July Jobs: Pretext for a Fed Pause?

Subpar jobs growth might rule out another rate hike, or the Fed may still see inflation risk in the wage and earnings numbers

If the Federal Reserve wanted cover for its intended pause in its series of rate hikes at its Aug. 8 policy meeting, the July employment report released on Aug. 4 should do the trick. Nonfarm payrolls rose 113,000 in July, well below the 146,000 median forecast of economists. June's job growth was revised to 124,000 from 121,000, while May was revised to 100,000 from 92,000 for a net increase over the two months of 11,000.

But pardon Fed staffers if they don't breathe a sigh of relief. While the headline payrolls number appeared soft—and encouraged investors that subpar job growth would ease inflationary pressures—other components of the July report show that wage acceleration continues to gain steam. Average hourly earnings were up 0.4% in July after a 0.4% rise in June (revised from 0.5%).

On a year-over-year basis, earnings slowed to a 3.8% clip, compared to a 3.9% pace previously on the seasonally adjusted table. But the more important year-over-year not seasonally adjusted (NSA) calculation revealed a hefty boost to 4.1% in July from 3.9% in June. The Fed has to be concerned that the pass-through of energy-led headline inflation to the various core measures is now also penetrating these important labor-market measures of cost-push inflation.


  Elsewhere in the report, the unemployment rate surged to 4.8% (median 4.6%), from 4.6% in June, with the household employment series dropping 34,000 following the strong gains over the last several months. The July pop in the unemployment rate is as much a reflection of a temporary labor-force rise as it is of job weakness. The workweek held at a high 33.9 hours (median 33.9), and the factory workweek surged to 41.5 hours.

Payrolls over the last four months have been notably underperforming their 162,000 two-year average monthly gain, even though many indicators suggest a continued tightening in labor-market conditions. To the extent that the market focuses on payroll numbers, the desired slowdown in the economy is under way.

But any slowing trend may not be evident in other reports for July. We project a 0.6% industrial production gain in July based on the factory workweek strength and likely robust utility figures for the month, following the big 0.8% surge in June, to leave a big 6% growth clip for the index in the third quarter. The personal income gain for July should be a hearty 0.5%, led by the jumbo 0.4% wage gain and continued workweek strength. Hours worked are poised for a solid 2% growth clip in the third quarter.


  These factors, combined with the favorable implications for income and industrial production, would generally signal a 3%-4% real (adjusted for inflation) gross domestic product gain in the quarter, though we will continue to keep our forecast at a cautious 3%. Even our low-end forecast for GDP growth is much stronger than the 2% internal estimates that the Fed must have for the third and fourth quarters to support the annual forecasts revealed in the Fed's midyear Monetary Policy Report.

Financial markets keyed on the softer headline payrolls figure on Aug. 4. Bond yields tumbled, while equities posted solid gains on the prospect of a pause by Ben Bernanke & Co. Fed funds futures, a vehicle for market pros to make bets on interest rate moves, soared on the July jobs print and now imply only about 20% risk for a quarter-point hike on Aug. 8. But deferred futures contracts show about a 50% chance for a tightening to 5.5% over one of the subsequent three Federal Open Market Committee (FOMC) meetings in 2006.

We expect the Aug. 8 FOMC statement will contain hawkish elements, still citing concerns over inflation risks amid high resource utilization and elevated commodity prices. The Fed may indeed be comfortable with a near-term pause to assess both the inflation up-trend and economic slowdown, though policymakers may not think it desirable to maintain this holding pattern for long.

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