Jobs: A September Shocker

Solid payroll growth and a reversal of the previous month's decline eased worries about an economic slowdown. But rising wages may signal inflation headaches

Did the Federal Reserve really need to cut rates a hefty 50 basis points on Sept. 18? Policymakers' case for a jumbo easing was diminished by the September U.S. employment report released on Oct. 5. While the gain in headline nonfarm payrolls of 110,000 on the month was right in line with market expectations, the real shocker came in the revision to August's figure. Recall that the decline of 4,000 jobs originally reported for August was seen as the catalyst for the central bank's big rate cut. Well, that figure was revised by the Bureau of Labor Statistics (BLS) to a gain of 89,000 in the September report.

Action Economics thinks the Oct. 5 report powerfully refuted expectations of a rapidly softening economy, by revising away much of the weakness in the August report and returning to the solid levels of job growth typical of the current expansion in September. And another hefty round of wage increases in September provided a not-so-subtle reminder of the two-sided risk that faces Fed policymakers, as inflation continues to percolate.

The report no doubt occasioned some "I told you so" reactions from market observers who believed that the Fed's Sept. 18 cut fell into the "one and done" category. Treasury prices fell, and yields rose on Oct. 5 as the likelihood of rate cuts at the Fed's Oct. 30-31 meeting receded. In contrast, equities ramped higher and the dollar managed to recover somewhat on the day from its recent weakness vs. other major currencies.

Positive Effect on Other Indicators

Looking elsewhere in the September report, the unemployment rate ticked higher, to 4.70% from 4.64%, while the household employment measure surged 463,000, following the 316,000 drop in August that appeared troublesome at the time. The average work week held at a solid 33.8 hours. Average hourly earnings increased a hefty 0.4% (median 0.3%), which left year-over-year earnings growth at 4.3%. This matches the cyclical high set in April, 2006.

As for industry payroll growth, manufacturing dropped 18,000, construction declined 14,000, private service payrolls rose 106,000, and government payrolls rose 37,000. The bulk of the upward revision to August was found in government payrolls, with a current gain of 57,000 compared to the initially reported loss of 28,000.

The strength in the September report has positive implications for other key economic data for the month. We now assume a 0.5% personal income gain that will leave disposable income growth bouncing to the 5.9% area in the third quarter, following the bonus-related gyration between the first and second quarters of this year of 9.1% and 4.8%, respectively. We now project a 0.1% September industrial production gain that will leave this measure poised for a 4.1% third-quarter growth rate. This follows rates of 3.6% in the second quarter and 1.1% in the first.

Growth Revisions Smaller than Projected

The 0.1% rise in the September hours-worked index leaves this aggregate growing at a 1.2% rate in the third quarter, following 2.1% growth in the second and a 1.1% rate in the first. The 3.8% second-quarter final gross domestic product growth rate outpaced hours-worked growth by 1.7%, and our third-quarter GDP forecast of 3.0% suggests almost the same mark-up in growth from hours worked.

The drop in construction employment in September, but with a 0.1% rise in construction hours worked, has boosted our September construction spending forecast to –0.2%, following the surprising 0.2% August rise.

The BLS also said it estimates a downward revision of 297,000 in payroll growth between April, 2006, and March, 2007. Although this revision is downward and translates to a decrease of 25,000 per month over the twelve months ending in March, the revision is smaller than many economists had expected to see earlier this year. It now appears that the payroll back-revisions in 2008 will still leave a general out-performance of job growth through late 2006 and early 2007, though to a smaller degree than reported previously. Productivity growth will likely be boosted by around 0.2% over the period to offset the lower payroll trajectory.

Inflation Risks Continue

For the Fed, the September jobs report provides cover for the unchanged policy stance we expect at the Oct. 30-31 FOMC meeting. And the hefty 0.4% September wage gain, and 4.3% year-over-year increase, will heighten concerns that Bernanke & Co. may have used too much policy firepower at the Sept. 18 meeting, as many inflation-wary Fed watchers, including ourselves, thought at the time.

Of course, we still aren't out of the woods with regard to credit market turmoil, but the risks of a slowdown have been reduced by the September jobs data. And the strength in wages reminds us that the upside inflation risks to the economy are still intact.

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