Stephen Foley: Only the Federal Reserve can jump-start the recovery at this stage


US Outlook: Is the financial market tail wagging the economic dog?

The reaction to yesterday's poor US employment figures sent the Dow Jones Industrial Average down more than 130 points at its worst, and the equity market here has made basically no progress at all this year. In the credit markets, spreads have not returned to their narrowest levels before the freak-out over European sovereign debt in the spring.

This, despite the fact that the global economy and the US economy are each progressing along the recovery track that had been expected, at least so far, and demand from consumers and business customers has not taken a turn that would indicate anything like a double-dip recession.

The underperformance of the financial markets is becoming a problem. It has sapped the confidence of American business leaders and has a real impact on the cost of capital, both of which are holding back investment and job creation. After a strong start to 2010, private sector job growth is now running consistently below the roughly 100,000 per month level that economists say is needed to start bringing unemployment down.

Businesses are still making their employees work longer hours and average earnings are going up, so yesterday's numbers from the Labour Department show a more nuanced picture than the missed-expectations of the headline number.

But the reluctance to hire shows – more concretely than any survey, although most of those show the same thing – that uncertainty over the future is trumping relatively sanguine current conditions. As Tim Geithner, the US Treasury Secretary, likes to say, business leaders are still traumatised by the credit crisis. Hoarding cash and strengthening corporate balance sheets is also an economically rational move, given what we have learnt about how quickly access to capital can vanish, and businesses should not return to running a just-in-time financing model reliant on continual access to the money markets.

But we would be running out of patience with the "time heals everything" approach to the private sector recovery around now, even if financial markets weren't putting downward pressure on the economy.

Policymakers need to look at where to place the electrodes for some quick electric shock treatment for the private sector.

If only the federal government was functional. There could be some easy hits were the Obama administration and Congress able to introduce some business-friendly tax gesture. A change of tone in the White House would be helpful too, since the notion that it is somehow "anti-business" has seeped into the received wisdom.

But there are more vital matters that look likely to swamp these efforts. Reports in Washington last night were suggesting that House of Representatives Democrats might be going wobbly on the $26bn (£16bn) aid package to state and local governments, designed to keep local teachers, firefighters and policemen in their jobs.

If that measure failed, it really would introduce austerity to the US. The 50 states' budgetary problems were behind the shockingly high public sector lay-off figures in the July jobs report.

The partisan battles over fiscal measures are so intense here that there can be no consensus on the economic effectiveness of any particular plan, and that means they are pretty poor as the basis for a restoration of confidence.

Once again, we must look to the Federal Reserve. Since the electrodes are best placed as far away from the political arena as possible, and because the financial markets belie a lot of the caution being felt across corporate America, a lot hinges on next week's meeting of the Federal Open Market Committee. The absence of inflation in the US economy gives the Fed a great deal more room for manoeuvre than, say, the Bank of England. Ben Bernanke, the Fed's chairman, would be in no danger of having to write a letter explaining himself, even if he had acted on his urge to set a formal inflation target.

An extension of sorts of last year's quantitative easing is on the agenda. The Fed bought $1.1trn of mortgage-backed securities to push down mortgage rates and boost the housing market, and is considering changing its policy with regard to that portfolio.

The Fed has allowed the portfolio to shrink as the bonds get paid off, but is considering, instead, reinvesting the cash in more mortgage-backed securities, a move that will neutralise what is otherwise modestly contractionary monetary policy.

All the smoke signals were that change will be approved on Tuesday, precisely because it is a technical and uncontroversial-sounding plan. But it would seem to me to be a missed opportunity.

Boosting the housing market is not the priority right now. By shifting the money from mortgages into the purchase of US Treasuries, the Fed would ease conditions for businesses more generally, and signal that it sees Treasury-based quantitative easing as an insurance policy against a double-dip or deflationary economy.

Not for the first time, the US economy needs bold moves from the Fed, because politicians here seem unable to get their act together.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

Ashdown Group: Business Analyst - Financial Services - City, London

£50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...

SThree: Trainee Recruitment Consultant

£18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: Did you know? SThree is the o...

Day In a Page

General Election 2015: Chuka Umunna on the benefits of immigration, humility – and his leader Ed Miliband

Chuka Umunna: A virus of racism runs through Ukip

The shadow business secretary on the benefits of immigration, humility – and his leader Ed Miliband
Yemen crisis: This exotic war will soon become Europe's problem

Yemen's exotic war will soon affect Europe

Terrorism and boatloads of desperate migrants will be the outcome of the Saudi air campaign, says Patrick Cockburn
Marginal Streets project aims to document voters in the run-up to the General Election

Marginal Streets project documents voters

Independent photographers Joseph Fox and Orlando Gili are uploading two portraits of constituents to their website for each day of the campaign
Game of Thrones: Visit the real-life kingdom of Westeros to see where violent history ends and telly tourism begins

The real-life kingdom of Westeros

Is there something a little uncomfortable about Game of Thrones shooting in Northern Ireland?
How to survive a social-media mauling, by the tough women of Twitter

How to survive a Twitter mauling

Mary Beard, Caroline Criado-Perez, Louise Mensch, Bunny La Roche and Courtney Barrasford reveal how to trounce the trolls
Gallipoli centenary: At dawn, the young remember the young who perished in one of the First World War's bloodiest battles

At dawn, the young remember the young

A century ago, soldiers of the Empire – many no more than boys – spilt on to Gallipoli’s beaches. On this 100th Anzac Day, there are personal, poetic tributes to their sacrifice
Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves

Follow the money as never before

Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves, reports Rupert Cornwell
Samuel West interview: The actor and director on austerity, unionisation, and not mentioning his famous parents

Samuel West interview

The actor and director on austerity, unionisation, and not mentioning his famous parents
General Election 2015: Imagine if the leading political parties were fashion labels

Imagine if the leading political parties were fashion labels

Fashion editor, Alexander Fury, on what the leaders' appearances tell us about them
Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

The architect of the HeForShe movement and head of UN Women on the world's failure to combat domestic violence
Public relations as 'art'? Surely not

Confessions of a former PR man

The 'art' of public relations is being celebrated by the V&A museum, triggering some happy memories for DJ Taylor
Bill Granger recipes: Our chef succumbs to his sugar cravings with super-luxurious sweet treats

Bill Granger's luxurious sweet treats

Our chef loves to stop for 30 minutes to catch up on the day's gossip, while nibbling on something sweet
London Marathon 2015: Paula Radcliffe and the mother of all goodbyes

The mother of all goodbyes

Paula Radcliffe's farewell to the London Marathon will be a family affair
Everton vs Manchester United: Steven Naismith demands 'better' if Toffees are to upset the odds against United

Steven Naismith: 'We know we must do better'

The Everton forward explains the reasons behind club's decline this season
Arsenal vs Chelsea: Praise to Arsene Wenger for having the courage of his convictions

Michael Calvin's Last Word

Praise to Wenger for having the courage of his convictions