Stocks in the U.S. saw one of their steepest declines late last week on worries that the Federal Reserve will begin tightening its monetary policy this week. Bond yields also rose in last week trading, with the 10-year U.S. Treasury rose over 15 basis points in a month to 2.62%. Some analysts believe the sell-off is likely to continue as several metrics point to a much-needed correction in equity markets.
The Federal Open Market Committee will meet to discuss its plans for monetary policy over two days on September 16th and 17th. After the last meeting, U.S. stocks saw a steep correction, losing 3% in the week following the meeting.
The Standard and Poor’s 500 index lost over a percent in the first half of September, while the Dow Jones was off a little nearly 0.9%. Both remain positive for 2014.
“Significant Underutilization of Labor Resources”
Analysts believe that the Federal Reserve is expecting greater inflationary pressures to enter the market after several rounds of quantitative easing has caused the Fed’s balance sheet to grow from about $1 trillion to nearly $4.5 trillion in six years.
In an attempt to improve employment and minimize the damage of the global financial crisis, the Fed has attempted to stimulate the economy through purchases of bonds, asset-backed securities, and other financial products through a series of QE programs.
While many analysts believe these efforts minimized unemployment in the short-term, others believe that the Fed would remain focused on indications of unusually high unemployment in its monetary policy throughout the remainder of 2014 and 2015. In a report to investors, Merrill Lynch said that the Fed is likely to remain dovish in the Federal Open Market Committee meeting this week by emphasizing the need to improve employment rates in the nation. “Given the soft August jobs report, we expect them to continue to see a ‘significant underutilization of labor resources.’ That language change probably requires a couple of better jobs reports,” said the bank in its report.
Likewise, in a separate report Goldman Sachs announced that the FOMC would not likely raise its funds rate until the middle of 2015. “There is nothing to indicate that those previously expecting a mid-2015 hike have moved,” said the report.
Despite a declining headline unemployment rate, which fell to 6.1% in August compared to 7.2% a year ago and 10% at the height of the financial crisis, expectations remain dovish.
Many analysts believe the Fed is looking at more indicators of slack in the labor market beyond the unemployment rate. The labor participation rate, which Fed Chairwoman Janet Yellen has commented on in recent speeches, is at a 36 year low. Some analysts believe this is due to more retiring baby boomers, while others note that labor participation is lower amongst Americans of prime working age. The impact this will have on inflation rates remains controversial.
Wages, job openings, and job churn have also faced greater scrutiny amongst analysts. Despite declining unemployment in 2014, voluntary job quits and wage growth have remained extremely low, which suggest that many workers remain uncomfortable with the current job market, while negotiating power for more pay and benefits remains limited amongst employees as the economy offers less job opportunities to a continually growing population.