Janet Yellen, chair of the U.S. Federal Reserve, listens during a House Financial Services Committee hearing in Washington, D.C., on Wednesday, June 22, 2016.
Photograph by Andrew Harrer—Bloomberg
By Chris Matthews
September 1, 2016

Much of America is already starting to check out and looking forward to the long Labor Day weekend. But Janet Yellen and the rest of the economists at the Federal Reserve are on the edge of their seats, waiting to see the latest job-growth estimates from the Labor Department, due Friday morning.

In her speech at Jackson Hole, Fed Chair Yellen hinted that the central bank may be ready to raise interest rates as soon as next meeting in late September, based on the unusual strength of the labor market of late. The American economy has been adding on average 190,000 jobs per month this summer, despite the fact that overall real economic growth is likely to come in under 2% this year. The consensus for Friday’s number is a headline figure of 180,000 jobs, although August has a recent history of disappointing the Street, as Bloomberg notes.

Given that a strong report could tip the scales in favor of raising rates, one might think that such an outcome would be bad for stocks. But Jim Paulsen, Chief Investment Strategist at Wells Capital Management says that traders have “changed their stripes from worrying about the Fed hiking to embracing it.” He argues that “most investors” are ready for the Fed to start normalizing, and that a strong jobs report would give traders confidence that Fed policy and the overall economy are getting back to normal.

Therefore, a miss Friday morning could cause stocks to tumble, while a reading above consensus could conceivably send markets to new highs, according to Paulsen.

Either way, “this report will rule the day,” because the Fed has been citing the job market as the prime reason to consider raising rates, he says.

At the same time, if you look at the fed funds futures markets, the market doesn’t expect a rate hike in September. In fact, futures traders don’t expect one at all this year, and those opinions didn’t really budge as the result of Yellen’s relatively hawkish speech last Friday. If a strong jobs report does in fact result in a rate increase at the FOMC’s meeting on September 20-21, these data suggest many traders will be caught off guard.

Whatever the outcome of Friday’s BLS report, it won’t be an easy decision. There’s ample evidence on both the “hike” and “hold steady” sides of the interest-rate debate. Hawks can point to the fact that wage growth has been accelerating of late, and that the current unemployment rate is roughly where the Fed has said it considers full employment. Doves argue that we don’t really know what full employment is in an economy that is behaving by different rules than before the financial crisis. Meanwhile, inflation remains well below the Fed’s 2% target, so why risk slowing the economy when the bank’s mandates aren’t even being met?

Worse still, the Fed itself has been having doubts as to the correct theoretical framework for understanding how exactly their moves filter through to their dual goals of promoting maximum employment and stable inflation. Most importantly, economists are beginning to question whether a low unemployment rate necessarily contributes to inflation. And to top it all off, there’s little hope around the developed world for a significant jolt from more government deficit spending, Japan’s halfhearted new program notwithstanding.

Nevertheless, the Fed will meet three more times this year, and its own forecasts show that every member of the bank’s interest rate-setting committee thinks that there will be at least one more increase in 2016. Markets, on the other hand, are not so sure, as they have been repeatedly fooled by Fed economists who were too sanguine about the bank’s ability to normalize policy. The growing divide between Fed rhetoric and what traders are anticipating leaves the market open to a big surprise, and financial markets generally don’t like surprises.

 

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