If Not September Then December

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The weak August employment report will do little to dissuade the FOMC from hiking interest rates by December.

The Fed will pay more attention to the longer-term gains in payrolls and hourly wages.

The Fed may skip September, but with strong consumer spending and an economy near full employment, a December hike is a foregone conclusion.

The 151,000 increase in nonfarm payrolls in August fell considerably short of the 180,000 consensus estimate. The market's immediate reaction was to rally. Why? Because investors are betting that the weak jobs report means that Federal Open Market Committee can't raise the fed funds rate at their next meeting on September 21.

There is no doubt that the probability of a September hike just decreased. Even so, this does not necessarily rule out a September hike entirely. And it does virtually nothing to the probability of a hike by December. Despite the weaker-than-expected headline number in the August employment report, there were a few bright spots, which leaves plenty of room for the Fed to raise interest rates sometime in the very near future.

The August payroll figure is just a single observation. The bigger picture is more upbeat. Over the course of the past year, nonfarm payrolls have increased by an average of 204,000 per month. That's reasonably strong job growth. In addition, the employment situation is quite strong in several key industries. Admittedly, some industries continue to struggle. Mining, in particular, has been a big loser, shedding 223,000 jobs since September 2014. However, the decline in mining is a direct result of plunging oil and gas prices. What's bad news for oil and gas workers is actually good news for consumers overall. We saw that in the GDP report for the second quarter. Personal consumption expenditures jumped 4.4%.

In addition, despite a slight downtick in average weekly hours, average hourly earnings moved higher. They are now up 2.4% year over year. Like the average monthly gain in nonfarm payrolls, this, too, is a reasonably healthy increase and one that suggests that the employment market is tighter than the historically low labor force participation rate indicates. The FOMC has been looking for higher wages to fuel the inflation it wants to see before raising interest rates.

It is wrong to conclude that August's weaker-than-expected gain in nonfarm payrolls signals a struggling labor market. On the contrary, it could be telling us that the economy is near full employment. The U-3 unemployment rate of 4.9% is very close to its lowest level since just before the financial crisis. Even the more inclusive U-6 unemployment rate of 9.7% is near its pre-financial crisis lows.

The labor market is much stronger than the August report suggests. In my view, it will have no impact on the thinking of FOMC members. The bottom line is that interest rates have been too low for too long. The Fed is itching to increase them marginally and the market is ready to absorb a small hike. With a presidential election on the horizon, the FOMC is not likely to move in September; but unless the economy suddenly tanks in the next three months, a rate hike by December is a foregone conclusion.

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