Weak U.S. labour market data for July prompted financial markets to scale back expectations of a Federal Reserve interest-rate hike next month, reversing a trend of rising bets for tighter policy after several Fed officials had argued that stubborn inflation warranted higher rates, Reuters reported.
U.S. interest-rate futures moved to price the odds of a rate increase at the Federal Open Market Committee's September 15-16 meeting at below 50%, compared with expectations earlier in the week that a hike was more likely than not. Markets were also divided over where interest rates would stand by the end of the year, Reuters reported.
The shift followed government data showing that the U.S. economy lost 23,000 jobs in July, while the unemployment rate edged down to 4.1% from 4.2% in June. The decline in the jobless rate was largely driven by workers leaving the labour force rather than stronger employment growth.
The figures raised concerns that the relative stability of the U.S. labour market could be more fragile than previously thought. That could complicate the Fed's efforts to bring inflation under control, as raising interest rates could further weaken already subdued hiring.
The FOMC last week kept its federal funds target range unchanged at 3.5%-3.75%, although three officials dissented in favour of a rate increase. The decision came as inflation remained above the Fed's 2% target, with the personal consumption expenditures price index rising 3.7% year-on-year in June.
Fed officials maintain hawkish stance
Several Fed officials have continued to signal support for higher interest rates or indicated they would be willing to tighten monetary policy if inflation remains persistent.
The three officials who dissented at last week's meeting argued that monetary policy was not restrictive enough to bring price pressures back to the Fed's target. Leaders of the Kansas City and St. Louis Fed also subsequently reiterated their preference for higher rates, Reuters reported.
Other policymakers who supported keeping rates unchanged have left the door open to a hike if economic conditions warrant it. New York Fed President John Williams has indicated that further policy action could be appropriate if inflation is not moving towards the 2% target. Fed Governor Lisa Cook has similarly said she could support an increase if necessary, Reuters said.
Philadelphia Fed President Anna Paulson has maintained an open stance on the policy outlook, suggesting that the Fed could either raise rates or keep them at current levels for longer.
Richmond Fed President Thomas Barkin, meanwhile, indicated that the weak July jobs report may not significantly alter his assessment of the labour market, which he has viewed as broadly balanced rather than clearly weak or overheated.
The Reuters report noted that the unusually direct comments from Fed officials on the monetary-policy outlook have stood out as the central bank's new leadership has taken a less explicit approach to providing forward guidance. Fed Chair Kevin Warsh has preferred to allow financial markets to form their own expectations rather than signalling the likely path of interest rates.
Inflation remains key to policy outlook
Despite the sharp repricing in rate-hike expectations, some economists believe the prospect of tighter monetary policy remains alive, particularly if upcoming inflation readings prove stronger than expected.
The July employment report and downward revisions to previous months have weakened the case that the labour market is completely stable, but economists noted that Fed officials have recently indicated that the economy may require relatively few job gains to maintain labour-market balance.
According to Reuters, Omair Sharif, president of forecasting firm Inflation Insights, believes the softer employment data may not materially change the Fed's focus on inflation. He expects policymakers could still consider raising rates if inflation readings for July and August remain firm.
Rick Rieder, chief investment officer for global fixed income at BlackRock, also expects inflation to remain the dominant consideration for the Fed despite the softer labour data, Reuters reported.
Citibank economists took a more dovish view, saying the combination of weaker labour-market conditions and potentially cooler inflation would force policymakers to weigh inflation risks against the possibility of further deterioration in employment. They expect the Fed's next move to be a rate cut rather than a hike, with October their base-case timing.
The conflicting signals leave the Fed facing a delicate policy trade-off. Persistent inflation argues for maintaining or increasing monetary restraint, while weakening employment conditions raise the risk that further rate hikes could unnecessarily damage the labour market.
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