by Kristina Hooper, Allianz Global Investors
Recent data, including the August jobs report, suggests the US economy is not overheating, but it's not overcooling either. This doesn't mean everything is just right, however. Kristina Hooper says the Fed is seeking convincing data one way or the other.
Kristina Hooper is the US Investment Strategist and Head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law, a master's degree from Cornell University and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Weighing the burden of proof
When I was in my early 20s and a law school student, I had the privilege of working at both the Manhattan District Attorney's Office and the US Attorney's Office. I quickly learned that there are different standards of proof for different types of casesāand that the highest burden of proof was placed on prosecutors who, in order to obtain a criminal conviction, had to provide proof "beyond a reasonable doubt."
But as I mentioned there are different standards of proof depending on the type of case. The lowest standard, used in most civil cases, is "a preponderance of the evidence" which simply means that the evidence be strong enough that a fair and impartial mind would gravitate toward one side or the other. Somewhere in between those two extremes is "clear and convincing evidence." This standard requires that the evidence show that something is highly probable.
[Tweet "A rate hike requires data that confirms the Fed outlook for growth, inflation and jobs"]I think of those three different standards of proof in law when I think of Fed Chair Yellen and her speech at Jackson Hole on the last Friday in August. Yellen said that a policy rate hike would require a stream of data "that confirms the outlook" for real economic growth, inflation and employment. This sounds like the Fed is applying the medium standard, "clear and convincing evidence", in its decision-making processāwhich in turn suggests it will be not be raising rates in September.
Jobs growth unspectacular
Last Friday saw the release of the August employment situation report, which showed that job growth was solid but unspectacular with a non-farm payroll gain of 151,000 for August. This report was characterized by lackluster private sector job growthājust 126,000 (the other 25,000 came from the government). Higher-paying industries saw job losses: construction was down 6,000 and manufacturing was down 14,000. This is unsurprising given that the job losses come on the heels of a disappointing ISM Manufacturing reading (which actually fell into contraction territory).
In addition, July non-farm payrolls were revised up from 255,000 to 275,000 while June non-farm payrolls were revised down from 292,000 to 271,000 for a net job loss of 1,000 due to the previous two months' revisions. The unemployment rate remained unchanged at 4.9% and the labor force participation rate remained unchanged at 62.8%. The 3-month average job gain for the US is 232,000; however August's print is much lower. Average hourly earnings rose just 0.1%, which is disappointingābelow consensus expectations and the wage growth we saw in July. This all paints a picture of a job recovery that is moderatingāwhich makes sense given where we likely are in the economic cycle.
Consumers feeling more confident
But that doesn't mean the economy is doing poorly. The Conference Board's consumer confidence reading for August shows a nice rebound in consumer confidenceāit's now at an 11-month high. This suggests that US consumer spending will remain strong in the third quarter, heading into the all-important holiday shopping season.
[Tweet "Consumer confidence rose to an 11-month high, helping to drive consumer credit demand"]The New York Fed recently released its Quarterly Report on Household Debt and Credit for the US, which painted a somewhat constructive picture. Overall household debt rose 0.3% from the first quarter to the second. In addition, the number of credit inquiries within the past six months increased, suggesting rising consumer credit demand. Meanwhile, overall household debt is still below its peak in the third quarter of 2008 (it's 3.1% below where it was then) but it is significantly higher than its trough in 2013. Mortgage originations rose (although credit scores declined slightly) in the second quarter, while overall delinquency rates improved and there were fewer bankruptcies. In general this paints a picture of a healthier consumer poised to borrow and spend moreāand is complemented by the August consumer confidence report.
Data-dependent until December
In summary, recall that FOMC participants, including Chair Yellen, had made it clear that September was a "live" meeting so the latest jobs report carried a lot of importance. Due to this solid but unspectacular report, the pressure is off the Fed to raise rates in September because they seem to want clear and convincing evidence and this data doesn't meet that standard.
[Tweet "The pressure is off the Fed for a September rate hike; now all eyes turn to the December FOMC meeting"]Think back to when the Fed raised rates last Decemberācoming on the heels of three consecutive jobs reports where more than 250,000 jobs were created each month. Now that's clear and convincing evidence. While June and July (both above 250,000 jobs created) were forming a similar trend, August's results fell well short of that. That doesn't mean the bar is necessarily as high as 250,000+ non-farm payrolls, but the bar is still high enough.
We have been saying we thought a December rate hike was far more likely than a September rate hike and we continue to hold that view.
All eyes switch focus to December as the most likely next rate hikeāand also on the data that will shape the Fed's case going into that meeting.
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