Jobs Report Could Sway Fed Rate Hike Decision

It’s possible that no recent piece of economic data will play a bigger role in helping to determine the timing of the first interest rate hike in nearly a decade than Friday’s jobs report.

The Labor Department will release the report Friday at 8:30 a.m. ET.

A solid report, as is widely expected, could serve as the final piece of a puzzle that now completed allows Federal Reserve policy makers later this month to announce the long and anxiously-awaited rate hike.

The policy-setting Federal Open Markets Committee meets September 16 and 17, and despite the recent market turmoil brought about by signs of weakness in Chinese economic growth, a rate increase is still firmly on the table.

A weak report could exacerbate concerns that the U.S. economy is struggling and could even be headed for another downturn if global economies continue to flounder.

“The most important report for markets and for the Federal Reserve will be the August Jobs report due out on Friday,” said David Kelly, chief global strategist at JPMorgan Funds.

“Our models suggest that more than 200,000 jobs were added for the fourth month in a row and that the unemployment rate fell back to 5.2%, its lowest level since April of 2008.  We also believe the wage growth for production workers grew by 0.2%, still up just 1.8% year-over-year,” Kelly added.

In fact, analysts are predicting the addition of 220,000 new jobs in August.

With regard to the Fed’s dual mandate – full employment and price stability – the labor market has proven far more accommodating in terms of meeting the Fed’s goals for raising interest rates.

Most Fed economists agree that the strong monthly job gains and the significant decline in the headline unemployment rate have met the central bank’s criteria for a rate hike.

The key element missing from the labor reports – strong wage growth – directly impacts the second part of the Fed’s rate hike equation – price stability via a healthy inflation rate which the Fed has targeted at 2%.

Labor Markets, Wages, Inflation All Linked

Inflation has been well below the Fed’s target rate for a long time but Fed policy makers have repeatedly expressed confidence that inflation will move higher once slack tightens in the labor markets, forcing employers to pay higher wages to keep and attract qualified workers.

The problem is that those predictions haven’t come to fruition. In fact, the Fed has been consistently wrong with its inflation forecasts for a long time and economists remain vexed as to why the labor market appears to be strengthening but wages aren’t rising accordingly.

On Tuesday, Boston Fed President Eric Rosengren suggested that the Fed should delay raising rates precisely because inflation hasn’t risen as forecasted and in his view probably won’t in the near future.

Rosengren said inflation has already taken a hit from the strong dollar and falling oil and other commodity prices. If global economies slow it could tamp down demand for goods, which would lower prices and keep downward pressure on inflation.

All of that means it may be a lot harder than initially believed for the Fed to achieve the second half of its dual mandate – price stability – according to Rosengren.

In any case, the global turmoil of the past few weeks has apparently not dampened the enthusiasm of other influential Fed members for pulling the trigger on a September rate hike.

Last week New York Fed Chair William Dudley said the market volatility made a September rate hike “less compelling,” but stressed that new data could offset the volatility and allow for an increase on Sept. 17.

And Richmond Fed President Jeffrey M. Lacker is already scheduled to give a speech Friday after the release of the jobs report titled “The Case Against Further Delay,” which suggests he is convinced the economy is ready to absorb higher borrowing costs.

A strong labor report Friday morning could well convince a majority of Lacker’s FOMC colleagues that he’s right.