The probability of a December hike has fallen as recent muted inflation readings have come in, and today’s jobs report further lowered that probability very slightly–but a December hike remains our baseline call for now. Today’s employment report was only a slight disappointment to us and doesn’t meaningfully change our view of the labor market. We believe the FOMC needs to see evidence of inflation firming before pulling the trigger on the next rate hike. As for the announcement of the phasing out of reinvestment, we continue to expect it will happen at the September FOMC meeting, as this employment report has no bearing on that decision.
On the surface, the August employment report might appear quite disappointing: Payrolls increased 156K in August, and downward revisions to previous months totaled 41K.1 But when the FOMC judges the thrust of labor demand, it focuses more on the private side, and these data were notably better. The August increase in private payrolls was a solid 165K, essentially in line with consensus expectations, and previous months were actually revised up slightly. So the downward revisions were all in government payrolls. All in all, the trend in job growth is still very solid, with three-month average payroll gains of 185K. Indeed, if anything these job figures make us more comfortable with our forecast of moderation in job gains from its recent elevated pace.
But while the payroll figures weren’t as bad as they may have appeared at first glance, this was still a slightly soft labor market report overall. The unemployment rate edged up a tenth, to 4.4%, with the participation rate unchanged. Average hourly earnings posted only a modest gain, which left the 12-month rate stuck at 2.5%; the continued lack of a firming in wage inflation may warrant a downward revision to the path of the ECI in our upcoming forecast. The disappointment in aggregate hours worked in August–a two-tenths decline-
-combined with soft average hourly earnings suggests weaker income growth and slightly less support for consumer spending in the near term.
We view the December rate-hike decision as principally hinging on the Committee’s view of underlying inflation. We see the annualized core PCE inflation rate from March to October as being the primary consideration for the FOMC at the December meeting, and each instance of soft inflation data reduces the probability that we assign to a rate hike in December. Yesterday’s numbers for PCE prices showed a very little pickup in the pace of inflation since the decline in core PCE prices in March. But the momentum in the labor market could be relevant at the margin, and employment growth averaging near 200K with further declines in the unemployment rate would certainly lead some participants to feel more urgency about a December hike. So while today’s employment report was only a slight disappointment, in our view, it does make our assumption of a December rate hike an even closer call. 1 We note that the August payroll data appear to have issues with seasonality; in recent years, August payrolls have tended to disappoint. We also note that Hurricane Harvey is essentially irrelevant for interpreting this report; much of the data for the August employment report had already been collected.