The Labor Market's Cruel Summer

Financial markets were expecting the U.S. economy to shed jobs in the August employment report, released Sept. 5, but a big jump in the U.S. unemployment rate took Wall Street by surprise. The weaker-than-expected data for August suggest the U.S. economy is headed for recession and puts pressure on the Federal Reserve to lower rates rather than raise them, as the Fed has indicated it wants to do.

The unemployment rate jumped 0.4 percentage points to 6.1% in August, as nonfarm payrolls fell another 84,000, compared with an upwardly revised decline of 60,000 in July. Even worse for the labor market, June's 51,000 decline was revised to –100,000, for a net –58,000 revision over the prior two months. The drop in payrolls wasn't too far off economists' consensus estimate of 71,000, but the spike in the unemployment rate was another matter: The consensus estimate had called for it to remain at 5.7% (it was at 5.0% in April).

Manufacturing lost 61,000 jobs in August (44,700 in transportation equipment). Construction fell 8,000. Services employment fell 27,000, with a 61,600 drop in administrative and support services. The government added only 17,000. Household employment declined 342,000, while the civilian labor force rose 250,000.

Pressure for a Rate Cut
"The data are worse than expected across nearly every category and will likely add to the angst in stocks, weaken the dollar, but should give further support to Treasuries," wrote Action Economics analysts in a Sept. 5 Web site posting.

"The data are more confirmation that this is a recession," wrote S&P Economics in a Sept. 5 note.

The rise in the unemployment rate was entirely in adults, as the teenage rate dropped sharply as teens returned to school. Average hourly earnings rose 7¢ (0.4%), a slight acceleration from the recent 0.3% trend, and are up 3.6% from a year earlier, compared with 3.4% in July.

"The wage acceleration, although slight, could also cause some nervousness at the Fed," says S&P Economics.

Financial markets showed a relatively sharp response to the payrolls dive and jobless jump on Sept. 5. Treasury prices headed higher, with bond yields already at five-month lows following the rout in stocks this week. Stock index futures, meanwhile, headed lower. The dollar initially slid lower vs. other major currencies.

What does the market see ahead on the Fed policy front? Fed funds futures, a vehicle for market pros to make bets on future loan interest rate moves, extended their gains after the worse-than-expected employment report, and are now tilted toward another potential rate cut later in the year. "That's a far cry from the 75 [basis points] in tightening that had been suggested two months ago," notes Action Economics. At this point, it's unlikely the Fed will cut rates again, as policymakers have made it quite clear that they don't plan to take the funds rate below the current 2%.