Jobs growth galore
We saw powerful job gains in the month of July, with non-farm payrolls expanding 255,000. And June's blowout report was actually revised slightly upward - from 287,000 to 292,000. What's more, the Bureau of Labor Statistics revised upward the May and June job count by a total of 18,000, bringing the 3- and 12-month average increases to an impressive 190,000 and 206,000, respectively.
Even labor force participation slightly improved, although it remains low in relative terms, likely reflecting longer-term demographic trends.
Because some of the job gains came from typically higher paying sectors (such as professional and business services along with financial services), it's not surprising that we saw some wage growth. Average hourly earnings rose 0.3% for the month and 2.6% year over year (y/y) - which is a high level for the past decade.
However, wage growth may be tempered going forward if we continue to see a lack of job growth in manufacturing, construction and mining. Weak productivity may also explain the increase in wages as rising unit labor costs look set to continue impacting profit margins.
Fed's precarious balancing act
Given this strong jobs report, the question becomes what it will take for the Fed to raise rates, which is complicated by the Fed's dual mandate of price stability and full employment. Interestingly, many central banks have a single mandate, focused on controlling inflation.
However, as a result of the Humphrey-Hawkins Act of 1978, which amended the Employment Act of 1946, the Fed was instructed to pursue dual goals.
Early in his tenure, Fed Chair Paul Volcker was criticized for pursuing just the inflation goal and explained in his 1981 testimony to the Senate Subcommittee on Banking, Housing and Urban Affairs:
I bring in price stability because we will not be successful, in my opinion, in pursuing a full employment policy unless we take care of the inflation side of the equation while we are doing it. I don't think we have the choice in current circumstances - the old tradeoff analysis - of buying full employment with a little more inflation.
Inflation isn't what it used to be
Fast forward to the past few years and, of course, controlling inflation has not been the issue; stimulating inflation has become the difficult task. While we have reached the Fed's definition of full employment, its inflation target has been more elusive. It seems that inflation could become increasingly important in dictating the Fed's next rate hike decisions. Both the overall Personal Consumption Expenditures (PCE) index and the core index (excluding both food and energy) are up only 0.1% for the month. The year-over-year figures remain unchanged with overall PCE up 0.9% and core PCE up 1.6%.
While we haven't yet seen a substantial increase in inflation, we wouldn't be surprised to see it climb materially higher this year and force the Fed's hand; in other words, a little more employment might deliver a little more inflation - and then some. There is already strong momentum in service price inflation, which is up 3.2% (y/y), although it has been offset somewhat by goods price deflation this year in the non-core component-commodities.
Nevertheless, even with a more inflationary bias to the economy, the Fed has already demonstrated that its bar for raising rates is much higher than many expected. Therefore we need to remember the caveat that even if the market prices in a greater probability of a hike, the resulting rise in the dollar may be sufficient to prevent the FOMC from following through, as has been the case earlier this year.
Fuel for September Fed hike?
In short, what appears to be labor market tightening increases the possibility - at least slightly - of a rate hike in September. There seems to be something of an urban legend that the Fed won't act so close to the US presidential election.
We think it is a mistake to automatically assume the Fed won't act; the probability of a rate hike in September still seems too low.
The Fed remains "data-dependent" and will continue to base its decisions on data related to inflation and inflation expectations, currency market valuations and the level and shape of the yield curve.
In addition, policy and economic developments in both developed and emerging economies and the flow of other data on US real economic performance will also be crucial factors. While it may be too early to speculate as to whether or not the FOMC will vote to raise policy rates at their September meeting, market participants must prepare for this possibility - and follow upcoming data closely.