Goldman Sachs economists believe Fed officials were intentionally sending a strong signal about raising interest rates in September when they met at Jackson Hole, Wyoming, and September remains on the table even with a disappointing jobs report.
Goldman is going against the herd, as most economists believe the weakish jobs report for August ruled out a September rate hike.
Goldman Sachs chief economist Jan Hatzius discussed the call Friday on CNBC immediately after the jobs report's release, but over the Labor Day weekend, the firm's economists issued a more detailed note surrounding their minority view.
Goldman on Friday put 55 percent odds for a hike at the Fed's Sept. 20-21 meeting and 80 percent odds by the December meeting. The firm said the soft jobs report makes it a "close call" for September. As of Tuesday morning, Fed funds futures put odds of a September rate hike at just 26 percent, and only 68 percent by December.
"The strength of the message surprised us, but we don't think it came out of the blue. Back in the spring, the committee was ready to go in June or July, but then the weak May payroll report and the Brexit vote interfered. Now both of these worries have dissipated, the labor market has made further headway, financial conditions are easier than they were three months ago, and no major new risks have appeared," they wrote.
The next metric they are watching is the words of Fed speakers themselves.
"So we would probably need to see some hawkish Fedspeak between now and the start of the blackout period on September 13 to keep the chance of a hike alive. A signal that the August employment report showed sufficient employment growth to confirm the committee's baseline outlook might be enough to shift market expectations toward a hike at the September meeting," they wrote.
San Francisco Fed President John Williams speaks Tuesday evening in Reno, Nevada, and two Fed presidents — Richmond Fed President Jeffrey Lacker and Kansas City Fed President Esther George — give testimony on Capitol Hill on Wednesday.
Hatzius and his team dispute the view by many that the Fed will be stopped by the election, since there is a precedent of Fed actions before elections in the Greenspan and Bernanke eras.
Friday's jobs report left many economists confident in their forecasts that the Fed would hike rates in December rather than September. The disappointing 151,000 nonfarm payrolls for August was about 30,000 below expectations and not seen as strong enough to force the Fed's hand.
But Goldman economists say Fed Chair Janet Yellen set a low bar for the jobs report in her Jackson Hold speech Aug. 26. She specifically said given the "continued solid performance of the labor market and our outlook for economic activity and inflation" that she believed the case for increasing the federal funds rate "strengthened in recent months."
Yellen's comments were more strident than they needed to be, were she only preparing markets for a December hike, they argued. Yellen suggested that the hike was conditioned on a premise that the data needed only to "continue to confirm" the Federal Reserve Open Market Committee's outlook.
The same message was delivered shortly after Yellen spoke by a second key Fed official, Vice Chairman Stanley Fischer.
The Goldman economists wrote: "Fischer was asked by Steve Liesman on CNBC later that day whether the 'strengthened' comment meant that we should be 'on the edge of our seats for a rate hike next month' (i.e. in September), he answered 'what the Chair said today was consistent with answering yes.' This wording sounded like a deliberate signal that both of them, not just Fischer personally, think September is on the table for a hike."
In his CNBC appearance on Friday, Hatzius said Fed officials made clear in the comments that they were looking for just confirmation of progress. He said: "151,000 is clearly about their estimate of what it takes to improve the labor market over time."
Wall Street economists had expected an unemployment rate of 4.8 percent, but it held at 4.9 percent. Wage growth slowed to a disappointing gain of just 0.1 percent while some economists had expected 0.3 percent.
Strategists had said a jobs report with nonfarm payrolls of 200,000 or more and strong components, like higher wages, would have possibly nudged the Fed to raise interest rates at its September meeting.
Goldman economists had forecast just 165,000 payrolls and pointed out the quirkiness of past August reports. They said August payrolls have fallen short of consensus by about 49,000 since 2011, but were revised higher by an average 71,000 in later releases.
The economists have also said this factor may make the Fed look past the initial September report.
They also said the economic data have been mixed but that GDP for the third quarter looks to be stronger, and their forecast is 2.9 percent.
"If they thought a hike made sense then (in June), it should make more sense now. In this context, it is also noteworthy that the number of regional Federal Reserve Bank boards asking for discount rate increases — a barometer of policy sentiment within the system — has risen further in recent months and now stands at 8 (the highest since December)," they wrote.
The Fed raised its fed funds rate for the first time in nine years last December but has held firm since then.