Soft July Job Numbers Won't Sway Fed

Still, the Aug. 7 statement is likely to acknowledge continued housing woes as well as increased volatility in the markets

The U.S. government's report on job growth for July—along with a closely watched survey of the service sector—showed some softness for two key components of the U.S. economy. A smaller than expected rise in the key nonfarm payrolls figure in the July jobs report will provide fuel for bond-market bulls to continue to focus on downside risks for growth as they look for acknowledgment—from the Federal Reserve's statement at its Aug. 7 policy meeting—of some signs of weakness in the economy.

Yet the jobs data overall did little to alter the view that labor markets remain tight—with a payroll growth path that is generally in line with the 136,000 average monthly gain in 2007. After all, the payroll growth shortfall in July was mainly due to a decline in the government component for teacher employment that will likely be reversed in August and September. And the Fed is likely to receive only a bit of solace from an uptick in the unemployment rate, and no comfort at all from the persistent strength in wage growth.

Overall, labor market tightness should continue to reinforce the Fed's view that the balance of risk toward higher inflation remains. While there may be some private angst on current conditions among some policymakers, other FOMC members are likely to retain their hawkish stances. Hence, the compromise in the Aug. 7 statement is likely to show some acknowledgment of continuing woes in housing, as well as the increased volatility in the markets, but with the usual statement that moderate growth is still expected. We also suspect concerns over inflation risks will remain paramount.

We see the data released Aug. 3 as consistent with a 2.8% third-quarter gross domestic product forecast, following the 3.4% GDP growth rate in the second quarter that looks poised for an upward revision to 3.5%. The mix of figures is likely right in line with internal Fed estimates, as implied by their 2007 economic projections in the July Monetary Policy Report.

Here, Action Economics takes a closer look at the Aug. 3 reports:

Employment: Nonfarm payrolls rose 92,000 in July from a revised 126,000 in June (from 132,000 previously), while May's 190,000 gain was revised to 188,000, for a net revision of –8,000. The unemployment rate ticked up to 4.6%. Average hourly earnings posted a 0.3% gain on the month following an upward bump to June, leaving a 4.0% year-over-year gain in both months. The average workweek dipped to 33.8 hours from 33.9 hours in June.

In short, the payroll and workweek shortfalls are modest relative to the June overshoots, and the rest of the data largely tracked expectations.

As for some of the components of the report, jobs in the goods-producing sector fell 12,000, while manufacturing employment fell 2,000, and construction employment fell 12,000. Jobs in the service-producing sector rose 104,000.

The report revealed only small shortfalls for both the workweek and payrolls, a slight overperformance for wages, and flat factory figures that shaved other July projections only modestly. We assume a 0.3% July personal income gain that will leave third-quarter disposable income bouncing to the 5% area, following the bonus-related gyration between the first and second quarters (9.5% and 3.5%, respectively).

We expect a 0.4% July industrial production gain that will leave a 3% third-quarter growth rate. This follows rates of 2.9% in the second quarter and 1.1% in the first. The 12,000 drop in construction employment in July, and 0.5% drop in construction hours worked, following the 1.0% June surge, implies a flat July construction spending figure.

The hours-worked index dropped 0.1% in July, following the 0.5% June surge, which left this measure on track for 1.9% growth in the third quarter that is right in line with the 2.3% pace of the second, but above the 1.1% rate in the first.

ISM Nonmanufacturing Index: This service-sector gauge fell to 55.8 in July from a robust 60.7 in June. New orders dropped to 52.8 from 56.9. Employment fell to 51.7 from 55.0. Prices paid dipped to 61.3 from 65.5.

Despite the headline drop from the lofty June level, the figure is in line with the generally solid readings of 53.8 for the ISM manufacturing reading on Aug. 1, though weaker than the Chicago PMI, Philly Fed, and Empire State reports. It may be worth noting that surveys conducted later in the month proved less robust than the figures released earlier, which may suggest some turn in business sentiment through the month.

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