By Neil Irwin, The New York Times
By a lot of measures, the United States economy is looking pretty good right now. The unemployment rate has fallen below 6 percent for the first time in half a dozen years, and jobs are being added at the fastest rate since before the Great Recession.
Things are looking better, that is, unless you turn your eye to Wall Street. There, the stock market’s main gauge, the Standard & Poor’s 500-stock index, fell 0.8 percent on Wednesday after a wild ride during the day. It is off 7.4 percent since mid-September.
Moreover, longer-term interest rates are down sharply, which normally signals pessimism in the bond market about the nation’s economic future. A measure of expected volatility hit its highest level since 2011 on Wednesday, signaling that more manic days could lie ahead.
This apparent contradiction — and how it is resolved — points to the basic question for the United States economy and for Federal Reserve policy makers right now. How powerful is that underlying economic strength? And will the recent market volatility prove ultimately inconsequential, or does it presage harder times ahead for a nation still trying to muddle its way out of a downturn that technically ended more than five years ago?
In other words, does Wall Street know something that the rest of us don’t?
There are some reasons that, unnerving as these market moves have been, people who do not trade stocks and bonds for a living should still feel reasonably good about where things stand. Yes, the market sell-off on Wednesday was driven partly by a weak reading on United States retail sales, which fell 0.3 percent in September. But some of the most direct effects of the market action are actually positives for ordinary Americans.
The price of oil is down about 20 percent since summer, which is making a wide range of fuels less expensive. Gasoline now averages $3.18 a gallon, down 14 percent since the spring, according to data from AAA. A slump in the prices of agricultural commodities like corn, soybeans and wheat should, over time, make trips to the grocery store cheaper.
And with money gushing away from risky investments like stocks into safer bonds, long-term interest rates have fallen steeply; the yield on a 10-year Treasury note briefly dipped below 2 percent on Wednesday morning, the lowest it has been in more than a year. (It closed the day at 2.13 percent.)
Those lower rates are likely to be passed through in the form of lower home mortgage interest rates, which could bolster a still-struggling housing market. Thirty-year fixed-rate mortgages averaged 4.13 percent on Tuesday, according to Bankrate.com, a number that could tumble further as the latest bond market moves are priced into consumer mortgages.
But perhaps the overriding message is that this market sell-off, to the degree it is a sell-off at all (the S.&P. 500 decline of 7.4 percent was matched by a similar fall in late 2012), may be bringing market prices more in line with the brutal realities of the economy.
While job growth has been solid this year, wages are rising barely faster than inflation, and the United States economy is producing far below its economic potential by most official estimates. Yet the stock market and other risky investments have generally been on tears since early in 2009, soaring to relatively high valuations relative to earnings. The Fed’s policies of printing trillions of dollars to buy bonds have been an important factor.
So the correction may not be about Wall Street knowing something about the outlook for the future that the rest of us do not, but rather about markets adjusting to more realistically reflect economic reality. Yes, things have improved, but maybe not enough to justify stock prices that are quite so high relative to corporate earnings.
“Due to excessive confidence in central banks, investors eagerly decoupled high market valuations from what was warranted by the sluggish fundamentals,” said Mohamed A. El-Erian, chief economic adviser of Allianz, the financial services company. That disconnect, he said, has been undermined over the last few weeks by signs that the global economy’s fundamentals are weaker than they seemed and concern that the European Central Bank will not adequately fight that continent’s economic drift.
The renewed bout of volatility partly reverses a trend through the first half of the year in which almost all global assets — both safe ones like Treasury bonds and risky ones like stocks and real estate — were increasing in value. Now money is shifting out of risky assets and toward the safe ones, which is a more normal pattern.
There is a big question, though, as to what, if anything, global policy makers ought to do about it. Fed officials have been clear that they expect to start raising interest rates from their longstanding near-zero levels in the middle of 2015. Until this month, markets have believed them.
On Oct. 1, futures markets priced in only about 9 percent odds that the Fed would not raise rates by December 2015. By Wednesday, that had risen to about 40 percent. That means investors are now betting, given the recent declines in stock prices, bond yields and inflation expectations, that Janet L. Yellen, the chairwoman of the Fed, and her colleagues at the central bank are quite a bit less likely to follow through with their plans to increase interest rates next year. There have even been some early rumblings of a new round of quantitative easing, or bond buying (the previous round is set to end in the weeks ahead).
The decision whether to increase interest rates next year will be Ms. Yellen’s first big test in a tenure as chairwoman that began in February, but has thus far largely carried out policies shaped by her predecessor, Ben S. Bernanke.
The quandary for Ms. Yellen, and for anyone reading scary headlines about the latest market moves, is this: Are these the kinds of routine gyrations on Wall Street that can be safely ignored? Or are they a signal that something is seriously wrong and the Fed needs to re-evaluate the path it has embarked on?