August Jobs Report Could Seal Fed Rate Hike

In her speech from Jackson Hole, Janet Yellen said that U.S. economic activity continues to expand, led by solid growth in household spending. The second estimate of GDP backed up that sentiment. Although government and business spending slipped in the second quarter and overall growth was just 1.1 percent, consumer spending increased at a 4.4 percent annualized pace, the biggest gain since late 2014 and far better than last year’s 3.2 percent. Yellen also noted, “while economic growth has not been rapid, it has been sufficient to generate further improvement in the labor market” and “the case for an increase in the federal funds rate has strengthened”. And if there is continued economic progress, as the central bank expects, the Fed should be able to gradually keep increasing the federal funds rate, despite the fact that inflation is running below the central bank’s stated two percent objective.

For most of this year, the Fed has been focused on the U.S. labor market, along with international developments/dramas (China’s slowdown earlier in the year and the UK Brexit vote in June), in managing monetary policy. That’s why this week’s release of the August jobs report could tip the scales for the September 20-21 FOMC policy meeting. If job creation jumps well beyond the consensus estimate of 200,000 expected for the month, the Fed could argue that the labor market is gaining steam (June saw a 292,000 gain and July increased by 255,000) and therefore a September rate hike might be justified. Conversely if the August jobs number is a disappointment and/or if other upcoming economic data disappoint, the Fed could remain on the sidelines.

Traders, who had seen just a 20 percent probability of a September rate hike the week prior, interpreted Yellen’s comments as more hawkish than previously believed. According to fed-funds futures’ Friday settlement, the probability of a quarter-point rise in September had doubled to over 40 percent and the likelihood of a rate hike at the December 13-14 FOMC meeting was up to over 60 percent, from 50-50 a week ago. While there is a meeting in early November, it occurs just days before the presidential election, so most believe the Fed will choose to stay mum for that one.

MARKETS: As traders turn the page on August and look to September, it is worth mentioning that September has historically been the worst month for stocks. According to the Stock Traders Almanac, September has seen an average decline of 0.5 percent in the Standard & Poor’s 500 index since 1950.

• DJIA: 18,395, down 0.9% on week, up 5.6% YTD
• S&P 500: 2169, down 0.7% on week, up 6.1% YTD
• NASDAQ: 5219, down 0.4% on week, up 4.2% YTD
• Russell 2000: 1238, up 0.1% on week, up 9% YTD
• 10-Year Treasury yield: 1.63 (from 1.58% week ago)
• British Pound/USD: 1.3136 (from $1.3078 week ago)
• October Crude: $47.29
• December Gold:  at $1,324.80
• AAA Nat'l avg. for gallon of reg. gas: $2.21 (from $2.15 wk ago, $2.53 a year ago)

THE WEEK AHEAD:

Mon 8/29:

8:30 Personal Income and Spending

10:30 Dallas Fed Mfg Survey

Tues 8/30:

9:00 Case-Shiller HPI

10:00 Consumer Confidence

Weds 8/31:

8:15 ADP Private Payroll Report

9:45 Chicago PMI

10:00 Pending Home Sales Index

Thursday 9/1:

Motor Vehicle Sales

8:30 Productivity and Costs

9:45 PMI Manufacturing Index 10:00 ISM Mfg Index

10:00 Construction Spending

Friday 9/2:

8:30 August Employment Report

10:00 Factory Orders

Jobs Report Complicates Fed Policy

The economy added 173,000 new jobs in August and the unemployment rate edged down by two tenths of a percent to 5.1 percent, the lowest level since the spring of 2008. Although the top line job creation number was short of expectations, the previous two months were revised higher; putting monthly job creation at 213,000 this year and the three-month average at 221,000. With job creation remaining consistently above 200,000 over the past year and the unemployment rate within the Fed’s desired range of 5 to 5.2 percent, the central bankers may believe that the economy is now out of the intensive care unit and no longer requires emergency-level medicine in the form of zero to a quarter of a percent interest rates. As Mark Spindel, CEO and CIO of Potomac River Capital, LLC, noted: “The strength of the U.S. economy came through loudly and clearly in the employment figures announced this morning. As for raising rates, if not now, when?”

That would be perfectly reasonable thinking, if global markets were not in turmoil over a potential hard economic landing in China and the ripple effects that a Chinese slow down is causing in emerging markets and natural resource exporting countries like Canada, Australia, Brazil, Mexico and Russia.

Minutes after the jobs report was released, Mohamed El-Erian, chief economic adviser at Allianz SE and Chair of President's Global Development Council told me “It’s a really tricky call as domestic and external factors are locked in a complex tug of war – domestic economic conditions warranting a hike but global ones urging patience and caution. If global financial instability continues, I suspect that they will wait rather than hike in September.”

As volatility in global financial markets amped up in late August, El-Erian said “The window [to raise short-term interest rates] was open a few weeks ago when you had strong domestic economy, which you still do, you had pretty neutral international economy and the financial markets were in relatively good shape,” but global uncertainty has “turned violently against the Fed, so I don’t think the Fed will take the risk of hiking in this environment, because if it makes a mistake, it will end up making a mistake that will spill back on to the U.S. economy.”

The International Monetary Fund agrees with El-Erian. In a note prepared for the Friday kick off of a two-day G-20 Finance Ministers and Central Bank Governors meeting in Turkey, the IMF warned that “global growth remains moderate, reflecting a further slowdown in emerging economies and a weak recovery in advanced economies. In an environment of rising financial market volatility, declining commodity prices, weaker capital inflows, and depreciating emerging market currencies, downside risks to the outlook have risen, particularly for emerging markets and developing economies.” As a result of that assessment, central banks’ “monetary stance must stay accommodative.”

Paul Ashworth of Capital Economics summed up the debate, when he noted that the August employment report “can be used to make a case for or against a rate hike at the upcoming FOMC meeting. As far as we’re concerned, the September meeting is a 50-50 toss-up. Nevertheless, even if the Fed doesn’t hike rates this month, it won’t leave rates at near-zero for much longer.”

MARKETS:

• DJIA: 16,102 down 3.3% on week, down 9.7% YTD
• S&P 500: 1,921 down 3.4% on week, down 6.7% YTD
• NASDAQ: 4,684 down 3% on week, down 1.1% YTD
• Russell 2000: 1136, down 2.3% on week, down 5.7% YTD
• 10-Year Treasury yield: 2.13% (from 2.19% a week ago)
• October Crude: $46.05, up 1.8% on week
• December Gold: $1,121.40, down 1.1% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.40, the lowest Labor Day weekend price since 2004 (from $2.48 wk ago, $3.44 a year ago)

THE WEEK AHEAD:

Mon 9/7: US MARKETS CLOSED FOR LABOR DAY

Tues 9/8:

6:00 NFIB Small Business Optimism

3:00 Consumer Credit

Weds 9/9:

10:00 Job Openings and Labor Turnover (JOLTS)

10:00 Quarterly Services Survey

Thurs 9/10: 8:30 Import/Export Prices

Fri 9/11:

8:30 Producer Price Index

10:00 Consumer Sentiment