The first quarter was volatile compared to the placid markets we experienced from 2012-2014. The main cause of concern for investors is the increasing likelihood the Federal Reserve will end its financial crisis policy of zero short term interest rates. The Board of Governors of the Fed meets ten times each year. Recent meetings have yielded signs the Fed intends to begin a return to more traditional monetary policy in 2015. The two questions facing investors are: when does the Fed start and how high will short term rates go?
The Fed’s mandate is twofold; control inflation and promote full employment. Inflation gauges currently indicate tame price pressures. The big drop in energy prices insures that inflation will remain modest. Judging full employment and the subsequent inflationary movement of wages is more difficult; should the Fed act to promote more jobs or to fight wage inflation?
While the headline rate of unemployment has dropped below 6%, this recovery has been marked by a consistent drop in the number of working age adults participating in the labor force. The problem accelerated during the Great Recession.
How many workers have permanently left the labor force and how many are waiting for a signal to return to work? Signals that could entice workers to return to work include higher wages, completion of retraining or additional education or being recalled to work from a previous employer.
The Fed does not want to derail economic growth and has signed a willingness to wait until data confirms the recovery in the labor markets is indeed durable. Four points the Fed may be watching are:
Less labor market slack – the number of part-time workers drops back to traditional levels.
Inflation data – higher prices at the consumer level would be welcome. Two percent is the Fed’s target.
Wage growth – another sign the overall labor market is getting tighter.
Prices of commodities, strength of the dollar, stocks and the direction of long term interest rates.
The Great Recession has ended and most parts of the US economy are functioning normally. A return to more traditional monetary policy will be welcome as it will indicate the worst recession in 80 years is finally behind us.