Jobless Data Casts Doubt on Rate Hikes

A startlingly weak July employment report released Friday cast doubt on the path of Federal Reserve (search) rate hikes for the rest of the year but many economists stuck to their expectations for a move next week.

"This report is a major shock, especially following ... the downward revision from June's already anemic gain. The pace of job creation has slowed sharply over the past four months," said Steven Wood, chief economist at Insight Economics in Danville, Calif.

July payrolls eked out a meager 32,000 gain, a fraction of the median of Wall Street forecasts, which called for a 228,000 increase. It was the smallest increase since December and employment gains for May and June were also revised downward.

The Fed holds its next interest rate (search) policy meeting on Tuesday, and many economists, though disappointed by the employment report, said they still expect a quarter percentage point increase to 1.50 percent from 1.25 percent.

"The Fed still raises by 25 basis points on Tuesday; it's too soon to change course," said Scott Brown, chief economist at Raymond James in St. Petersburg, Florida, referring to the Fed's just-started tightening cycle.

So far the Fed has raised rates only once, in June, and has pledged a slow and steady series of rate hikes to return borrowing costs from rock-bottom lows to more normal levels provided there is no spike in inflation, which hurts growth.

Other analysts were less sure about Tuesday's outcome, saying the payrolls report cast doubt on the Fed's mantra that the weakness in the economy in June would prove short-lived.

"It certainly will give the Fed cause to think about whether they are going to raise next week or not, and how they are going to approach the course of tightening this year," said Rick Egelton, deputy chief economist at the Bank of Montreal in Toronto.

Futures markets reacted swiftly to remove the chance of one rate hike in either September, November or December, and economists said that both employment and consumer spending numbers would have to bounce back to justify the steady path of "measured" rate rises the Fed has said it plans.

The implied fed funds rate for December was 1.87 percent, which assumes two more quarter-point hikes and a 50-50 chance of a third.

Complicating the markets' reaction to Friday's unambiguously weak data was a report in the Wall Street Journal by Fed-watcher Greg Ip that said the Fed was unlikely to pull back from its tightening campaign despite signs of a slowdown.

The timing of its publication just before the weak jobs report raised suspicions among bond traders.

"It's hard to believe the Ip article was accidental; in which case the Fed is telling us to ignore this data point. It's going to hike next week and probably in September as well," said Drew Matus, economist at Lehman Brothers in New York.