Analysis: Labor-Market Strength Should Keep Fed Plans on Track -- Update

Strong gains in hiring and a slight decline in the jobless rate last month keep the Federal Reserve on track to begin slowly shrinking its balance sheet this fall and to raise short-term interest rates after that for the third time this year.

The addition of 209,000 jobs in July was slightly ahead of the 184,000 hiring average so far this year, and the unemployment rate edged down to 4.3%. Average hourly earnings for private-sector workers were up 2.5% over the last year, and the employment rate for workers in their prime earnings years -- ages 25 to 54 -- rose to its highest level since September 2008.

All of this should firm the resolve of Fed officials who have puzzled over a surprising deceleration in inflation pressures this spring. In recent weeks, officials have pointed to labor-market strength -- the kind affirmed by Friday's report -- to maintain their policy plans in the face of the pullback in price pressures.

Fed officials will have one more employment report before their Sept. 19-20 policy meeting, and recent speeches and interviews with officials indicate a relatively high bar has been set to knock the central bank off its plans to begin shrinking the balance sheet this fall. An announcement on the balance sheet is expected at the September meeting.

The Fed isn't expected to raise rates again until December, and it will have several more jobs reports to study before that last policy meeting of the year, in addition to new data on inflation, consumer spending and economic output.

Continued declines in the unemployment rate over the past year -- it stood at 4.9% one year ago -- have motivated officials to gradually but steadily raise interest rates to avoid overheating the economy.

For several years, the Fed's two objectives to provide maximum, sustainable employment and to maintain stable prices -- they maintain a formal 2% inflation target -- pointed in the same direction, and they held rates near zero and engaged in several rounds of bond buying to stimulate the economy.

They began raising rates nearly two years ago and have prepared to start shrinking their holdings of more than $4 trillion in bonds. But earlier this year, improving labor markets and weaker inflation gauges sent conflicting signals about the urgency of tighter policy.

While hiring has been solid this year, price pressures have retreated. The Fed's preferred inflation gauge rose 1.5% in June from a year earlier, excluding the often-volatile categories of food and energy, down from an increase of 1.9% in February. Part of that has been due to price declines for a handful of items, such as wireless phone plans, but some officials have said they want to see proof of a stronger upturn before committing to more rate increases.

Still, even without clearer signs of price pressures, strong hiring gains and declines in the unemployment rate could be enough to keep the Fed on track to raise rates due to officials' expectation that low unemployment ultimately will force employers to compete for workers, sending up wages and prices.

"We are watching data very carefully, and I would say I regard the risk as being two-sided with respect to inflation," Fed Chairwoman Janet Yellen told lawmakers on Capitol Hill last month. "On the one hand, we are seeing low inflation numbers for several months. On the other hand, we have quite a tight labor market, and it continues to strengthen."

Boston Fed President Eric Rosengren this week said he would put greater weight on longer-run labor-market trends than on monthly changes in inflation readings. Employers' frustration over labor shortages should force them to eventually raise wages, and the depths of the 2007-09 recession could be partly responsible for extending that process during the current expansion.

"All that can take a fairly long period of time. We haven't had a period where we had really low unemployment rates for quite a while," said Boston Fed President Eric Rosengren in an interview. "If we really do continue to tighten labor markets, I do expect that in the longer run it's going to start being reflected in wages and prices."

The Fed has raised rates at two meetings this year, most recently in June, bringing its benchmark federal-funds rate into a range between 1% and 1.25%. Minneapolis Fed President Neel Kashkari, who voted against raising rates at both those meetings, said after Friday's report that rising labor-force participation and few signs of wage acceleration supported his view that the Fed doesn't need to raise rates now.

The jobs report offered little confidence about any pickup in inflation, he said in posts on Twitter. Fed officials have "repeatedly declared" the economy to have reached maximum employment only to be "surprised by strong job growth" and weak wages and inflation, as well as an increase in labor-force participation, he said. Friday's report "is more of the same."

Write to Nick Timiraos at

(END) Dow Jones Newswires

August 04, 2017 11:52 ET (15:52 GMT)