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Weekly Economic and Financial Commentary: Data Keep Fed on Track for September Rate Hike

U.S. Review

Data Keep Fed on Track for September Rate Hike

  • The Employment Cost Index rose to its highest year-over-year pace of the expansion in Q2, signaling rising labor costs.
  • The ISM manufacturing index cooled slightly in July but remained firmly in expansion territory despite recent swirling trade war concerns.
  • Nonfarm payrolls were below expectations at 157,000 new jobs in July, but upward revisions to the previous two months softened the blow.
  • Against this domestic backdrop, the Fed elected to remain on hold at its August meeting. We continue to expect the Fed to hike rates twice more this year in September and December.

Data Keep Fed on Track for September Rate Hike

The U.S. economic data this week were broadly consistent with a domestic economy that is grinding toward an output gap that is positive rather than negative. The Employment Cost Index rose to its highest year-over-year pace of the expansion in Q2 (top chart). Employment costs at private businesses have risen 2.9 percent amid a more rapid rise in wages and benefits. Public sector costs have been more subdued, however, as wage growth has slipped back under 2 percent. For all the hand-wringing over slow wage growth in the current cycle, there is a clear upward trend in compensation costs over the past few years (top chart). While total compensation growth remains below the previous cycle’s peak, this make senses from a fundamental standpoint given lower levels of productivity growth and inflation.

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The ISM manufacturing index cooled a bit in July but remained firmly in expansion territory at 58.1. Most sub-indices moderated over the month and, along with comments from respondents, hint that the recent trade environment has begun to impact activity. The current production component edged down, and new orders fell to the lowest level in a little over a year at 60.2 (middle chart). That said, orders and activity are still at fairly high levels, and the modest slowdown of late does not look problematic for the overall growth picture. Similarly, the consumer confidence index was only slightly down in June and July relative to May despite rampant headlines over the past two months about a possible trade war. Like the Fed, we will be watching the data closely to see if trade concerns begin to bear down more noticeably on broad activity.

U.S. employment data for July were released this morning. Nonfarm payrolls growth disappointed with a 157,000 print, below the 193,000 Bloomberg consensus estimate. The net revisions over the previous two months were +59,000, however, softening the blow of the miss. Manufacturing payrolls were particularly strong, rising 37,000 in July, the fastest pace of 2018. The unemployment rate dipped to 3.9 percent, while average hourly earnings were unchanged at 2.7 percent year over year. One encouraging sign was the broader U-6 unemployment rate, which counts those working part-time for economic reasons and those who want a job but have stopped looking, reaching the lowest level since 2001 (see chart on front page).

Against this domestic backdrop, the Fed elected to remain on hold at its August meeting, which concluded this week. In our view, the FOMC upgraded its assessment of the economy compared to the statement that was released at the end of the last meeting in June. When describing growth, the FOMC upgraded its characterization of the pace of economic activity from “solid,” which it used in the last policy statement, to “strong.” Trade tensions continue to lurk in the background for the