Sensex falls 4% in a week but easy money rally will be back soon

deflationVivek Kaul  

The BSE Sensex has now been falling for close to a week now. As I write this, it’s trading at around 20,000 points, having fallen by nearly 4% since January 27, 2014.
The main cause of this fall has been the decision of the Federal Reserve of the United States, the American central bank, to go slow on printing money. In a meeting on January 29, 2014, the Fed decided to print $65 billion a month, in comparison to $75 billion earlier.
By doing this, the Fed signalled that it would be going slow on the easy money policy that it had unleashed a few years back, in order to revive the stagnating American economy. The money printed by the Federal Reserve was used to buy government bonds and mortgage backed securities, in order to ensure that there enough money going around in the financial system. This led to low interest rates and the hope that people would borrow and spend more money, and thus help in reviving the economy.
Investors had been borrowing at these low interest rates and investing money all over the world. But with the Federal Reserve deciding to go slow on money printing (or what it calls tapering), this game of easy money is likely to come to an end, soon. At least, that is the way the markets seem to be thinking. And that to a large extent explains why the Sensex has fallen by close to 4% in a week’s time.
One of the major reasons behind the Federal Reserve’s decision to print less money has been the falling rate of unemployment. For the month of December 2013, the rate of unemployment was down to 6.7%. In comparison, in December 2012, the rate had stood at 7.9%. This is the lowest unemployment rate that the American economy has seen, since October 2008, which was more or less the time when the financial crisis started. This measure of unemployment is referred to as U3.
A major reason for the fall in the unemployment numbers has been the fact that a lot of people have been dropping out of the workforce. In December 2013, nearly 3,47,000 workers left the labour force because they could not find jobs, and hence, were no longer counted as unemployed. This took the number of Americans not working to a record 102 million. As Peter Ferrara puts it on “In fact, 
all of the decline in the U3 headline unemployment rate since President Obama entered office has been due to workers leaving the work force, and therefore no longer counted as unemployed, rather than to new jobs created…Those 102 million Americans are the human face of an employment-population ratio stuck at a pitiful 58.6%. In fact, more than 100 million Americans were not working in Obama’s workers’ paradise for all of 2013 and 2012.” Interestingly, the labour force participation rate, which is a measure of the proportion of working age population in the labour force, has slipped to 62.8%. This is the lowest since February 1978. Also, in December 2013, the American economy added only 74,000 jobs. This was lower than the 1,96,000 jobs that Wall Street had been expecting and was the lowest number since January 2011.
What this means is that even though the rate of unemployment is at its lowest level since October 2008, things are not as well as they first seem to be. Interestingly, in December 2013, the U6 “rate of unemployment” which includes individuals who have stopped looking for jobs because they simply can’t find one and individuals working part-time even though they could work full-time, stood at 13.1%. This was about double the official rate of unemployment of 6.7%. Interestingly, through much of 2013, the U6 rate of unemployment was double the official U3 rate of unemployment.
What all this tells us is that the unemployment scenario in the US is much worse than it actually looks like.
In this scenario it is unlikely that the Federal Reserve can keep tapering or reducing the amount of money that it prints every month. Other than the rate of unemployment, the other data point that the Federal Reserve looks at is consumer price inflation as measured by personal consumption expenditure(PCE) deflator. The PCE deflator for the month of December 2013 stood at 1.1%. This is well below the Federal Reserve target of 2%.
If the PCE deflator has to come anywhere near the Federal Reserve’s target of 2%, the current easy money policy of the Federal Reserve needs to continue. As Bill Gross, managing director and co-CIO of PIMCO wrote in a recent column “the PCE annualized inflation rate– is released near the 20th of every month but you will not see CNBC or Bloomberg analysts waiting with bated breath for its release. I do. I consider it the critical monthly statistic for analyzing Fed policy in 2014. Why? Bernanke, Yellen and their merry band of Fed governors and regional presidents have told us so. No policy rate hike until both unemployment and inflation thresholds have been breached.”
Given these reasons, it is safe to say that foreign investors will continue to be able to raise money at low interest rates in the United States, in the months to come. Hence, the recent fall in the Sensex is at best a blip. The easy money rally will soon be back.
The article originally appeared on on February 4, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)