This August was different

The strength of the U.S. labour market gives the Federal Reserve cover to continue hiking interest rates aggressively. The August employment report is what the Fed wants.

Employment growth moderated and monthly gains in average hourly earnings cooled. Also, the labour force participation rate increased. If sustained, higher participation would help alleviate some labour supply issues. The primeage employment-to-population ratio also increased, rising from 80% to 80.3%.

The August employment report doesn’t settle the debate on whether the Fed will hike the target range for the fed funds rate by 50 or 75 basis points later this month. Financial markets view it as a toss-up. They are pricing in 65 basis points of tightening at the September meeting of the central bank’s Federal Open Market Committee.

What will determine the size of the rate hike is the September consumer price index.

The Fed needs to tighten monetary policy sufficiently to slow GDP growth to a below-potential pace to rebalance supply and demand in the labour market enough to bring down wage growth and inflation.

The July Job Openings and Labour Turnover Survey data suggest that the weakness in GDP hasn’t helped rebalance labour supply and demand. Monetary policy can’t directly affect labour supply, but it can impact demand.

August employment better than expected

Nonfarm employment increased by a net 315,000 jobs, modestly stronger than either we or the consensus anticipated. The net revision to the prior two months subtracted 107,000 jobs. The three-month moving average in nonfarm employment was 378,000 in August, a slight step down from 402,000 in July.

Goods-producing employment increased 45,000 in August following a 66,000-job gain in July. Within goods, mining and logging rose 7,000, in line with that seen over the prior two months.

Construction employment continues to hold up, even though it is interest-rate sensitive and residential investment has weakened recently. Construction employment added 16,000 in August after rising 24,000 in July.

Private services employment increased 263,000 in August, noticeably weaker than the 411,000 gain in July. Despite the shift from spending on goods to services, retail employment growth remained strong. It was up 44,000 in August following a 29,000 gain in July and 22,000 in June. Transportation and warehousing employment increased 5,000, while information rose 7,000.

Temporary help services employment was up 12,000 in August compared with 9,000 in July. Temporary help is normally a leading indicator and declines ahead of recessions. Elsewhere, education and healthcare increased 68,000 after jumping 118,000 in July.

Average hourly earnings rose 0.3% in August, in line with our forecast. The gain in August leaves average hourly earnings up 5.2% on a year-ago basis, matching the gain in July. The labour income proxy rose 0.2% in August, noticeably weaker than that seen over the past several months.

Rising for right reason

Household employment increased 442,000, while the number of unemployed rose 344,000. Duration of unemployment rose, as did the labour force.

The labour force participation rate increased from 62.1% to 62.4%. The unemployment rate increased from 3.5% to 3.7%. Unemployment rates across demographic cohorts generally rose in August.

The rush is on

The debate about whether the Federal Reserve raises the target range for the fed funds rate by 50 or 75 basis points later this month hasn’t ended, but U.S. companies know borrowing costs are going to get more expensive and are tapping the corporate bond market before it does.

Average U.S. investment-grade funding costs have jumped and will likely climb further after the September meeting of the central bank’s Federal Open Market Committee.

With higher funding costs coming, investment-grade and high-yield corporate bond issuance has risen and should remain solid ahead of the September 21 meeting. The pattern of an issuance binge before FOMC meetings could be the norm for the rest of the year. Beyond September, markets are pricing in rate hikes of 48 basis points at the November FOMC meeting and 25 basis points at the December meeting.

Markets are not fully pricing in rate hikes at any of the first couple of FOMC meetings next year and are betting on a terminal rate just south of 4%. Under this scenario markets expect the Fed to return inflation to target soon, according to inflation swaps, which are priced on the CPI.

Year-over-year growth in the CPI of 2.5% would be consistent with the Fed’s inflation objective, and inflation swaps are betting this occurs in 2025.