Jobs Report Gives Fed Free Rein for Continued Rate Hikes

A moderate rise in August payrolls sealed expectations Friday that the Federal Reserve (search) will continue its rate-hike campaign in September without a pause.

A Reuters survey of the top economists on Wall Street taken after the payrolls report found all 22 analysts now expect another tightening at the Fed's Sept. 21 policy meeting.

Many economists had thought a weak report would give the central bank good reason to hold off raising interest rates in September.

But the increase of 144,000 jobs, while not robust, was close enough to forecasts to suggest the economy could weather another rate hike. It was the first time in months the actual number was within the range of estimates.

"For the Fed, this report offers just enough reassurance on jobs to keep the 25-basis-point tightening on the schedule for September," said FTN Financial (search) chief economist Chris Low.

Futures markets moved to fully price in a quarter-percentage point increase in September, compared with an 82 percent chance before the jobs report.

The Reuters survey found the four economists last month who thought the Fed would stand pat, regardless of payrolls, changed their minds.

If the Fed does tighten again this month, it would be the third move this year, taking the federal funds rate (search) up to 1.75 percent. Fed officials have maintained they are not trying to slow the economy, but only trying to restore official rates to more normal levels.

Financial markets were tightly wound ahead of the payrolls report, since figures for both June and July proved to be huge disappointments in the third year of an economic recovery. Job gains for those months were revised up modestly by a total of 59,000, but still showed a combined gain of an anemic 169,000 jobs.

"I'm changing my Fed call reluctantly to a 25-basis-point move in September, because that's what the market thinks they're going to do and they're not going to disappoint the market," said Steve Ricchiuto, chief economist at ABN AMRO (search).

"I doubt (Fed Chairman Alan) Greenspan will change anything dramatically when he talks next week," in testimony before Congress on Sept. 8.

Economic data have been decidedly mixed over the past three months, and what the Fed referred to as a "soft patch" in June appears to have dragged on. August retail sales are expected to be weak after major stores and the automakers reported disappointing sales this week.

"We viewed the September meeting as a candidate for a pause in monetary adjustment if the August jobs figures, in the end, printed particularly soft," said Neal Soss, chief economist at CSFB.

But he said Friday's report did not satisfy that criteria, and he cited recent Fed officials' comments that they wanted to reduce accommodative policy "unless the slowdown in growth becomes more entrenched."

This month's Fed meeting is the last before the November presidential election, and the Fed has two more meetings after that. Futures markets are pricing in a federal funds rate of 2.0 percent by Christmas, implying one more Fed hike at either the November or December meeting.

"The Fed is not inclined to pause until they get to at least 2 percent (on fed funds), maybe a bit higher," said Deutsche Bank chief economist Peter Hooper.

He noted the 1.50 percent federal funds rate was still below inflation, and depending on which measure of inflation was used, interest rates are as much as 1.5 percent below inflation.

"The Fed is going to be very much in the mode of making further progress in getting the real fed funds rate out of negative territory," Hooper said.