Friday, November 02, 2007

Why are the financial markets in such a panicky state?

Kevin Drum asks an interesting question.
"Employment is up smartly, but Wall Street still doesn't care. Is this because of the old high employment = tight job market = wage growth = inflation = higher interest rate cretinism that infests our economic elites? Or are the problems in the credit market even worse than us little people realize? Hmmm."
Here's my best guess for right now:

The problems in the credit market are serious, but they are long term and not likely to change by surprise tomorrow when the market opens.

The increased employment that will lead to inflation (as will the drop in the value of the dollar and the increase in the dollar-price of oil) are today, and together with the interest rate signals from the Federal Reserve are what is causing the day to day volatility in the market. These are all sources of day to day surprises. It is these day-to-day surprises that are causing the current volatility.

The volatility we are watching is mostly day-to-day and short-term players, and is based on new information entering the markets without any advance warning.

The problems in the credit markets, being already recognized and being medium term, have already been discounted. There was no new information regarding credit problems that would change the financial decisions already made. The volatility in employment has occurred for the last several reports, and has similarly been discounted for the most recent report. Since the information on those problems is not changing from what was expected, the market is not being effected by the credit problems or the increased employment. The volatility has come from things that were surprises that were not anticipated.

That's my bet, anyway.

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