Inflation Worries Fanned by Unemployment Figures
In what might seem a rather unseemly response to good news, investors reacted to the government’s announcement of low unemployment figures Friday by kicking long-term interest rates sharply higher and pummeling the stock market.
In fact, they had a reason: fear of inflation. “Obviously, a stronger economy means stronger demands for credit and possibly more inflation,” observed Lawrence Chimerine, chairman of the WEFA Group, economic consultants in Bala Cynwyd, Pa. “And the market is anticipating that.”
The persistent fears of inflation among investors, while not borne out by price statistics, arise from several reasons.
The nation’s extraordinarily low 5.8% unemployment figure for December means that wage demands could increase this year due to labor shortages. Evidence that the U.S. economy cruised past October’s stock market in surprisingly vigorous shape suggests that the Federal Reserve Board can raise interest rates to protect the dollar, without causing a recession.
Moreover, “A stronger economy usually means we’re buying like crazy; we’re taking in a lot of imports,” said Michael Penzer, an economist with the Bank of America in San Francisco. “And that’s not good for the trade deficit.”
Investors also reacted to a decline in the dollar and bad news about America’s other severe financial imbalance, the federal budget deficit, which the White House officially projects at $136 billion for 1988. On Friday, the Washington Post reported that private economics firms--using White House data--projected that the gap will actually reach $167 billion.
‘Emotional Snowball Effects’
But despite everything, inflation jitters would not ordinarily flare up at a time of modest price increases. Since last July, inflation increased at an annual rate of 3.8%--a level that actually declined by more than a point from earlier in 1987. That is why some experts caution against reading too much into Friday’s turbulent markets--other than the nervousness among investors since the Oct. 19 stock market crash.
“I really just feel that the market is very susceptible to emotional snowball effects,” said Thomas D. Stevens, chief investment officer for Wilshire Asset Management in Los Angeles.
Still, there is some evidence to support rising fears of inflation. The 34-month fall of the dollar has provided significant cost-savings to U.S. manufacturers who export products overseas. And these savings--passed along in price cuts--have netted so many new customers that certain industries are operating near their limits, a significant change from just a few years ago.
Costs Go Up
For example, the U.S. paper industry is running at 97% of capacity, textiles are at 95%, petroleum refining is at 95% and plastics are at 89%, according to government figures for July through September of 1987. U.S. industry overall was running at 81.7% of its limit by last November, the most recent month for which figures are available.
Many economists caution that these high rates are close to the point where the economy could overheat, sparking new inflation. “The (economy’s) extra strength will now have a bigger effect on inflation than it would have had three years ago,” economist Chimerine said.
The dollar, which fell sharply Friday, also causes inflation in other ways. As it falls, foreigners’ costs of selling things in the United States go up, increases that are ultimately passed on to American consumers in the form of higher prices.
Other recent news fuels the inflation jitters. Unemployment has reached a level that threatens a new round of wage inflation, according to many analysts, for this simple reason: Workers have far greater leverage to demand higher wages when unemployment is low and employers cannot turn to a long list of unemployed workers to replace them.
These concerns were reflected in the market for long-term bonds Friday, as yields on 30-year Treasury bonds rose to 9.18% from 8.95% Thursday. The bond market is extremely sensitive to inflation worries because rising interest rates hurt those who have invested in fixed-rate bonds.
In that sense, said Penzer of Bank of America, “the bond market is always perverse. Most people that you talk to out on the street like a strong economy. But the bond market doesn’t.”
Indeed, the question underlying much of Friday’s financial turbulence was how strong has the economy become, a startling riddle in light of the recent historic collapse of stock prices.
“The question is no longer whether the economy is stronger than most think; it is how . . . tremendously strong it is,” said Allen Sinai, an economist with Shearson Lehman Bros. in New York.
