Fed Should Look at Global Unemployment, Not Just U.S. Payrolls

 | Apr 07, 2017 | 9:24 AM EDT
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European stock market indices softened after a much weaker than expected nonfarm payrolls report, despite the fact that it pours some cold water on expectations that the Federal Reserve will be accelerating the pace of its monetary tightening.

The euro softened slightly against the dollar immediately after the release of the data, which showed the U.S. economy created just 98,000 jobs in March vs. expectations of 180,000 in a Reuters survey. The unemployment rate fell to 4.5% from 4.7%.

This report serves as confirmation that investors should not rush to conclusions on a potential acceleration of interest rate hikes by the Fed.

Fresh evidence that the Fed will have to take into account global conditions, not just domestic ones, when deciding on the speed of monetary tightening, has emerged in the form of the International Monetary Fund's Global Financial Stability Report.

Part of the report, released ahead of the IMF and World Bank's spring meetings set to start on April 21, looks at the extent that individual countries can still steer domestic financial conditions in today's globally integrated financial system.

The more integrated countries are into the global economy, the more their financial conditions are vulnerable to external shocks. Also, global financial integration may weaken the transmission of monetary policy, the report says.

For example, if longer-term bond yields are increasingly determined by international markets, their response to short-term interest rates set by central banks in the country that issued the bonds will be weak. This is particularly true for smaller, less liquid emerging markets' assets, which are also more vulnerable to sudden shifts in investor sentiment that can lead to sharp capital outflows.

A single factor, "global financial conditions," seems to account for a big part of the variation in domestic financial conditions in countries around the world. Between 20 and 40% of the variation in domestic financial conditions across countries can be attributed to global financial conditions, which move in tandem with the U.S. financial conditions and with measures of global risk like the volatility index VIX.

Worse, a change in global financial conditions is more clearly associated with economic contractions than with economic expansions. In other words, if the Fed is to tighten monetary policy too fast, it risks sparking recessions around the globe, but it is not clear that if it eases them it spurs world economic growth.

The global economy is still very fragile. China's growth has slowed down and the country is laden with debt. Brazil is in its worst recession ever. Things look a bit brighter for the eurozone, despite upcoming elections in France and Germany, because the European Central Bank is still easing monetary policy with negative interest rates and continuing asset purchases.

But even in the single currency area we had two reminders this morning that things can take a turn for the worse: French industrial production surprisingly contracted by 1.6% in February, the worst contraction in six months, while Spanish industrial production shrank by 0.2%, confounding analysts who had expected a 0.3% rise.

"When assessing macro financial conditions, policymakers may need to increasingly take into account economic developments in emerging market economies," is one of the IMF's recommendations. Perhaps, besides U.S. nonfarm payrolls, the Fed should also look at employment data around the world.

(What will move markets this quarter and how should investors position themselves ahead of time? Jim Cramer sat down with four of TheStreet's top columnists recently to get their views. Click here to listen to his latest Trading Strategies roundtable with them and read their advice for stocks, bonds, forex and gold.)

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