Employment Data Affirm Fed Strategy of Gradualism

Payroll employment rose a less-than-expected 209,000 in the month of July, with modest upward revisions for a net 15,000 additional jobs in the previous two months. This is the sixth month that we have seen job gains exceed the 200,000 threshold, but just barely. Indeed, private sector job creation fell slightly below the 200,000 level, with the difference being made up by gains instead of cuts at the state and local levels. State and local government job cuts provided one of the greatest headwinds to growth in recent years and have finally turned the corner.

Gains were largest in business services, where once again we saw some meat on the bone, with strong gains in legal, accounting, engineering, architecture and consulting jobs instead of temporary hires alone. This is particularly important for new college graduates as it suggests that the market for individuals with higher education is finally firming. We also saw large gains in manufacturing, driven mostly by gains in the vehicle sector. That is partially due to the fact that many plants that are usually closed during July for retooling were left open to catch up on earlier losses and prime the pumps for a new model year. Ford has a particularly large number of new models coming on line for 2015. Indeed, jobless claims fell instead of rising last month in the state of Michigan because of fewer layoffs in the auto industry.

Separately, we saw some gains in furniture-making jobs, which reflect an increase in wealth tied to housing; home equity loans are coming back. The spillover effects from recent housing price gains, however, are still small relative to the past, most notably because many home owners have yet to reach their previous price peaks.

Finally, retail hiring was up and has been on an upswing after a dismal winter. Hiring in leisure and hospitality, which had been a primary driver of employment gains in recent months, slowed fairly dramatically. That is an area that includes food processing and drinking establishments. One trend we are watching closely is the role that tablets and kiosks are playing in replacing cashiers and waitstaff in taking customer orders. Anecdotal evidence suggests that this is a phenomenon we should watch, especially in light of the penetration (estimated at up to 75%) of smartphones in the U.S. and the ease customers feel in using the technology, relative to past experiments.

Year-over-year gains in average hourly earnings held at a stagnant 2%, which is well below the Federal Reserve Chair Janet Yellen’s target of 3-4% annual wage increases. Separately, the unemployment rate ticked up slightly to 6.2% from 6.1% in July as a few people put their toes in the water to test the ability to get a job. A slight improvement in job prospects also showed up in the consumer confidence measures for July, which if sustained would be a welcome trend. The largest increase in participation occurred in the 25-34 year-old age group, a group we have consistently argued represented slack in the economy and could not stay on the sidelines indefinitely. The largest declines in participation occurred among 20-24 year-olds, many of whom are staying in college and substituting community college courses over the summer to mitigate tuition costs. Other measures of labor market slack, such as the number of long-term unemployed and those forced to accept part-time instead of full-time work for economic reasons (the underemployed), remain largely unchanged.

Bottom Line: Employment is improving but not fast enough for the Fed. Those in the market who are betting on an earlier tightening of monetary policy are getting ahead of themselves and the economic data. The Yellen Fed has made it clear that it wants to see the whites of the eyes of a real healing in the labor market before shifting to tightening policy. Moreover, when the Fed does move, it will do so gradually.

That said, hawks within the Fed system are getting noisy and voicing their concerns using megaphones. Two (perhaps three, if we count the newly appointed Cleveland Fed President) only have three more meetings this year to have their dissents heard. After that, two of the three will lose their ability to vote on policy for another two years. Charles Plosser of the Philadelphia Fed and Richard Fisher at the Dallas Fed have been particularly vocal in their view that “liftoff” will happen sooner, not later. Others share that view: most notably, St. Louis Fed President James Bullard, who has shifted more into the hawks’ camp in recent months. He is not, however, voting this year or next.

Moreover, Plosser and Fisher will be replaced by some of the most dovish presidents, who will be tasked with the primary responsibility of when and how to exit the current asset-purchase program by using rate hikes and communication. Several of those presidents have expressed the exact opposite view of the hawks, suggesting that rate hikes could come later, instead of sooner.

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