US July employment report supports case for higher rates

The US labor market continues to be characterized by strong employment gains while wage increases remain modest. The unemployment rate remained at 5.3% but should fall further in the coming months given the pace of job gains (215k in July). Given the steady if unspectacular improvement the Fed should feel more confident that inflation will rise towards target.

"We continue to expect a first rate hike in September. The increase in nonfarm payrolls by 215k and the unchanged unemployment rate of 5.3% in July were both in line with our expectations", says Commerzbank.

Fed officials last month said they are looking for "some further improvement in the labor market" before hiking rates. Today's employment report will probably be viewed as step in that direction. The number of jobs increased by 215k, almost exactly the monthly average recorded in the first half of this year. With monthly job gains settling above 200k, unemployment is likely to fall further as gains of 80k-100k are sufficient to keep it trending down, even if the rate remained at 5.3% in July (5.26% rounded to two decimals).

It is already very close to the Fed's estimate of full employment which stands at 5.0% to 5.2%. A wider measure that includes people who have stopped looking for a job and part-timers who would prefer a full-time job fell a tenth to 10.4%, indicating the broad-based nature of the improvement in the labor market. The elevated number of persons working part-time for economic reasons has often been mentioned by Fed chair Yellen as an indication of substantial slack in the labor market, so she will undoubtedly take notice of the improvement here In addition to the solid pace of hiring, companies let employees work longer hours. This is a further sign of the strength of the demand for labor.

As in the last months, the weakest part of the report is on wages. Average hourly earnings rose a modest 0.2% from June (2.1% from a year ago), suggesting no increase in the inflation pressure emanating from wages. This is likely to be an important argument of the doves at the Fed to hold off at the September meeting. While the decision is likely to be close.

"We still believe that the absence of wage pressure will not prevent a rate hike in September, though. Firstly, the Fed is likely to expect that with full employment in sight, wage gains will at some point in time pick up. Secondly, Janet Yellen has stressed stronger wage growth is not a necessary pre-condition for higher rates", notes  Commerzbank.