July Employment Recap

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by: Tim Duy

The July employment report came in on the high side of expectations and sufficiently strong to keep the Fed's policy plans for this year and next intact despite low inflation. On average central bankers will have a hard time backing down from rate hike plans with job growth still in excess of that necessary to hold unemployment stable. They may believe the economy is not yet at full employment, but they don't want to be too far below their estimate of the neutral interest rate before they hit full employment. And they don't think that point can be very far off.

Nonfarm payrolls gained 209k, solidly above expectations of 180k:NfpA0817

The pace of job growth is easing, but only gradually. The 12-month average was 180k, compared to 205k in July of last year. The unemployment rate edged down to 4.3%, back to the level of June. The labor force participation rate rose, but remains in the range it has enjoyed since 2016:

NfpD0817

The Fed will take note that job growth remains in excess of labor force growth. That difference generally drives unemployment lower:

NfpD0817

The big labor force gains occurred at the beginning of 2016, which helped stabilize the unemployment rate. The current dynamic will almost certainly push unemployment lower and past the Fed's comfort levels, probably sooner than later.

The Fed will see hopeful signs in the wage numbers. Average wages grew at a 4.19% annualized rate in July, giving credence to the theory that the slowdown in wage growth earlier this year was temporary:
Nfpb0817

To be sure though, one month does not a trend make. But the Fed will not be making a decision on one month of data. Balance sheet normalization will almost certainly begin in September (barring a disruptive debt ceiling battle), leaving December for a potential rate hike. If wage data continues to come in closer to July's number than June's, the Fed will feel more confident that they a.) have the correct estimate of the natural rate of unemployment and b.) that inflation will return to their 2% target over the medium run. Hence, the December rate hike remains in play.

Solid job growth seems likely to continue. That at least is the story told by temporary help payrolls:

NfpD0817

We are well past the flattening out of early last year. For those looking for an imminent recession, this isn't showing one. And for those looking for a market crash, look at the similar behavior of this indicator in 1995. As is now well known, that market crash was still a long ways off.

Bottom Line: A solid report that suggests further declines in the unemployment rate in the months ahead. The Fed will want to stay preemptive in this environment. I don't foresee them backing off their rate forecast for this year and next very easily.

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