Today’s stock market decline

Stocks dropped sharply this morning.

In don’t view today’s decline in stock prices as being important.  In recent years, stocks have often plunged for a few days, and then recovered.  I put more weight on the level of stock prices, which is still quite high.  Thus I believe the macroeconomy is still in very good shape.

But there’s also something more interesting going on—bond prices have also been falling (i.e. higher yields):

“It’s always hard to judge at what point you hit an inflection point where the correlation between yields and stocks goes into reverse,” says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. “One of the markers to when that happens is typically when you move from a deflationary era or at least a deflationary mindset to more of an inflationary mindset.”

It’s potentially a big deal.

An enduring rupture in positive correlations — yields moving up along with stocks — would signal a break in the weak-growth, low-interest regime seen over much of the past decade. Markets driven by negative tandem moves — yields up, shares down — have tended to be in the grip of inflationary pressure or potential economic over-heating.

David Glasner did a very important study that found stock prices became positively correlated with TIPS spreads (inflation expectations) during the Great Recession, but not before.  This may have reflected the fact that market participants thought the US economy would benefit from a more expansionary monetary policy during the period of high unemployment and near-zero interest rates.  That assumption was correct in my view. If long-term bond yields and TIPS spreads start becoming negatively correlated with stocks, then presumably excessively tight money is no longer much of a problem.

That doesn’t mean money is now too easy.  In my view we are so close to optimal that it’s hard to be sure whether policy is appropriate or a tad too expansionary.  We’ll know better in a few years.  But certainly most of the data looks pretty good from a dual mandate perspective.

I’d encourage people not to think in terms of binaries, rather shades of grey.  Monetary policy has been gradually moving from much too tight, to slightly too tight, to about right.  We don’t know precisely where we are on the spectrum, but the trend it clear.  It’s also clear that current monetary policy is far more appropriate than policy in 2009, or 1979, or 1930.



29 Responses to “Today’s stock market decline”

  1. Gravatar of Brian McCarthy Brian McCarthy
    10. October 2018 at 10:35

    Fully agree in the “just about right” estimation of the current policy stance, but what about the fact that Fed leadership seems determined to drop 4 more 25bp hikes over the next year before even considering whether they’ve overdone it?

  2. Gravatar of Kgaard Kgaard
    10. October 2018 at 10:36

    Scott your economic analysis is always so fabulous — I agree with everything in the post above — I can never understand how it is I disagree with virtually everything you write about politics. It is a weird time.

  3. Gravatar of David Glasner David Glasner
    10. October 2018 at 10:47

    Scott, Thanks for mentioning my paper. A further point or perhaps a different way of making the same point is that when you’re at an optimum almost any change or perceived change is a change for the worse. Not that I’m trying to say that we are now in the best of all possible worlds. What was that line from Dickens about the best of times?

  4. Gravatar of ssumner ssumner
    10. October 2018 at 10:48

    Brian, I don’t agree that they are determined to do so; they are data driven. Recall that they planned lots of rate hikes for 2016, and then didn’t do them. They’ll probably do them only if appropriate. I pay more attention to what the markets are predicting for rates, than what the Fed is predicting.

    Kgaard, Thanks. I presume our political disagreement is because I’m a neoliberal who thinks that process (honesty, etc.) is super important, and you have other views? (I don’t always recall the specific politics of each commenter.)

  5. Gravatar of ssumner ssumner
    10. October 2018 at 10:50

    David, You said:

    “What was that line from Dickens about the best of times?”

    Yup, that perfectly summarizes 2018, or 1968 for that matter!

  6. Gravatar of ssumner ssumner
    10. October 2018 at 10:52

    David, BTW, Don’t know if you saw my post comparing judges to referees. I later saw your post. I should explain that I meant referee in the sense of “not being personally biased toward either groups of people disputing a case”, not in any other sense.

  7. Gravatar of Christian List Christian List
    10. October 2018 at 10:55

    The blog entry reminds me of your comment on Nike recently. If I remember correctly, you said that you have to look at the sales (in the coming weeks and months) and not at the immediate reaction of the stock price. That was very funny. You wrote such a beautiful book about the Great Depression, where current stock prices were very important.

    Now it’s about current stock prices again. Good to know. If it’s politically opportune again, let’s look at the sales again, okay? =)

  8. Gravatar of Brian Mccarthy Brian Mccarthy
    10. October 2018 at 11:34

    Yes, they’re “data-dependent” i.e. Powell is determined to do at least four more unless growth slows. That strikes me as bearish, at least relative to what they were signaling previously (i.e. a pause to asses at 2.625%-2.875)…

    Also, looking at market rate expectations can be deceiving. Consider this theoretical:

    Let’s say that “reality” happens to be that two more hikes before pausing is “just right,” but four hikes is too much and going to cause a 2015/16-like EM crisis.

    One day the Fed is signaling they will consider a pause after two hikes, so the market is priced for two hikes and risk assets are trading well.

    If the next day the Fed says “we’ve changed our mind and we’re now hell-bent on four hikes,” the market will not price in the four hikes because it “knows” that after 2-3 hikes we will descend into an EM / credit crisis. The market will simply start selling off risk assets and bring the inevitable crisis forward, causing the Fed to self-correct, with rate-hike expectations staying largely unchanged.

    Sorta feels to me like what’s going on…

  9. Gravatar of Michael Sandifer Michael Sandifer
    10. October 2018 at 11:43

    Monetary policy is still too tight. It’s been too tight for more than 10 years now.

    Unfortuately, the only data I have to support this claim represents such a slight hint, that it may as well be a Rorschach test. Sudden declines in productivity in the US, many European countries, Japan, and China, just after the Great Recession, and continuing in the context of expected secular productivity slowdowns makes the evidence muddy at best. The US productivity decline began around 2004, though has been pretty flat at a lower level since recovery from the Great Recession began.

    That said, if unemployment continues to drop, that is at least more data consistent with my claim, though not necessarily evidence for tight money. There are other possible, even plausible explanations.

  10. Gravatar of ssumner ssumner
    10. October 2018 at 15:41

    Christian, You said:

    “If I remember correctly,”

    Not likely!

    Let me help you. On the day of a shock, the stock market reaction may be the best forecast of what will happen to Nike sales over the next week. But what actually happens to sales over the next week is an even better indicator of what will happen to sales over the next week. Comprende?

    Brian, You can always construct scare stories, but don’t you sort of need EVIDENCE.

    Michael, Falling unemployment is evidence that money is too tight? Would you have felt that way in 1966? Or am I misreading your comment?

  11. Gravatar of Rodrigo Rodrigo
    10. October 2018 at 15:51

    Doc Sumner,

    I cannot argue that policy might be as close to perfect as it could be.

    My questions is the following: Being that monetary policy is as good as it is, why are we suffering through such high market volatility?

    I dont belive we had never experienced a faster drop off of all time highs than what we had in january/february. In my experiance as a market technician, such volatility is usually seen at market tops.

    My point being that there seems to be a discrepancy between the market (which is usualy right) and our perception of the general economy.

    Any thoughts?

  12. Gravatar of Benjamin Cole Benjamin Cole
    10. October 2018 at 16:10

    The Fed is probably too tight, and also may be causing financial instability in emerging markets. The Fed may be courting recession, globally.

    The Reserve Bank of Australia operates with a 2% to 3% inflation band target. They have had short stretches where inflation reached 4%. They have not had a recession since 1991.

    Hey, why go with what works? At the Federal Reserve, they have a theory that a 2% inflation target is what works.

  13. Gravatar of Michael Sandifer Michael Sandifer
    10. October 2018 at 16:23


    One key difference between the current period and ’66 is that inflation is tame. So, if the unemployment rate continues to fall sans increased inflation, I think it’s at least consistent with the claim that money was too tight.

  14. Gravatar of Benjamin Cole Benjamin Cole
    10. October 2018 at 16:35

    Tyler Cowan has posted an interview with Paul Krugman. I think Krugman’s take on monetary policy and central banking is certainly worth pondering.

  15. Gravatar of Benjamin Cole Benjamin Cole
    10. October 2018 at 16:37

    Tyler Cowen that is

  16. Gravatar of Benjamin Cole Benjamin Cole
    10. October 2018 at 18:59

    Worth nothing, the official unemployment rate has probably become a misleading signal–and worse, a signal grabbed onto by central bankers obsessed with finding a reason to tighten money. The 2% inflation totem might get angry!


    The total number of hours Americans are working per month is up about 5.3% from 2008, the previous apex.

    Yet the Fed reports with every Beige Book that there are ‘”widespread labor shortages” in the US.

    Huh? A 5.3% increase in total monthly hours worked from the 2008 apex and we have “widespread labor shortages”?

    Moreover, the civilian labor force has grown about 5% from 2008 to today.


    Back in July 2008, the Fed reported in a Beige Book, “Most Districts reported labor markets as unchanged or slightly weaker compared with the last survey period, and that wage pressures were generally modest.”

    Huh? This adds up like Bernie Madoff.

    Okay, so Americans are working scarcely more hours than in 2008, but now we have “widespread labor shortages.” But now we also have a larger civilian labor force.

    Okay, so nominal wages now are rising at under 3%, but productivity now notching above 1%, so wages remain a drag on the Fed’s putative 2% inflation target (ceiling).

    A drag! So we might tighten up!

    Housing and oil are causing some inflation—external shocks that should be accommodated. I count housing as an external shock, as prices will not bring on more supply in many large markets, like the entire West Coast. (Ironically, raising interest rates will cut supply in most markets).

    The Fed is courting recession.

    Invest accordingly.

  17. Gravatar of Benjamin Cole Benjamin Cole
    10. October 2018 at 20:42

    Is it a live proposition that the two modern-day macroeconomic theologies—that money always and everywhere should be tighter, and that free trade always and everywhere is divine—will plunge the US into the next financial debacle and recession?

    The IMF has posited that large and chronic current-account trade deficits are leading the US to bloated asset values and a Hyman Minsky moment.

    The Fed is raising interest rates, despite very tame wage markets. In fact, wages offset by productivity are still a drag even on the Fed’s low 2% IT.

    The problems are oil and housing. The CPI core minus housing is rising at….0.6% a year. See Kevin Erdmann.

    Never let theories become theologies….so Hyman Minsky is at the threshold, ready to rumble. The Fed is taunting, taunting….

    Ultimate irony pending?

    We get a recession, and the macroeconomics profession says, “See? We told you the Trump tariffs would do this!”

    See the Great Depression and Smoot-Hawley!

  18. Gravatar of anon anon
    11. October 2018 at 05:22

    Good post, Scott. Given your history of critiquing the Fed and their policy decisions, it’s nice to know that they aren’t being too tight these days, and that they haven’t gone crazy!

  19. Gravatar of ssumner ssumner
    11. October 2018 at 05:40

    Rodrigo. This is probably the least “volatile” market of my entire life. I presume the trade war talk adds a bit to volatility, but overall stocks are amazingly stable. How many 1% moves this year? In a normal year?

    Michael, Inflation has already increased somewhat.

  20. Gravatar of ssumner ssumner
    11. October 2018 at 05:47

    Rodrigo, Check this out:

  21. Gravatar of Michael Sandifer Michael Sandifer
    11. October 2018 at 07:07


    The Fed has been doing better under Powell at hitting their inflation target, but you don’t favor inflation targeting. You convinced me long ago not to favor it either, and since money might still be tight, I favor NGDPLT at 5%.

  22. Gravatar of Scott Sumner Scott Sumner
    11. October 2018 at 09:30

    Michael, You are missing the point. If I favor taking a vacation in San Francisco, and my wife successfully lobbies for San Diego, it doesn’t help things if I give road directions for San Francisco. Whatever target they choose, they need to hit it.

  23. Gravatar of Justin Justin
    11. October 2018 at 10:35

    Our wonderful financial media hardly commented on yesterday. They have time to speculate on the sky potentially falling because of…some weird detail of some class of debt or whatever, but when they actually get a broad sell off, 5th worst day since 2014…hardly anything! Still, as you say, not a big deal, we are still have a relatively high stock level, and only back to the levels seen in July of this year. Down again pretty substantially again today though, -1.3% at this moment. Makes me glad I took a modest short position on Hypermind yesterday, interpreting the market forecast.

  24. Gravatar of George George
    12. October 2018 at 00:17


    How do you see interest on reserves at 2.2% impacting the stance of monetary policy at the moment?

  25. Gravatar of Christian List Christian List
    12. October 2018 at 02:03



    I understand, I just think it’s against your previous theory that you have to look at the stock price right away. I still think that you have left your theory in this single case for political reasons.

    Of course you can look at the sales a few weeks later, but the event was there and the stock market has responded noticeably negative right away. There’s only one world we live in and only one timeline. You cannot know what the sales would have been without the negative event. Maybe they would have been better? Your theory was so ingenious and now you have left it for this incident. That is really too bad. Nevermind.

  26. Gravatar of ssumner ssumner
    12. October 2018 at 13:48

    Christian, My “previous theory” is the same as my current theory—stocks respond immediately to new information. Yes, it’s theoretically possible that sales suddenly jumped after the ad campaign for unrelated reasons, but how likely is that? The point is, I’m always looking at how stocks respond to new information.

  27. Gravatar of ssumner ssumner
    13. October 2018 at 11:41

    George, It makes it tighter than if there was no interest on reserves. But if the Fed abolished IOR, they would almost certainly do an offsetting open market sale to prevent it from being highly inflationary.

  28. Gravatar of DonG DonG
    14. October 2018 at 07:22

    I invest based on the very high savings rate of Chinese middle and upper class. Those folks have a lot of new money and habit of saving. That has kept global interest rates low and pushed up stocks. But, that can’t go on forever. Those folks will soon retire and their kids (what few they have) are not super savers. There will be a tipping point, when both US boomers and Chinese “boomers” both retire and start dis-saving.

    Are we there? Will a slowing Chinese economy or currency situation tip the balance earlier?

  29. Gravatar of ssumner ssumner
    14. October 2018 at 15:02

    Don, Have the Japanese stopped saving? They are decades ahead in terms of the demographics.

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