One of the interesting comments that I read in the early part of last week when markets were falling was that financial markets were doing poorly while the real economy was doing reasonably well.
Over the last five years, I’ve heard people say countless times that we’ve had a nice recovery in financial assets while the real economy has sputtered along at growth rates well below our historical long-term trend rate.
While that disconnect bothered some people a lot, I kind of thought it made sense because the real economy didn’t fall by more than half during the 2008 financial crisis – the contraction in gross domestic product (GDP) was around five percent.
Although it wasn’t obvious at the time, stocks had overreacted to the economic downturn and snapped back more briskly as the economy recovered.
Adding some evidence to the notion that the real economy is doing reasonably okay was a Commerce Department revision to second quarter GDP that showed an annual growth rate of 3.7 percent, which is much higher than the first estimate of 2.3 percent.
It’s important to remember that the economy had a relatively poor first quarter reading due in part to the cold weather (more here).
Even with the revision last week, the annualized growth rate for the first half of the year was 2.2 percent, which is consistent with growth since the crisis but well below the long-term historical average rate.
Over the weekend, after I had a chance to read up on the GDP revision and the commentary from Jackson Hole, I think I may have jumped the gun last week when I wagered that the Fed would have to wait to raise rates until next year due to the news from China and the associated market volatility. Thankfully, I have less than five dollars at risk…
Stanley Fischer, the Fed’s Vice Chair and headliner in the absence of Chair Janet Yellen, said that he saw ‘good reason’ to expect higher inflation as the economy continued to grow.
St. Louis Fed President said in an interview that the market volatility doesn’t have ‘that much of an impact’ on the outlook for the US economy.
When asked if the volatility affected her view, Cleveland Fed President Loretta Mester said, ‘if I had to say today, does [the volatility] fundamentally change my view, I would say no. I think the actual fundamentals in the economy are quite solid. We’ve gotten some good data.’
Whether the markets reconnect with the economy in the near term is still an open question. The link is probably not as strong as you think even over reasonably long periods, which is part of what makes the market nearly impossible to predict.