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The case for a June interest rate hike


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The case for a June interest rate hike

Kevin Dobbs isa senior reporter and columnist. The views expressed in this piece represent thoseof the author or his sources and not necessarily those of S&P Global MarketIntelligence. Follow on Twitter @Kevin1Dobbs.

The headlinejobs number for Aprilmay have disappointed, but signs of underlying momentum in wages and hours workedbode well for the consumer-driven U.S. economy and, as a result, could give FederalReserve policymakers the ammunition they need to raise interest rates in June, someobservers say.

Asset-sensitivecommunity banks could enjoy boosts to lending profitability in a higher rate environment,making the Fed's next move a highly anticipated one.

Americanemployers added 160,000 jobs in April, down from the 208,000 added the month beforeand far fewer than the 200,000 that Econoday data indicated economists on averagehad expected. The three-month moving average gain through April was about 200,000,below the nearly 230,000 jobs that employers added on an average monthly basis in2015.

However,wage growth and an increase in hours worked last month are indicators of advancesin income that could drive consumer spending this summer. The average workweek forAmericans on private nonfarm payrolls increased about 2% from a year earlier. Averagehourly earnings in April climbed 2.5% from a year earlier. In March, year-over-yearearnings rose 2.3%.

On thesurface, such figures may not jump out as impressive. But the wage increases dorepresent improvements from the roughly 2% level at which wage growth had been confinedfor the last several years.

If upwardmomentum on wages and hours worked develops into a trend, economists say, it wouldlikely lead to more consumer spending power. And if spending not only rose but weresustained for several months, it could put upward pressure on inflation.

"Ifthere were a pick-up that became clearly consistent, inflation could follow, andthe Fed would almost certainly look to act," Christopher Probyn, chief economistat State Street Global Advisors, said in an interview.

Policymakerswould eventually bump up rates to keep mounting inflation in check, and some arguethat the Fed's policy arm would be wise to get in front of such a trend.

"Wethink they're behind the curve and the labormarket is a primary reason for this view," BMOPrivate Bank Chief Investment Officer Jack Ablin saidin an email, referring to Fed policymakers. While the recent increases in wagesare not striking on their own, he said, they are "indications that incomesare heating up."

Ablinsaid that, when the wage increases are combined with rising levels of hours workedand the total number of people employed, incomes are rising notably. He said privatepayroll workers collectively earned $125 billion per week in April; that is $5.3billion more than a year earlier.

Ablinestimated that, over the last three years, Americans' paychecks have grown at a4.3% annualized rate, "far outpacing real GDP growth." The Commerce Departmentestimated that GDP expanded at a 0.5% rate in the first quarter of this year andat a 2.4% rate in 2015.

What'smore, he said, there is a strong early sign of inflation in the form of Americanspaying more to dine out. Restaurant prices tend to rise when business is brisk.Citing Labor Department data, Ablin said increases in restaurant prices paid haveexceeded the cost of eating at home by more than 3% over the past year.

"Asurefire way to determine if household budgets are squeezed is to assess whetherpeople are eating at the kitchen table or in restaurants," Ablin said. Theuptick in prices paid dining out "may not sound like much, but the Fed shouldnote what happens to inflation when people start opening their wallets."

Probynsaid that the recent wage increases are not enough on their own to drive inflationup to or beyond the Fed's 2% target. The latest federalestimate of the U.S. inflation rate through the 12 months ended in March was 0.9%.The tame inflation, along with global economic weakness, has resulted in cautionamong Fed policymakers. They raised short-term interest rates by 25 basis pointsin December 2015, marking the first bump in years. But they have not followed withthe additional increases that many observers had expected for the first half 2016.Policymakers next meet in mid-June.

Probyn said market expectations now peg the odds of a rate increaseat any point this year at under 50%. "So an increase in June, while I don'tthink it's impossible, I do think it's a stretch to expect it," he said.

He saidthat, given the Fed's reluctance to date this year, policymakers likely want tosee several months of wage growth before moving on rates. That noted, he said Fedofficials have in recent weeks made it known that rate increases are on the tablethis year, and if the government's next jobs report shows robust wage gains forMay and another increase in hours worked, it might be enough to spur a 25-basispoint rate increase in June.

"Rightnow, it does not look likely," Probyn said."But June is not completely off the table."