Fear Is Mounting On Wall Street That The Fed Will ‘Fall Behind The Curve’ Like In 1994

There is growing concern on Wall Street that there may be less slack in the job market than the Federal Reserve perceives, leading to a scenario where the central bank finds itself “behind the curve” with regard to winding down unprecedented levels of extraordinary monetary stimulus as inflation returns.

Aneta Markowska, chief U.S. economist at Société Générale, writes in a note to clients that “Could the Fed hike rates in 2014?” is one of the top questions that has come up in recent meetings with investors.

The proximity of the current unemployment rate to the Fed’s threshold is stoking the debate on Wall Street surrounding a potential scenario that has largely been lost in all of the negative sentiment toward the pace of economic recovery in recent years: what if the central bank’s own projections for prices and the labor market are too pessimistic, and justifications for continued stimulus are quickly waning?

“Albeit 20 years ago, 1994 has not yet left the collective memory of markets, and the fear is that 2014 could see a replay hereof,” says Markowska.

Key to the debate is to what extent recent declines in labor force participation — one of the drivers of downward pressure on the unemployment rate — are cyclical (i.e., reflecting economic weakness) versus structural (i.e., resulting from longer-term trends like demographics).

If the decline in participation is largely cyclical, inflation is not a threat. If it is structural, then there will be a smaller pool of workers available to fill job openings as the economy picks up, and the risk becomes upward pressure on wages and inflation.

Fed officials fear a significant amount of the decline in participation is cyclical, which is why they have increasingly sought in recent communications to downplay the 6.5% unemployment rate threshold for consideration of rate hikes in order to push out the market’s timeline for when the central bank is expected to move.

Full article: Fear Is Mounting On Wall Street That The Fed Will ‘Fall Behind The Curve’ Like In 1994 (Business Insider)

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