Booming job market makes interest rate hike more likely

A suite of positive economic news this week makes it more likely that the U.S. will raise interest rates sooner than most experts have been anticipating.

On Thursday, the U.S. Commerce Department unveiled data showing the American economy added another 288,000 jobs in June. That's the fifth straight month that the figure has come in better than was expected, and the strong job gains are pushing the stubbornly high unemployment rate lower.

"Since February, this has now become a textbook jobs expansion," said Patrick O'Keefe, director of economic research at the consultancy CohnReznick. "It is both broad and accelerating."

America's jobless rate is now at 6.1 per cent, the lowest it's been since September 2008, which is before bank failures such as Bear Stearns and Lehman Brothers kicked off a worldwide recession from which the global economy is still recovering.

The global downturn is also what compelled central banks, including those in Canada and the U.S., to slash rates to record lows in an attempt to spur borrowing and spending.

All that cheap money has lit a fire in equity markets, with the TSX and Dow Jones Industrial Average each breaking  all-time record highs this week. By their mandate, central banks don't care much about things like the stock market in making their interest rate decisions. But as the good news mounts, it's getting harder and harder for them to ignore: the economy is starting to heat up, so there's less and less reason to keep rates so low.

In Thursday's report, June's figure was strong, but the data agency also upgraded its numbers for April and May higher, showing that those months added 224,000 and 304,000 new jobs, respectively.

"The steady stream of positive U.S. data continues, with the key report— hiring — the icing on the cake," BMO economist Jennifer Lee said in a report Thursday.

While the strong jobs data certainly adds fuel to the rate hike fire, it's far from a sure thing. The jobless rate is now at its lowest level in six years, but it's still above the 5.5 per cent level that the Fed is on record as saying is the "equilibrium rate" it is looking for.

Nor is there much evidence that wages are increasing in lockstep with new jobs. Average pay grew by about two per cent during the last 12 months, the report showed. That's a decent showing, but still below the historical average of 3.5 per cent it has shown when the economy is on solid footing,

Still, with a few more months like that, it's going to be impossible to ignore the improving economic picture forever. Most economists expect the Federal Reserve to slowly unwind it's qualitative easing bond-buying program by the end of this year, with a view to actually increasing rates some time in 2015. 

But this week's data is moving that timeline up in some people's eyes. "We expect the Fed to halt its quantitative easing this October and we anticipate that the first rate hike will come in March next year," Capital Economics' U.S. strategist Paul Ashworth said. That's three months earlier than the company was thinking would happen before the jobs data came out.

What's more, once rates do start moving, they're now a lot likelier to move higher and faster, he says. The Fed's benchmark rate will be at 1.25 by the end of 2015 and up to three per cent by 2016, Ashworth expects.

Any move to hike rates would undoubtedly have spillover effects into Canada. As it stands, the Bank of Canada's benchmark interest rate sits at a relative low of one per cent right now — the same place it's been for almost four years dating back to September 2011.

Technically, the Bank of Canada targets two per cent inflation above all else in setting its rate decision (and Canada's inflation rate is still well within its comfort zone) but it's extremely unlikely the Bank of Canada would sit idly by amid mounting evidence that Canada's largest trading partner is starting to heat up.

"The ongoing strength in job growth should put to rest any lingering doubts that the recovery is gaining traction," TD Bank economist James Marple said. "A strong job report like this may even get investors thinking about when the Fed may step off the sidelines."

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