Analysis: May Jobs Report Likely Keeps Fed on Track for Rate Increase Later This Year

© Seth Wenig/AP Photo​
© Seth Wenig/AP Photo​

The strong May employment report likely keeps the Federal Reserve on track to start raising short-term interest rates later this year, but officials are unlikely to move at a policy meeting later this month because they want to see more evidence of a solid economic expansion.

Fed officials before the report signaled they had moved into a wait-and-see mode ahead of their June 16-17 meeting, their confidence shaken by an ecxonomic contraction in the first quarter and preliminary signs of a slow rebound in the second.

They now want to see more data proving the winter economic contraction was transitory and not a signal of a more serious loss of momentum. Many investors are expecting a September rate increase, though Fed officials stress they are not bound to any particular date.

Many Fed officials began the year believing that by June they might start lifting their benchmark short-term interest rate from near zero, in what would be their first rate increase in nearly a decade. Instead, they were thrown by new signs of economic torpor.

They have been forecasting economic growth will pick up, as it did last year when a spring rebound followed a winter downturn. This year, the bad weather and work closure at West Coast ports that hindered output in the first three months of the year have run their course. The depleting effects of oil price declines on business investment and of a strong dollar on exports should be transitory.

They had already seen a few encouraging signs before the jobs report, including trade improvement in April and strong auto sales in May. The Labor Department report bolstered their case, showing employers ramped up hiring last month while wage gains accelerated.

WSJ Chief Economics Correspondent Jon Hilsenrath explains that the Federal Reserve, which is expected to wait several months to rate interest rates, is focused on managing Wall Street’s expectations.

While the latest jobs report will be seen as an important clue by Fed officials, it is unlikely to substantially shift their expectations or answer all of their doubts ahead of the June meeting.

“There are more questions at this point in 2015 than there were at this point in 2014,” Fed governor Daniel Tarullo said at a conference in New York on Thursday. The economy, moreover, appeared to lose momentum earlier this year, he said. “Our data dependent orientation is going to be particularly important.”

Mr. Tarullo’s comments are notable because he is a Fed governor based in Washington, working down the hall from Fed Chairwoman Janet Yellen. Fed governors–as opposed to regional Fed bank presidents—generally move in sync with the Fed’s leader.

His remarks echoed those of another Fed governor.

“I think there is value to watchful waiting while additional data help clarify the economy’s underlying momentum in the face of the headwinds from abroad,” Fed governor Lael Brainard said in Washington Tuesday. “If continued labor market strengthening is confirmed and inflation readings continue to improve, liftoff could come before the end of the year.”

Her comments show that officials have been holding out hope that the economy will regain enough momentum for them to start raising short-term interest rates from near zero later in the year.

“I think it’s very difficult to say that you’re trying to normalize interest rates just at the moment where the economy looks a little bit weaker,” James Bullard, president of the Federal Reserve Bank of St. Louis, said Wednesday. He said he thinks the economy’s first quarter stumble will prove transitory, but he wants to see a rebound confirmed in the coming economic data.

May jobs report is one piece of a complex economic puzzle.

Measures of economic output have been soft. Gross domestic product, a measure of the nation’s output of goods and services, fell at a 0.7% annual rate in the first quarter and many analysts are estimating growth at a rate near 2% in the second. Measures of employment and income, on the other hand, have been firmer. Gross domestic income, a measure of all of the corporate profits and household earnings generated by the economy, rose at a 1.4% pace in the first quarter.

Fed officials are looking for signs that income growth is offering a truer picture of the economy’s momentum and hope output will follow it. Payroll gains have averaged a little more than 200,000 per month since 2012 and a continuation of such gains gives Fed officials comfort on this front.

They also want to see signs that slack in the labor market is diminishing, which they expect to lead to rising wages and inflation. A drop in the unemployment rate from 5.5% in May, and in broader measures of unemployment that include part-time and discouraged workers, would give them confidence on this front, as does a pickup in wages.

It is possible the Fed might see a need to move toward raising rates even in an environment of slow growth in economic output. Weak gains in worker productivity can lead to falling unemployment even with little output growth. This would be a bad outcome for workers, because it tends to be associated with slow growth in inflation-adjusted wages.

Officials are now trying to figure out if that piece also fits in their puzzle.

Written by Jon Hilsenrath of The Wall Street Journal

(Source: The Wall Street Journal)

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