This Is The Fed's Worst Fear: Falling Unemployment, With Growth Still Weak

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On Friday, the government said that just 88,000 jobs were created in March, a number that came in well below expectations.

And yet the unemployment rate fell again, with big drops seen in some key demographics.

That means the unemployment rate is marching ever closer to levels where the Fed has indicated it might begin to consider tightening.

According to Morgan Stanley's chief economist Vincent Reinhart, this represents the Fed's #1 fear.

...the Fed’s chief fear will be that market participants will expect policy tightening to come sooner and more sharply than is consistent with sustaining the economic expansion.  All the talk about tapering off, or even ending, QE has been careful to be conditional on the outlook.  If our economic forecast unfolds and the remainder of the first half proves challenging, talk of tapering off will, well, taper off.  Against that backdrop, we think the Fed will continue to add $85 billion of securities per month to its balance sheet over the course of 2013.  Only as the expansion gets steam will the pace of QE be moderated.   

Of more pressing concern for the Fed is the inconvenient fact that the unemployment rate keeps dropping.  When the Fed first set the Evans threshold on the unemployment rate at 6-1/2 percent, it must not have envisioned the ongoing exit of workers from the labor market.  While the words of the FOMC statement reassure that policy makers will look at a wide array of information, “…including additional measures of labor market conditions,” it will be difficult to wean market participants away from the notion that 6-1/2 is a hard trigger for raising the policy rate.  Fed officials have already tried to put white space between their policy decision and that number, and we look for them to do so increasingly.



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