Fed Rate Hike Doesn't Signal Better Job Market

Anxious job-seekers in the United States might take comfort in this week's interest rate hike by the Federal Reserve (search) and its assurance that recent weakness in the job market was transitory.

After all, policy-makers wouldn't be raising borrowing costs and possibly slowing the economy if they were worried employment growth was stalling, would they?

Analysts are not so sure. It's not that the Fed is more optimistic than economists about the paltry 110,000 gain in jobs in the last two months, but rather that it is determined to raise rates to neutral levels regardless.

"I think rate hikes — at least the first 100 (basis points) or so — are impervious to what happens to payrolls," said Michael Gregory, senior economist at BMO Nesbitt Burns. "It may only take one more weak payrolls report to get them to pause a meeting but ... short of literally knocking on recession's door, rates are probably going to be going up."

The Fed had clearly signaled that the quarter-point increase in the fed funds rate (search) to 1.5 percent, decided at Tuesday's policy meeting, was necessary to head off inflation. But the historical weirdness of the move left some analysts reaching for the record books.

"Was it the most dismal six-week run of economic news ever to be followed by a Fed hike?" wondered Rory Robertson, interest rate strategist at Macquarie Bank.

The sluggish job growth in June and July is rarely the sort of economic news that precedes a rate rise, which the Fed typically uses to slow the economy.

The previous 14 increases by the Fed were preceded by a two-month payrolls gain averaging 600,000 jobs — more than five times that in June and July.

In fact, the Fed is often cutting rates when job growth is this anemic. Five of the last 15 rate cuts were preceded by stronger job growth rates than seen in the last two months.

While the rate increase was widely expected, the fact the Fed gave short shrift to job market worries and optimistically said "the economy ... appears poised to resume a stronger pace of expansion" surprised a few on Wall Street.

Some analysts said the Fed's sanguine approach suggested the job market may not be as weak as the Labor Department's (search) payrolls survey shows, arguing poorly measured seasonal factors might have dampened the numbers.

Others, including President Bush's campaign team, have pointed to a more buoyant but smaller household survey of employment as a better count of new jobs.

But James Glassman, senior U.S. economist at J.P. Morgan Chase, scoffed at the suggestion the rosier household survey was behind the optimism of Fed Chairman Alan Greenspan (search) or fellow Federal Open Market Committee (search) policy-makers.

"Payrolls is all that matters. The household survey is worthless and Greenspan has said that already," he said. "You shouldn't having to pull out the microscope or resort to seasonal arguments to make excuses for payrolls."

Glassman said hiring will probably not stage a dramatic rebound in August, with employers still focused on keeping a lid on costs and economic growth not robust enough to spur hundreds of thousands of new jobs.

The Fed was not trying to downplay job weakness, he said, but was instead preoccupied by inflation and convinced another small rise in rates would not threaten a jobs recovery.

"No central bank is going to tolerate an economy that grows but there is no job growth," Glassman said. "But there was no reason to wring its hands in the statement."

Besides, argued Wells Fargo chief economist Sung Won Sohn, if the Fed is determined to raise rates, it is wisest to put on a brave face.

"At this meeting to some extent they almost had to be optimistic lest they send the wrong message on the economy," he said. "I wouldn't be surprised at all if there are some doubts among other FOMC members about jobs and the durability of this recovery."