June job growth surged to a much stronger-than-expected 222,000, and 47,000 more jobs were added to April and May, putting the Federal Reserve on track to move full steam ahead in September, traders said.
Average hourly wage growth was shy of expectations, increasing 2.5 percent year over year versus expectations of 2.6 percent. The slight miss is not enough to cause the Fed to pause in its monetary tightening.
"The Fed has made it very clear their focus is not that narrow. Yes, the Fed would like to see wage growth accelerate, … the average hourly earnings is not going to change their view on inflation," said Ward McCarthy, chief financial economist at Jefferies. Janet "Yellen and Bill Dudley and the minutes made it clear they have dismissed the transitory factors that are subduing inflation."
Bond yields initially retreated as traders reacted to the softer wage growth, a nagging sign to markets that inflation is not improving. But the decline in the 10-year Treasury yield nearly reversed, and it was at 2.39 percent in morning trading. Bond yields have been rising recently on the view that global central banks, led by the Fed, are on the verge of moving away from easy policies.
The Fed is widely expected to begin to chip away at reducing its $4.5 trillion balance sheet in September, instead of raising interest rates at its meeting. It is then expected by many to raise rates for a third time this year in December.
"I don't see anything in this report that I would expect would change the Fed's position," said Luke Tilley, chief economist at Wilmington Trust. He expects the Fed will use the September meeting to launch its balance sheet reduction.
The Fed's expected balance sheet action is new and untested, and it could send real interest rates higher. The balance sheet ballooned as the Fed purchased Treasury and mortgage securities to help the economy during and after the financial crisis.
The Fed has maintained the size of the balance sheet by purchasing securities to replace those that mature. It is this program the Fed is targeting as a way to reduce the size of the balance sheet. It is expected to announce it will initially reduce its monthly purchases by up to $10 billion and then slowly increase them after three months.
The fact the Fed seems set to move ahead has made the question of inflation even more critical in markets.
"What we've seen in these figures is very different from what we hear from our clients," Tilley said. "They report significantly more wage pressure at the company level."
Tilley and other economists have said some of the lack of wage growth may have to do with the large number of baby boomers who are high paid and do not see large wage increases. As they retire, they are also replaced by lower paid millennial workers.
"It makes us a little suspicious of whether the overall data is reflective of what companies are facing and we expect wages will accelerate in future months," he said.
But in the bond market, inflation or the lack of it remains a concern.
John Briggs, head of rate strategy at RBS, said if inflation continues to be soft, it casts doubt on whether the Fed really could raise interest rates again in December. RBS currently forecasts a December hike.
"There's not a lot of impetus for me to believe that wages are going to pressure inflation higher," said Briggs.
"I think the number is fine. ... It's not a huge market mover but it reinforces the dichotomy where we have decent job growth but no wage pressures. It's a wait and see. They're [the Fed] on the path now where they've indicated they're going to wind down investments in September but not raise rates."
The unemployment rate rose to 4.4 percent from 4.3 percent.
Economists had expected just 179,000 payrolls in June. "I think it probably overstates underlying job growth a little bit," Tilley said. "We have some statistical bounces here. It will probably come down a little bit next month, but it's overall encouraging."
"This supports what we believe is going on in the economy. There is still strong demand for workers," he added.
Monthly employment growth has averaged 180,000 this year, compared with 187,000 last year.
"You've got the labor force picking up in a big way," said Tilley. "We still think the longer term trend is whether you look at the three month average or six month average, you have job growth outpacing labor force growth by far and that's going to keep pushing the unemployment rate down despite today's report."