The August Employment situation report is set to be released Friday morning. Most likely it will make little difference for the September FOMC meeting. I am challenged to see an outcome from this report that, in the context of the rest of the data, would forestall a hike at that meeting. And given strong momentum the US economy continues to enjoy, it seems that a December hike remains the baseline case.
Incoming data suggests the labor market remains solid. Employment components in both the manufacturing and non-manufacturing ISM reports both rose in August. Initial unemployment claims remains on a downward trend, falling to a record low with the most recent data. There is no evidence in that number that the tariffs announced to date have materially affected the labor market despite sporadic anecdotal reports of layoffs.
The ADP report estimates private sector payrolls for August of 163k, a bit soft relative to expectations but still enough to push unemployment down further over time. Altogether, the numbers point me to expect an employment gain of 190k tomorrow, pretty much in line with the consensus expectation of 195k in a range of 150k-237k. Note though that Calculated Risk reminds us that August is often below consensus.
To be sure, the Fed will be looking deeper into the report than just the job gains. Unemployment is expected to edge back down to it’s current cycle-low of 3.8%. That is a number that will keep fears of overheating alive, which in turn means ongoing rate hikes. Central bankers will also have their eyes glued to the wage numbers. Weak wage growth remains a mystery for the Fed and that mystery helps keep the rate hikes gradual. I suspect that signs of faster wage growth would rattle the Fed, raising concerns that hey have pushed too far past full employment. The policy implication would be either a faster pace of hikes or a longer period of hikes before the Fed pauses. Still, this has long been a risk and it has long been unrealized.
Looking forward, it appears that the economy holds the momentum of the second quarter. The Atlanta Federal Reserve currently pegs third quarter growth a 4.4%, a figure well, well above the median policymaker’s estimate of long run growth. It would be hard for the Fed to pause in the face of such a number. Support for a pause will grow as policy rates move closer to neutral (current estimates centered on a range of 2.75-3.0%). Until then, policy remains somewhat straightforward, but at that point the tension among Fed policymakers and staff will grow as some push for rates to rise above neutral and others advocate patience.
In Fedspeak today we had New York Federal Reserve President John Williams sticking to a story that supports a gradual pace of rate hikes. He remains willing to invert the yield curve if needed. Via Bloomberg:
“We need to make the right decision based on our analysis of where the economy is, and where it’s heading, in terms of our dual mandate goals,” Williams said Thursday while speaking to reporters after an event in Buffalo, New York. “If that were to require us to move interest rates up to the point where the yield curve was flat or inverted, that would not be something I would find worrisome on its own.”
Reiterating my opinion, an inverted yield curve is almost certain to be the only warning sign when that inversion happens, hence why the Fed tends to ignore that sign. In contrast, St. Louis Federal Reserve President James Bullard places more faith in the recessionary signal of an inverted yield curve. Still, I suspect that he would be in the minority of voting members next year should the yield curve invert. My thinking is that absent an obvious slowdown in the economy or a clear tightening of financial conditions that made a slowdown more than likely, the Fed will tend toward the direction of pushing past neutral even if it threatened or caused an inversion of the yield curve. We don’t have much guidance from Federal Reserve Chair Powell on the conditions for a pause.
Separately, Minneapolis Federal Reserve President Neil Kashkari provides this insight on Fed psychology, via Marketwatch:
There’s scarring from the financial crisis, yes. But there’s scarring, bigger scarring from the inflation of the 1970s. And I think that that is persuading us more than anything else and why we’re so biased towards … you know we say that we are we have a symmetric view of inflation. We don’t mind if it’s 2.1 or 1.9 but in our practice, in what we actually do, we are much more worried about high inflation than we are low inflation. And I think that that is the scar from the 1970s.
Yep, that sounds about right. If there was no threat of the zero lower bound, I think the Fed would have set the inflation target lower at 1.75% compared to 2%. Somewhere deep inside the genetic makeup of you average central banker is a deep aversion to inflation. And that is arguably a desirable quality in a policy maker charged with maintaining price stability. But that same quality has in recent years tend to lead the Fed to tighten maybe just a little too hard and a little too long with the result being no real threat to price stability but two recessions.
Bottom Line: Fed still hasn’t found a reason to pause. The US data isn’t really giving one. And don’t expect emerging market turmoil to factor much into the Fed’s decisions – until the problem threatens to wash up on US shores, it will fall into the general category of “risks we talk about but don’t act on.”