Could July unemployment numbers signal Fed rate increase?

The release of this week’s July employment report will likely receive heightened interest from Federal Reserve watchers after last week’s soft second quarter Employment Cost Index report. Private industry wages and salaries rose just 0.2% for the second quarter and have gained only 2.2% over the past year. The Fed has noted liftoff from zero interest rates will be data dependent. Wage growth is a key sign to the Fed of health in the employment market. This week’s employment report will be reviewed to confirm or dismiss the softness signaled in employment cost. Consensus expectations for average hourly earnings are for a gain of 0.2%, and a payroll increase of 225,000 jobs.

Second quarter U.S. gross domestic product (GDP) growth rose less than expected at 2.3% for the quarter, but broad revisions to prior data drew attention, as well. First quarter growth was revised to a gain of 0.6% (previously negative 0.2%), with upward revisions to inventories, investments, and federal spending. Revisions for prior years confirmed economic growth has been slow for a few years now, with the first half of 2015 averaging growth of just 1.5%. We expect growth to remain slow but positive into next year, with growth in the second half of this year averaging around 3% based on better consumer spending and investment trends.

Outside the United States, a key signal of economic activity arrives this week in the form of purchasing manager business activity surveys. Preliminary data for Europe and China indicated some slowing of growth. We expect growth to generally be stable to improving in developed economies, while emerging market economies see more diverse outcomes. Commodity-producing economies will be generally weak due to the recent declines in commodity prices. Commodity-consuming economies should generally perform better. Growth in China will likely slow due to restructuring in the economy through efforts to improve international tradability of currency and financial markets.

Generally, we expect activity in Europe to improve slightly, with improving confidence due to progress in the Greek debt crisis. Confidence in consumers, businesses, and the economy improved for July. Although the unemployment rate remained relatively high (11.1%) for June, core inflation has risen 1% for the year ending in July, indicating European Central Bank quantitative easing may be leading to slow improvements in the economy.

Economic activity in China may experience further slowing. However, growth is not likely to be hurt much by recent stock market volatility. There appeared to be no discernable positive impact from the doubling of stock market values, and therefore, we believe the decline is unlikely to impact the economy much at all. Rebalancing continues across the economy, with slower investment spending and stable growth in consumption. We are watching for signs the government slows the pace of reforms as an indicator of the likelihood of a “hard landing” for the economy. For now, we believe the economy should avoid the hard landing scenario.

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Robert L. Haworth, CFA, is a senior investment strategist and Darrell Behnke is the Madison market leader for the Private Client Reserve of U.S. Bank.

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