On Thursday, we got great news about unemployment – it has been improving! In response the stock market immediately fell.
A lower unemployment rate is a good sign for the economy. And the stock market is supposed to show the health of all the companies that operate in the economy. So why would it fall?
The answer tells us about one of the biggest problems in Australia today. It’s a fascinating paradox at the heart of our economy
But let’s go back to the start.
December’s unemployment numbers had been hotly awaited. Would they be good or bad? It was very hard to predict.
October showed dismal numbers but then November was amazing – and either of those could have been a statistical anomaly. December data was needed to settle the debate about whether Australia’s economy was really showing signs of life.
When it came, the result was clear: This was good stuff. The number of people with jobs shot up by 29,000 and unemployment fell to 5.1 per cent. The only downside was that the new workers were in part-time positions, while full-time unemployment barely budged.
This result is not the best result imaginable, but it is a lot better than market watchers feared. A stronger labour market means less need for the RBA to step in.
On Wednesday the stock market was predicting a 58 per cent chance of a rate cut at the next RBA board meeting. But by Thursday that had slumped to 28 per cent.
And that’s why the stock market fell sharply at exactly 11.30am – the time the unemployment data was released.
STOCK PRICES, HOUSE PRICES AND THE RBA
In theory, the RBA’s rate cuts make the economy stronger. In theory, lower interest rates make it easier for companies to borrow money to build new factories and expand operations and therefore hire new staff. That theory worked well for many years.
But recently? Recently the theory is looking a bit threadbare. Because these days the clearest effect of interest rate cuts is on asset prices.
When the RBA cuts rates, the economy might improve slightly. But we get a big lift in house prices. We saw this in 2019 – not long after the RBA slashed rates to record lows, house prices turned from falling to rising.
And as we saw on Thursday, you need only a change in the chance of a rate cut to get an immediate change in stock prices.
The lower interest rates are, the more people want to buy stocks. It makes sense – stocks pay dividends and for many investors that is better than accepting interest rates that are practically zero.
So the stock market’s recent record highs – in the US and the Australian stock market – have a lot to do with record low interest rates worldwide.
It’s the same thing with house prices – investors want to buy houses because leaving money in cash brings such bad returns. They are able to buy houses with borrowed money, paying little interest.
The net result is that a weaker economy causes lower interest rates and lower interest rates cause higher asset prices.
Does that make you nervous? It makes the RBA governor nervous. “ … easier monetary conditions will push up asset prices, which brings its own set of risks,” he said in a speech last year.
For now, we seem to have a stronger economy and a slightly lower stock market. That’s great. But when we get data on the economy for January, when the effects of the bushfires come through, the economy could look worse, and the RBA might come under renewed pressure to cut rates. And if that happens, we could see the same paradox in reverse – stock markets rising as bad data comes in.