Whether it was really a return to “normal” was a subject of some debate among commentators. Much of the discussion hinges on wage growth, or the lack thereof. If the economy is taking off and employment is getting to levels we often think of as “full employment,” then why are workers not able to demand more money? As Neil Irwin writes in the New York Times:
There are at least a couple stories we could tell to explain relatively stagnant wages. One story is that we really aren’t near “full employment.” We’ve seen a striking drop in the labor force participation rate—the number of Americans looking for work. If there is a large pool of workers just waiting to reenter the labor force, that would keep a lid on wage pressures.
An alternative story is that we have seen the effects of extraordinarily loose monetary policy accumulate in unconventional places, pushing up housing and stock prices, for example. If this is an asset price bubble, then those inflationary pressures could be released at some point in the future. Whereas the first story says the Fed should stick with its loose policy, the second story says it will soon be time to tighten.
Economists can argue about this all they like, but markets voted for Story #2 on Friday. The 10-year Treasury bond jumped almost 13 basis points to close at 2.24 percent, the highest level since late December (and a very large move in a single day). That is consistent with a new expectation that the Fed will tighten sooner rather than later.
Even before today’s jobs report and bond move, this morning’s Wall Street Journal noted that the spread between US and German bonds was the widest since data became available. That gap only grew in today’s trading. German and European rates are much lower, with weak growth, no signs of inflation, and the European Central Bank launching a new round of quantitative easing.
And now we come to a key international ramification of the jobs report—when US interest rates rise and European interest rates fall, there is an incentive to move money from Europe to the US, bidding down the euro and bidding up the dollar. [And if you don’t already have money in Europe, you can go there and borrow it, as Warren Buffett plans to do].
That’s what happened. One year ago it cost $1.39 to buy a euro; at the end of today’s trading it cost about $1.08. That means that European exports look much cheaper to American buyers, and US products look more expensive overseas. Nor is this effect limited to Europe. Data from the St. Louis Fed shows that in the last year, the dollar has risen more than 17 percent on a trade-weighted basis against major world currencies.
This will pose at least two challenges, moving forward. First, it will create serious economic headwinds for the US economy. From 2012-2014, US GDP growth was in the 2.2 to 2.4 percent range and the contribution of international trade was estimated to be roughly neutral. In the fourth quarter of 2014, however, trade was estimated to have taken 1.15 percentage points off GDP (which ended up at 2.2 percent). That was before much of this exchange rate appreciation.
The second challenge will be political. US trade negotiators have already been pushed to address “currency manipulation.” The concept is ill-defined; it’s very hard to differentiate currency moves from standard monetary policy. That may be a reason that Fed Chair Janet Yellen opposed the linkage of trade sanctions and currency measures last month. Today’s market moves both demonstrated the intimate linkage between (expected) monetary policies and currency moves, and foretold of more political pressures to come.