Job Fair 2012 text
A job fair in New York. Reuters

July’s jobs report, coming at a critical time for policymakers at the Federal Reserve, left the Fed with mixed signals as it weighs a taper in its $85 billion a month in bond purchases.

The U.S. economy added 162,000 jobs in July, a slimmer gain than estimates of 185,000, the Labor Department said on Friday. Job gains for June and May were also revised lower. The number of new jobs created in June was revised down to 176,000 from 195,000, and June’s increase was trimmed to 188,000 from 195,000.

“The economy is still expanding and we are still adding jobs, but we’d like to see stronger job growth and this means that we are still having trouble digging ourselves out of the hole that we are in,” said PNC Financial Chief Economist Gus Faucher, who described Friday’s jobs report as “disappointing.”

Over the past 12 months, the economy has added an average of 189,000 jobs a month.

The unemployment rate fell from 7.6 percent to 7.4 percent -- the lowest since December 2008 and below the forecast of 7.5 percent. The decline in the unemployment rate reflects a 227,000 increase in the household survey measure of employment, which was compounded by a 37,000 decline in the size of the labor force.

“The latter has increased by around 800,000 over the preceding three months, so the drop back isn't entirely surprising,” Capital Economics’ Paul Ashworth said in a note to clients. “It's noise rather than a sign that desperate job seekers are giving up and leaving the labor force again.”

Average weekly hours worked dipped to 34.4 from 34.5, and average hourly earnings fell by 0.1 percent month-on-month, albeit after an outsized 0.4 percent gain in June. Over the past year, average hourly wages are up 44 cents, or 1.9 percent. That's basically in line with the inflation rate.

“Wage growth is very weak right now, which means we are really counting on job growth to power our income gains and not wage growth and it’s going to take a while before we start seeing really stronger growth in wages,” Faucher said.

Federal Reserve

“Overall, while July itself was a bit disappointing, the Fed will be looking at the cumulative improvement since it restarted its asset purchases last September,” Ashworth said, noting that the unemployment rate has fallen from 8.1 percent in August 2012, to 7.4 percent this July, which is a significant improvement.

The Fed on Wednesday said it would continue an $85 billion a month bond-buying program meant to help lower long-term interest rates. The central bank also said it plans to hold its key short-term rate at a rock-bottom level at least as long as the unemployment rate stays above 6.5 percent and the inflation outlook remains mild.

The tone of the FOMC statement was on the dovish side, with references to soft growth, rising mortgage rates and the need for inflation to increase over time.

“We view the substantive changes as mainly aimed at separating the decision to taper the pace of asset purchases from that of implementing the first rate hike, rather than signaling that tapering has become less likely,” Dean Maki, Barclays chief U.S. economist, said in a note to clients. Fed officials described the pace of growth in the first half as "modest" and noted risks to the economy if inflation runs "persistently below" their 2 percent objective, as it has been. For the past three months, inflation has been running near a 1 percent annual rate, well below the Fed's goal.

The newly released second-quarter gross domestic product report, while showing lackluster growth of 1.7 percent, contains information that suggests that the second half of the year will see faster growth than the first half.

Consumer spending growth contributed 1.2 percentage points of the overall 1.7 percent growth -- that is, had consumer spending not grown at all, overall GDP growth would have been only 0.5 percent rather than 1.7 percent. This is about in line with the relative size of the consumer spending sector. “In conjunction with other data that describe near-term consumer spending patterns, this suggests that the rate of growth is highly sustainable,” IHS Global Insight Chief U.S. Economist Douglas Handler said in a note to clients.

Gross private domestic investment also contributed 1.3 percentage points to the 1.7 percent growth. Residential investment (housing) and industrial machinery contributed large portions to this gain. Inventory growth contributed a relatively modest 0.4 percentage point of this investment growth, suggesting that no material excess inventory issue exists for the third quarter, Handler noted.

“While the U.S. economy undoubtedly slowed down in the first half of the year, growth seems to have troughed in the first quarter and momentum is already improving,” Aneta Markowska, chief U.S. economist for Societe Generale, said in a note to clients. "We believe that the economy will accelerate meaningfully in the second half of the year, having gone through an inflection point on private sector deleveraging and now also through fiscal restraint.”

Although the committee isn't satisfied with the 1.4 percent GDP growth rate seen in the first half, Fed official still expect the pace of growth and inflation to move back toward the levels they’d like to see later this year. The description of growth was a slight downgrade from the previous “moderate pace.” However, the committee noted that it expected growth would “pick up” from its recent pace and “proceed at a moderate pace.” Policymakers will get another jobs report a few weeks before the Fed's Sept. 17-18 meeting.

“I think it [July’s jobs report] makes September tapering less likely, but doesn’t necessarily take it off the table,” Faucher said. “We have been counting on September, but we’ll get another employment report before then. My expectation is that if the next employment report is as weak as this one, then we will see the Fed hold off until October.”