Reading the changing market mind has become a more difficult exercise.
The report on US payrolls report on Friday, which was up 142 000 and well below the consensus estimate of 201 000, was not good news about the US economy.
The initial reaction of the equity and bond markets after the data release was to drive share prices sharply lower and bond values higher. But an hour later the share market reversed itself and ended the day 1.5% higher. Bad news about the economy had become good news for markets. These reactions, in the form of higher equity values to a weaker than expected employment number, might be a consistent response to a view that short term interest rates in the US would not now be rising any time soon.
The US dollar also weakened significantly through the day against the very hard pressed emerging market currencies, including the rand. Bad news was not only good news in New York; it was well received everywhere.
These market reactions on Friday – bad news for the economy translated into good news for markets, because interest rates would be lower than previously expected – were however in sharp contrast to the negative market reactions to the Fed decision on 23 September to delay any increase in interest rates for global rather than US economic weakness. Then, after initially welcoming the Fed decision, the equity markets turned sharply lower and emerging market currencies and equities were then particularly hard hit.
Other things being equal, lower interest or discount rates can justify higher equity (present) values. But the economic activity, or lack of it, that move interest rates are other things, especially the revenue and operating profit lines of companies. This means that other forces driving equity values cannot be assumed to remain unaffected by the state of the economy. Helpfully for shareholders, the market seems convinced for now that the lower US discount rate attached to expected operating earnings, as interest rates stay lower for longer, will more than offset any pressure on revenues and operating profits. Lower US interest rates relative to interest rates elsewhere, may well mean a weaker US dollar and also stronger emerging market currencies. Such prospects are helpful to emerging and commodity-producing economies.
Such very different reactions and market patterns revealed within a short period of time to market making news, makes for confusion about the state of the market mind. Will bad news about the US remain good news about the equity and bond markets and vice versa? Will the economic data releases confirm the strength of the US economy and send equities, currencies and bonds in the direction they mostly took in August and September 2015, for fear of higher interest rates? Ideally for shareholders around the world, the Fed will continue to worry more about slow growth and deflation than the reverse, and that such caution, reflected in consistently low short rates, will prove to be too pessimistic about both threats to the global economy, for an extended period of time.
Reflationary policies are usually helpful to share markets. The bullish argument for markets is that the Fed and the ECB (and indeed EM central banks) remain in a reflationary mood while growth prospects remain largely unchanged.