517.22 points or 1.88% to close at 27,975.86 points yesterday (i.e. March 30, 2015). On March 27, 2015 (i.e. Friday), Janet Yellen, the Chairperson of the Federal Reserve of the United States, gave a speech (after the stock market in India had closed). In this speech she said: “If conditions do evolve in the manner that most of my FOMC colleagues and I anticipate, I would expect the level of the federal funds rate to be normalized only gradually, reflecting the gradual diminution of headwinds from the financial crisis.” The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans. What Yellen was basically saying is that even if the Federal Reserve starts raising interest rates, it will do so at a very slow pace. In the aftermath of the financial crisis that started in mid September 2008, when the investment bank Lehman Brothers went bust, central banks in the developing countries have maintained very low rates of interest. The Federal Reserve of the United States, the American central bank , has been leading the way, by maintaining the federal funds rate in the range of 0-0.25%. The hope was that at low interest rates people would borrow and spend more than they were doing at that point of time. This would help businesses grow and in turn help the moribund economies of the developing countries. While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. For the rallies in financial markets all over the world to continue, the era of “easy money” initiated by the Federal Reserve needs to continue. And this is precisely what Yellen indicated in her speech yesterday. She said that even if the Fed starts to raise interest rates it would do so at a very slow pace, in order to ensure that it does not end up jeopardizing the expected economic recovery. Yellen went on to add in her speech on Friday that: “Nothing about the course of the Committee’s actions is predetermined except the Committee’s commitment to promote our dual mandate of maximum employment and price stability.” This is where things get interesting. The rate of unemployment in the United States in February 2015 was at 5.5%. This was a significant improvement over February 2014, when the rate of unemployment was at 6.7%. But even with this big fall, the Federal Reserve is unlikely to raise interest rates. Typically, as unemployment falls, wages go up, as employers compete for employees. But that hasn’t happened in the United States. The wage growth has been more or less flat over the last one year (it’s up by 0.1%). The major reason for the same is that more and more jobs are being created at the lower end. As economist John Mauldin writes in his newsletter: “66,000 of the 295,000 new jobs[that were created in February 2015) were in leisure and hospitality, with 58,000 of those being in bars and restaurants…Transportation and warehousing rose by 19,000, but 12,000 of those were messengers, again not exactly high-paying jobs.” Further, in the last few years the energy industry in the United States has seen a big boom on the back of the discovery of shale oil. But with oil prices crashing, the energy industry has started to shed jobs. In January 2015, the energy industry fired 20, 193 individuals. This was 42% higher than the total number of people who were sacked in 2014. As analyst Toni Sangami pointed out in a recent post: “These oil jobs are among some of the highest-paying blue-collar jobs in the country, so losing one oil job is like losing five or eight or ten hospitality-industry jobs.” The labour force participation ratio, which is a measure of the proportion of the working age population in the labour force, in February 2015 was at 62.8%. It has more or less stayed constant from December 2013, when it was at 62.8%. This is the lowest it has been since March 1978. The number was at 66% in December 2007. What this means is that the rate of unemployment has been falling also because of people opting out of the workforce because they haven’t been able to find jobs and, hence, were no longer being counted as unemployed. So, things are nowhere as fine as broader numbers make them appear to be. The overall inflation also remains much lower than the Federal Reserve’s target of 2%. The Federal Reserve’s preferred measure of inflation is personal consumption expenditures(PCE) deflator, ex food and energy. For the month of February 2015, this number was at 1.4% much below the Fed’s target of 2%. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised. Yellen summarized the entire situation beautifully when she told the Senate Banking Committee earlier this month that: “Too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.” What does not help is the weak durables data that has been coming in. Orders for durable goods or long-lasting manufactured goods from automobiles to aircrafts to machinery, fell by 1.4% in February 2015. The durables data have declined in three out of the last four months. Given this scenario, it is highly unlikely that the Yellen led Federal Reserve will start raising the federal funds rate any time soon. Further, as and when it does start raising rates, it will do so at a very slow pace. What this means is that the era of easy money will continue in the time to come. And given this, more acche din are about to come for the Sensex. Having said that, any escalation of conflict in the Middle East can briefly spoil this party. The article originally appeared on The Daily Reckoning on Mar 31, 2015