Strong Jobs Data Keeps Fed Hike on Table for September

The US economy added 162,000 jobs in August, a payroll number that pushed the 2-year Treasury yield to 4.41% and kept the September Fed rate hike as a live option. The unemployment rate held at 4.1%, and average hourly earnings rose 3.1% year-over-year, down from 3.2% in July. The quits rate dropped to 1.9% in July, a level that signals workers are not confident enough to leave their jobs.

Other labour indicators pointed to steady expansion without overheating. Temporary help employment rose to 2.52 million, a category that often leads permanent hiring. The index of aggregate weekly hours climbed 1.2% from a year earlier, and manufacturing production and nonsupervisory workers averaged 4.0 overtime hours per week.

Chair Kevin Warsh described the labour market as near full employment but said his focus has shifted to inflation. The wage and quits data give the Fed room to wait, but the strong payroll print keeps the pressure on.

Financial conditions remain loose despite the elevated policy rate. The Chicago Fed National Financial Conditions Index fell to -0.558, a negative reading that indicates conditions are looser than the historical average. Commercial bank reserve balances at the Fed have dropped to about $2.895 trillion, a level that still provides ample liquidity to stocks and credit markets. Warsh has signalled a desire to reduce the Fed's balance sheet further, but the September 2019 repo turmoil remains a cautionary precedent for removing reserves too quickly.

Fiscal policy adds another layer of uncertainty. Treasury Secretary Scott Bessent said stronger economic growth, supported by AI productivity gains, will help manage the US debt burden of over $40 trillion without stoking inflation.

Gross domestic product grew 6.5% in nominal terms in the second quarter, while real GDP expanded 2.1%. The wide gap between the two measures shows that higher prices contributed heavily to nominal growth. The Atlanta Fed's GDPNow model projects real growth of 4.7% for the third quarter. Strong nominal growth supports tax revenues but can also keep inflation and bond yields elevated.

The 10-year Treasury yield is near 4.8%. If the Fed holds rates at current levels while growth and inflation remain high, yields could surge above 5%. A similar pattern emerged in the two previous tightening cycles: positive momentum in 2-year yields preceded the first rate hike by about 18 months in 2015 and by about five months in 2022.