July jobs report 'scorcher' raises odds of another super-sized Fed rate hike

The sizzling-hot July jobs report could force the Federal Reserve to continue raising interest rates at the fastest pace since 1994 as it tries to crush inflation and cool the labor market.

U.S. employers unexpectedly added 528,000 jobs in July, the Labor Department said Friday, a surprisingly strong gain that defied fears of a slowdown in labor markets as they confront scorching-hot inflation and rising interest rates. Wage growth also accelerated, surging by 0.5% in the one-month period from June.  

But the blowout jobs report, coupled with higher-than-expected wage growth, could ultimately pave the way to a third consecutive interest rate hike of 75 basis points — triple the usual size — when Fed policymakers meet in September.

Traders are already pricing in a 70% chance of another super-sized increase in the fall, according to the CME Group's FedWatch tool, which tracks trading. 

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"The July jobs report was a summer scorcher and will likely be seen as uncomfortably warm for policymakers focused on cooling off inflation," said Curt Long, chief economist and vice president of research at the National Association of Federally-Insured Credit Unions. 

Earnings rose 5.2% in July from the previous year, much higher than the pre-pandemic average of 3%. On a monthly basis, wages rose 0.5%, coming in hotter than economists expected. 

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That is continuing to fuel record-high inflation, which Fed policymakers have stressed they are determined to crush. Consumer prices jumped 9.1% in June on an annual basis, the highest since 1981, and are expected to remain high for months.

"Wage gains showed no sign of weakening, and that does not bode well for a Federal Reserve tasked with reining in inflation," Long said. "Unless the data turns between now and then, another 75 basis point hike from the Fed in September looks likely."

Policymakers approved the second straight 75 basis point hike last week and hinted in their post-meeting statement that additional increases are likely in the coming months as they remain "strongly committed to returning inflation to its 2% objective." 

Chairman Jerome Powell said during his post-meeting press conference that another 75 basis point hike could be appropriate in the future, but that it ultimately hinges on upcoming economic data. That includes the July jobs report and forthcoming reports on inflation and consumer expectations regarding inflation. 

The jobs report, particularly the wage data, "is not quite what the Fed was hoping to see, particularly the acceleration of average hourly earnings to a 0.5% month-over-month growth pace," said Jason Pride, chief investment officer of private wealth at Glenmede. 

"All else equal, this should take away any excuse from the Fed to begin slowing down its tightening pace, as there are still few concrete signs of inflation returning to normal."

The uptick in hiring comes amid a growing consensus that the economy is losing momentum as the Fed raises rates. The Commerce Department reported last week that gross domestic product, the broadest measure of goods and services produced in the nation, shrank 0.6% in the three-month period from April to June. That followed a decline of 1.6% in the first three months of the year. 

With back-to-back quarterly declines in GDP, the economy meets the technical criteria for a recession.

While many economists have argued the strong jobs market has so far prevented the U.S. from sliding into a downturn, job growth momentum is expected to cool markedly in coming months as companies cut staff to accommodate lower demand.

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Jobless claims have started to steadily tick higher in recent weeks, and many companies, including Alphabet's Google, Walmart, Apple, Meta, Robinhood and Microsoft, have announced hiring freezes or layoffs in recent weeks.

Another three-quarter percentage point interest rate increase could create even more burdens for businesses because hiking interest rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.