Gearing Up For Employment Day, by Tim Duy: The big event this week is the employment report. Fed watchers will eagerly dive into the data, looking for signs that the labor market made "some" further improvement. "Some" improvement appears to be an important hurdle to clear before the Fed will raise interest rates. How much "some" is necessary? I suspect it's like pornography - you will know it when you see it.
Incoming data continues a pattern general mediocrity. Today we received the June income and spending report, which one could have largely backed out of the second quarter GDP numbers. Real incomes edged up 0.2% while real spending was flat. Spending softened compared to last year, not unlike the pattern of 2004:
Recall that it was in July of 2004 that the Fed initiated the previous tightening cycle. Note also that one aspect of consumer spending, auto sales, showed no signs of softening in July.
Inflation remains below target, but arguably not far below target:
While on a year-over-year basis, core-PCE remains well below target, recent reading are more solid. On an annualized basis, core-PCE rose 1.79% in June, within the range that I suspect most policymakers believe is consistent with their mandate (you can't hit exactly 2% all the time). The Fed will see these numbers as supporting their view that the 2014 inflation drop was driven by largely temporary factors.
Manufacturing numbers remain on the soft side:
Stronger dollar, lower commodity prices, and softer global demand took the wind out of that sector, to be sure. Note that a sharp decline in ISM numbers from mid-2004 through mid-2005 did not deter the Fed from continuing its rate hike campaign.
Coming on the heels of last week's disastrous employment cost report, Friday's measure of wages will be closely watched. The tentative signs of wage growth acceleration we had been seeing in the ECI were quickly wiped out in the second quarter:
How will the Fed view this data? Tough call at this point. Digging into the data may lead them to conclude that this report was more smoke than fire. Millan Mulraine via across the curve:
...I wanted to make a few observations on the ECI report following our conversation with the BLS. The key findings reinforce our earlier view that this anomalous performance in both wages and benefits has been driven by one-off factors that should unwind. As such, we believe that this report does not reflect a germane deterioration in underlying inflation dynamics, and will have little bearing on the Fed’s deliberation on policy.
1. The sharp deceleration in the growth rate of the wages and salaries component (which accounts for about 70% of total compensation) was driven by a sharp falloff in incentive pay this quarter versus Q1. This accounted in the sharp drop in the growth rate of private industry wages (on an NSA basis) from 0.8% q/q in Q1 to 0.2% q/q in Q2. Excluding commission sale incentives, wages and salaries were unchanged at a solid 0.6% q/q pace in both quarters.
2. Benefits were also affected by special factors, and the key driver was the redefinition to retirement benefits in Q2, perhaps caused by the underfunding of some retirement pension plans. The 0.8% q/q drop in unionized workers benefits was a big part of this. Here is a link of various stories highlighting this fact earlier this year...
The Fed may also find solace in the Atlanta Fed Wage Growth Tracker:
Of course, maybe they don't need faster wage growth at all, as Jon Hilsenrath at the Wall Street Journal reminds us:Given her [Fed Chair Janet Yellen] stance, Friday’s employment cost report doesn’t look like a deal breaker for the Fed in its long-running debate about when to raise short-term interest rates. Wages appear to be stagnant but not clearly weakening, which is what she set out as her threshold for not acting. Still, it creates new doubts for officials and doesn’t help them build the confidence they’re hoping to build that the job market is nearing full employment and inflation rising toward 2%.
At least one Fed official is on record saying he couldn't care less about the ECI report. That is St. Louis Federal Reserve President James Bullard, via the Wall Street Journal:“We are in good shape” for increasing the Fed’s currently near-zero short-term rate target at the Sept. 16-17 central bank gathering, Mr. Bullard said in an interview with The Wall Street Journal. He said officials needed to see how growth data released Thursday shaped up before clearing the way to act.Mr. Bullard shrugged off a report Friday showing surprising tepid wage gains, saying he isn’t that worried about that situation right now.
That said, I think that most Fed officials would be more comfortable ignoring the ECI report if they see some hard evidence in the next two labor reports that wage growth really is strengthening.
Bottom Line: My general sense is that the data is falling in line in such a way that the Fed can justify a rate hike in September. Not sure I would describe the situation as being in "good shape" as Bullard does, but I see where they can find room in the data, especially if their logic is to go early so they can go slower. A 200k+ nonfarm payroll gain, a tick down in unemployment, and some wage growth would support that case. September is a hard call, however, because I doubt that the next six weeks of data will give them a clear, consistent story free of any warts or boils. If they ultimately need perfect data to move forward, then they will again take a pass on September. Perfect data will simply be hard to come by, I suspect, in a world where 2% growth is the new 4%.