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Many news outlets, such as this one (there are many examples), are reporting that the current US stock sell-off is due to a stronger-than-expected jobs report in January and fears of inflation and rising interest rates.

I don't follow the logic, so I'm hoping someone can explain to me:

  • How/why does increasing the number of jobs increase inflation?
  • Why would rising inflation (and interest rates cause people to sell off their stocks? Is it true that interest rates are intentionally raised to combat inflation?
  • What does this kind of news mean for me on a personal finance level? I personally don't actively invest in stocks at present, but do have some savings in the bank, but I'm sure other readers would be interested in a holistic answer covering stocks/bonds/cash/employment/etc.

closed as off-topic by Dheer, Nathan L, Joe, JoeTaxpayer Feb 6 '18 at 22:02

This question appears to be off-topic. The users who voted to close gave this specific reason:

  • "Questions on economics are off-topic unless they relate directly to personal finance." – Dheer, Nathan L, Joe, JoeTaxpayer
If this question can be reworded to fit the rules in the help center, please edit the question.

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    Most analysis on why the market did something are post-facto stories that probably don't have a lot to do with what actually happened. – zeta-band Feb 5 '18 at 22:36
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    @SimonB It is a question of risk. Higher inflation means rising bank rates. So there would be a small amount of movement from risky stock market to safe bonds. As there is outflow of money, the price in stock market will fall – Dheer Feb 6 '18 at 0:55
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    @Dheer only if you get to choose the definition of "inflation". To most people, inflation is just prices going up, whatever the cause. That could be the government printing too much money, or it could be shortages of essential materials. – Simon B Feb 6 '18 at 8:30
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    @jamesqf Inflation in very simple terms if More Demand, Less Supply with all other thing being equal. There is whole economics branch dealing with this. Increase of money by Govt "printing" is just one aspect of it. There are tons of other factors reasons. – Dheer Feb 6 '18 at 10:49
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    The real answer to why this is happening: greekshares.com/images/article-images_en/… – JonathanReez Feb 6 '18 at 18:40
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Many news outlets ... are reporting that the current US stock sell-off is due to a stronger-than-expected jobs report in January...

Had the market done well in the last few days those same people would have claimed it was due to the stronger than expected jobs report, and in fact oftentimes a strong jobs report does lead to a bump in the market. Furhtermore, inflation in the long run means prices increase, including stock prices; not the other way around. (Which is why a small amount of inflation is healthy for a generally growing economy.) It's true that interest rate increases temporarily stall the market, but they go up on purpose when the economy is doing well to give the fed more wiggle room to provide an economic boost in the future when necessary (by lowering rates). Eventually inflation has a larger effect on the economy than higher rates and the markets continue to rise regardless.

The current market dip is happening because it is happening. Perhaps some people (and trading algorithms) decided to temporarily lock in their recent gains, and others immediately followed suit, and then it snowballed into everyone falling in line. Sometime in the future (perhaps tomorrow, perhaps a month from now) some investors will get the bright idea to try to beat the slow growth of bonds with some large stock purchases, then others will try it too, and then everyone will fall in line again and up it goes. Rinse and repeat.

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    In other words, a load of sheep following a twitchy sheep... – TripeHound Feb 6 '18 at 10:31
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    Media wants to feed confirmation bias. Good answer! – Crosscounter Feb 6 '18 at 18:19
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    @TripeHound a load of electric sheep following twitchy electric sheep; virtually all stock trading now is done on the millisecond timescale by computers anyways. – cms Feb 6 '18 at 19:27
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    @Patrick - I assume you are arguing semantics on both of your points? If the question is "Why does X cause Y?" You don't consider "It doesn't." to be a valid answer? And banks/financial institutions and stocks/mutual funds is bothering you? – TTT Feb 8 '18 at 15:34
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    @Patrick this is a communal site; please feel free to edit the answer. – TTT Feb 8 '18 at 18:24
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First, I advise against attributing stock market movements to particular pieces of news. Many cable shows depend on your interest in this question, but unless the news is nuclear war, its long-term effect is generally exaggerated on the day that it takes place. And the jobs report really wasn't so out-of-line, and other similar reports over the last several years had no effect like this.

The rise in interest rates is in this case likely to result in stocks dropping for at least three reasons. One is that for some time the stock market (and to some extent real estate) has been the only place to get decent returns. Money might move into cash or new, higher-rate bonds. Not existing bonds; they have also been dropping in the expectation their real (inflation-adjusted) fixed interest rate will be less valuable. There is also the possibility that rising Fed rates coupled with the huge jump in the Federal deficit will make capital expansion much more expensive, hurting profitability. And finally there is the possibility that interest rates will rise enough to slow economic growth (take Trump's prediction of GDP growth north of 3% as nonsense) so much we go into recession, just as demand was finally picking up.

  • Could rising rates also motivate selling to free up cash to pay off debt before that debt becomes more expensive? – Todd Wilcox Feb 6 '18 at 13:41
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    The app I use for checking prices has a newsticker that sometimes reads xyz happened and now stock abc rises. Then the tide turns and they change the headline by substituting rises with falls. Just like that. – DonQuiKong Feb 6 '18 at 13:52
  • @ToddWilcox So, you'd probably be paying off either a variable rate credit card or an adjustable-rate mortgage. That's possible, but people with large balances there probably have modest investments in stocks at best. Now, institutions might be selling to have more cash to lend; that could easily contribute. – Andrew Lazarus Feb 6 '18 at 16:43
  • I thought maybe corporations, non-profits, municipalities, and other entities might also have variable interest debt that they might want to pay down, or they might want to pay cash instead of incurring new debt. Just an uneducated guess. – Todd Wilcox Feb 6 '18 at 16:45
  • I'm sure it exists, but those entities are mostly issuing fixed-rate instruments. – Andrew Lazarus Feb 6 '18 at 17:45
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How/why does increasing the number of jobs increase inflation?

When the economy gets towards the theoretical Full Employment level (not the same as 0% unemployment), and employers still need more employees, then according to the law of supply and demand they should start to bid up wages so as to poach employees from other companies.

Practically, I find that dubious.

Why would rising inflation (and interest rates, I understand that interest rates are intentionally raised to combat inflation) cause people to sell off their stocks?

As @AndrewLazarus mentioned, the stock market has been the best place to get yields, since interest rates have been so low.

With rising interest rates, you can (theoretically) get good returns without as much risk. Thus, you sell off now while the market is high, so as to have cash available when things shake out.

I think it's the herd of sheep mentality, though, combined with algorithmic trading that kicks in when certain conditions are reached.

What does this mean for me on a personal finance level? I personally don't actively invest in stocks at present,

Not much. Maybe you'll get a bigger than normal raise.

but do have some savings in the bank,

If it's in an online bank, you'll have notice increasing rates over the past couple of months.

but I'm sure other readers would be interested in a holistic answer covering stocks/bonds/cash/employment/etc.

There are too many computer algorithms, and so many people automatically shoveling money into the stock market (401k, etc) for me to even dream of a holistic answer. Anyone who gives you one is guaranteed to be wrong.

  • Even if employees do not become so rare that higher demand for lower supply makes wages rise, it is already the very fact that more employees do have income that increases spending power - and this increases demand (hence prices) on consumer markets that do not grow 1:1 parallel to the increased production – Hagen von Eitzen Feb 6 '18 at 16:04
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If the hiring market is strong, more people are employed and wages increase (as employers chase the better employees). It's not so much that more jobs causes inflation as that the same thing that causes more jobs causes wage increases. And wage increases lead to increased prices, otherwise known as inflation.

To combat inflation, the Federal Reserve reduces the amount of money in circulation. It does this by selling assets in its portfolio. This is mostly treasury bonds normally, but they expanded out to other securities. In particular, they own a lot of mortgage debt. Reducing the amount of money in circulation reduces inflationary pressures and it causes interest rates to rise. Because the Fed uses an interest rate target to tell when it has sold enough assets, this is often described as raising interest rates to combat inflation. But the actual effect is more direct than that.

If real (after inflation) interest rates are higher, then people who just barely preferred stocks at the lower interest rate now prefer the higher interest rate to stocks. And then of course there are all the people who now believe that stocks are going to fall, so they sell before the expected fall. Selling of course makes stock prices fall if not balanced by strong interest in purchasing.

Personal finance

This may be a good time to hit your boss up for a raise.

This may be a bad time to lock in interest rates that you will receive (e.g. a Certificate of Deposit).

This may be a good time to lock in interest rates that you will pay, e.g. for a mortgage or car loan.

Of course, all this assumes that this is the start of a market correction and not a one or two day event that will be followed by a strong increase over the next week or so.

  • Odd that you have to go four answers down to find an actual answer to the question of "why would rising inflation cause people to sell off their stocks?" – Patrick Feb 8 '18 at 13:36
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I'm not a 100% on this, but from what I have read: Recent tax cuts created new jobs from new/ existing companies. However, the tax cuts means less money for the government. Which means the government has to borrow money. Therefore it is more profitable to invest in the treasury than stocks as it is safer. So people are selling their stocks to reinvest elsewhere.

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Inflation is the result of an increased money supply in the economy. The economy has been growing faster over the last few months. This will impact the Fed's policy. They will drastically reduce the available money in the market (the supply), to avoid inflation rising faster than the actual growth of the economy, thereby effectively reducing the value of the USD as a legal tender. Reducing money supply will increase interests. Increased interest reduces profits of businesses (cost of capital increases).

Money supply is still high. The fed has been increasing the supply since the financial crisis and has only recently started to scale back. This additional money supply flowed to big businesses in the form of loans. Businesses were able to borrow a lot of money at low interest rates. This made profits soar (because very low costs of capital), which attracted investors into the stock market and as a result made the stock market soar to all time highs.

Unemployment is now low as well, and as a result of rising wages will impact the spending of consumers in the economy. This will also increase inflation, as prices of goods and services will increase due to increased demand.

But most of all, it seems the party of very low interest rates for businesses, and ballooning profits will soon be over (because of increasing costs of capital / interest rates). Investors in the stock market are taking their profits.

  • "Inflation is the result of an increased money supply in the economy." No, it's a result of higher ratio of money supply to goods and services. If the real economy is expanding (that is, the actual value of production is increasing), then that counteracts a higher money supply. – Acccumulation Feb 6 '18 at 17:24
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How/why does increasing the number of jobs increase inflation

The relationship between unemployment and inflation is known as the Phillips Curve

Think of it this way: Suppose you want your house painted. If there are many painters looking for work, you will need to pay less to paint your house than if painters are fully employed with other projects.

Why would rising inflation (and interest rates, I understand that interest rates are intentionally raised to combat inflation) cause people to sell off their stocks?

Think of a company as a stream of future earning. Each year a certain amount of money will be earned (or lost). What is the value of the sum of all the future earnings?

The value of each future payment must be discounted by 1/(1 + r)^t where r is the interest rate and t is time to find the present value.

For this reason, with no change in future earnings, the fact that interest rates are higher makes stocks (and all other streams of future payments) less valuable.

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Simple answers to your queries are following:

  1. How/why does increasing the number of jobs increase inflation?

Increase in jobs means more wages being paid out by companies. More wages lead to increase in spend. Increased spending leads to higher demand for products/services. Higher demand leads to increase in prices (low supply-high demand leads to price rise). Higher prices = Higher inflation.

  1. (part-one) Why would rising inflation?

I have just answered this question in previous paragraph.

  1. (part-two) what causes people to sell off their stocks?

I fear the answer to this question is rather indirect. More wages means more spend by companies. Higher spend on salaries COUPLED with potential increase in rates means decreasing margins in near future. Decrese in margins means a correction in stock prices.

  1. What does this mean for me on a personal finance level? I personally don't actively invest in stocks at present, but do have some savings in the bank, but I'm sure other readers would be interested in a holistic answer covering stocks/bonds/cash/employment/etc.

If you are saving in banks, then you are in a good position if rates are hiked. For others the simple advice is this: Never panic because everyone is selling. Not every company or asset is going to be affected by rate hikes. For example, a company employing high degree of automation and has savings may perform better in high inflation conditions. Hence the impact is on per-case basis.

  • Inflation means the price of goods is increasing too. A small increase in inflation should not result in substantially lower margins on average. People sell because they expect higher interest rates and reduced growth. – Patrick Feb 8 '18 at 13:38
  • I didn't say inflation directly reduces margins. Please check my answer for part-two of second question. I said the increased wages and increased workforce will hurt the margins of companies. – Kannan Feb 8 '18 at 14:09
  • Inflation will increased wages (usually, in aggregate) but it will also increase the price of goods sold (usually, in aggregate) so there's no reason to think margins will be squeezed. If I sell good for 10% more and I pay 10% more for inputs, my margin remains constant. – Patrick Feb 8 '18 at 18:20

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