Door Open for Fed Tapering

The strong July Employment Report increases the risk of the Fed cutting back its bond buying program before year-end.   Economic growth and the labor market are on solidly positive paths, allowing Fed officials to say they're seeing "substantial further progress" toward their "maximum employment" goal.  Officials will have many speech opportunities to inform the markets of a policy shift in coming weeks, as the next FOMC meeting is on September 21-22.  But, with the Unemployment Rate still well above pre-pandemic lows and inflation looking as if it will soon come off its extraordinary high pace, a Fed rate hike is likely a long way off.  Indeed, the increased chances of tapering could put additional downward pressure on commodity prices.  The markets' reactions to tapering will likely be muted as a result.

The July Employment Report was strong.  The +943k m/m surge in Nonfarm Payrolls is mostly attributable to Leisure & Hospitality (+380k) and State & Local Education Jobs (+231k).  But, even without these post-pandemic bounce-backs, Payrolls rose a strong 332k.  Moreover, June and May Payrolls were revised up.  The surge in jobs was also seen in the 1.0 Mn jump in Civilian Employment.  This swamped the moderate increase in Labor Force, so the Unemployment Rate dropped to 5.4% from 5.8%.  Total Hours Worked in July stand 4.3% (annualized) above the Q221 average, pointing to another strong Real GDP Growth in Q321.  The Atlanta Fed model's latest projection is 6.0% (q/q, saar), similar to the 6.5% growth rate in Q221.

While it is too soon to draw a conclusion about the risks to the August Employment Report, the early evidence from the Claims data suggests another strong report.  Specifically, the -366k w/w drop in Continuing Claims to 2.930 Mn, a new low for the move down, suggests a speedup in hiring.

Despite the strong growth, inflation may be moving down toward the Fed's target of 2%.  Consensus looks for +0.4% m/m Total and +0.5% Core in this week's July CPI report.  They are about half the June pace (+0.9% each).  Some of the culprits for the recent large increases -- used car prices, gasoline prices -- have begun to flatten.  The July report may be too soon to see the full extent of the flattening, however.  So a further deceleration in coming months is a good possibility.

Labor Costs are moving up, but they too may be starting to moderate.  Although Average Hourly Earnings were higher than expected in July, +0.4% m/m after an upward-revised 0.4% in June (was +0.3%), they were slower than the 0.5-0.7% seen in April and May.  Wages rose the most in sectors with labor shortages -- Leisure & Hospitality and Transportation/Warehousing sectors.  Wage pressures in these sectors may begin to ease in September when the ending of supplemental Unemployment Benefits may induce an increase in labor supply.  This week's report on Q221 Unit Labor Costs will show whether Productivity Gains are offsetting the higher wage inflation.  Consensus looks for a slowdown in ULC to 1.2% (q/q, saar) from 1.7% in Q121, which is in the right direction from an inflation perspective.