U.S. Payroll Gains Continue To Impress

Scott Anderson
Chief Economist
Bank of the West

The July Employment Report was another "sizzling read" – "a can't put down page-turner". Just like the summer's record breaking heat, the U.S. labor market heated up in July adding another 528k jobs up from an upwardly revised 398k jobs created in June. The July pace of net-job creation was double the consensus forecast that predicted a slowdown to around 250k jobs. U.S. job gains were once again broad-based with goods producers and service providers adding more jobs than in June (69k jobs and 402k jobs respectively).

Goods and Service Providers Still Scrambling For Labor

Job growth accelerated in construction (+32k), manufacturing (+30k), trade and transportation (+54k), financial services (+13k), education and health care (+122k), and leisure and hospitality (+96k). Government joined in too adding a net 57k jobs last month.

Broad-Based Job Growth Kicks Into A Higher Gear

Even employment from the Bureau of Labor Statistics Household Survey, used to calculate the U.S. unemployment rate, increased by 179k jobs - a marked improvement from the last three months when this measure of employment sank by an average 116k jobs a month in the second quarter.

This was good enough to send the U.S. unemployment rate down another tenth of a percentage point to 3.5% from 3.6% where it had stood for the last four months.

The still tightening labor market and rising price inflation continues to keep nominal wage growth higher than normal too. Average hourly earnings growth picked up to 0.5% in July and was revised up to 0.4% for June, keeping the year-on-year growth rate at a high 5.2%.

Nominal Wage growth Remains Elevated

This is the part where I have to say the better than expected labor market news is actually bad financial market news at this point in the cycle. It will likely mean a worse economic outlook down the road too. The stamina of the U.S. labor market that continues to grow jobs at an unsustainable monthly pace, with declining unemployment and rising wages to boot, will land with a thud at a Federal Reserve that is rapidly raising interest rates to cool down rampant demand and tame the worst inflation outbreak in the United States in more than 40 years.

This jobs report raises the odds that the Fed will choose another sizable 75 basis point rate hike at their September meeting rather than a more measured 50 basis point hike. Indeed, the Fed funds future market is currently placing the probability of a 75 basis point hike at the next FOMC meeting at around 71%. It also raises the odds that the Fed's terminal fed funds rate will need to move higher than currently expected and the Fed may need to continue hiking next year.

We will receive more important data points around this probability next week when we receive the July CPI and PPI reports. Economists and investors will be combing through these inflation reports looking for meaningful signs that inflation has peaked and is embarking on a sustainable path back down toward the Fed's 2.0% policy goal. The large drop in crude oil and gasoline prices last month is expected to drive a welcome slowdown in overall monthly inflation. We will also be looking for signs that inflation pressures are receding beyond just the volatile food and energy sectors.

Will The Inflation Fever Begin To Break?

For now we keep our Fed funds and interest rate forecast unchanged, but note the risks are more heavily weighted to the upside on the interest rate forecast than the downside. Where our view of the Fed funds rate differs the most from the current market view is the fact that we don't see much prospect for the Fed to start cutting interest rates next year. With CPI inflation currently running above 9.0% year-on-year, it's likely going to take far more than a year to bring it down into a more normal range, even if the U.S. economy enters a near-term recession. So you see, the tight policy spot the Fed finds itself in remains firmly in place.

To learn more, check out this week's U.S. Outlook Report.


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