Three Datapoints the Fed Is Likely Watching Ahead of the September FOMC Meeting

Key Takeaways:

• Investors will be watching the September 16 Federal Reserve interest rate decision closely. In Canada, the next Bank of Canada (BoC) decision is on October 28. We believe both central banks will likely weigh several datapoints, including labour market data, CPI inflation, and inflation expectations.
• The U.S. labour market remains healthy, but wage pressures continue to ease. August payrolls increased by 162,000, well above expectations, while wage growth slowed to 3.1%, suggesting labour demand remains solid without signs of wage-price inflation.
• The next set of inflation reports could play a critical role for the Fed and BoC. Inflation has been steady for the past two months, and a favourable reading could support keeping rates unchanged, while a reacceleration in price pressures may increase the likelihood of a rate hike.
• Long-term inflation expectations remain well anchored despite current elevated inflation. Market-based measures, such as break-even rates and forward inflation expectations, remain in the low-2% range, suggesting investors expect inflation to moderate over time rather than become entrenched at elevated levels.

Introduction

The next Federal Reserve interest rate decision and press conference is on Wednesday, September 16. For markets, this is a particularly notable Fed meeting because investors believe there is a real possibility that the Fed decides to raise interest rates – this would be the first rate hike since July 2023. In fact, the probability of a rate hike is now about 60%, according to CME FedWatch.

In Canada, the Bank of Canada (BoC) has already met on September 2 and kept rates on hold for the seventh consecutive meeting. However, BoC Governor Macklem did warn that the BoC is ready and willing to raise rates if inflation does not moderate further. The next BoC meeting will be on Wednesday, October 28.

What are the factors that the Fed and BoC are likely watching to help them make their upcoming decisions? We highlight three key factors below:

1. The U.S. labour market and wage growth

We know that the Fed has a dual mandate: Maximum employment and price stability. The first part of this mandate refers to the labour market and specifically keeping the unemployment rate low without causing inflation. For this, the Fed uses a number of labour indicators, but perhaps one of the most important is the monthly nonfarm-jobs report.

The August nonfarm-jobs report: On Friday, the U.S. nonfarm-jobs report pointed to a healthy pickup in the labour market for the month of August. New jobs added totaled 162,000, well above forecasts of 55,000, and above last month's revised 21,000 jobs added. Notably, job gains came from a broad set of sectors including leisure and hospitality, government, and education and health services. Most of the 14 sectors showed gains, except for financial services and information (which include telecom, media, data, and internet services).

The unemployment rate remained steady at 4.1%, well below the long-term average U.S. unemployment rate of around 5.5%. This comes even as the labour force participation rate ticked higher, from 61.4% to 61.6%, implying that even with new entrants to the labour force, the demand for labour and supply of labour remain roughly balanced, keeping the unemployment rate steady.

In Canada, the jobs report for August painted a weaker picture. Job losses totaled -41,700, versus an expected gain of 15,000 and well below last month's gain of 75,000 jobs. However, like in the U.S., the unemployment rate held steady at 6.4% in Canada.

Wage inflation? One of the key components of the jobs report that both the Fed and BoC monitor is wage growth. If the labour market were running "hot," this may show up as rising wages, as employers have to increase salaries to remain competitive. These higher wages may lead to higher prices and wage-price inflation.

However, we have not seen this wage inflation play out in the U.S. or Canadian labour markets. In the U.S., the August jobs report showed wage gains of 3.1% year-over-year, in line with forecasts and below last month's 3.2% reading. Wage growth has averaged about 3.5% this year, and the August reading was the lowest level since 2021.

Similarly, in Canada wage gains came in at 2.9% in August, above forecasts of 2.0% and slightly lower than last month's 3.0%.

Of note, wage gains in both economies have been outpacing headline inflation for much of the past three years, implying that consumers have seen positive real wages. This has shifted in the past few months, as CPI inflation has been elevated while wage gains have moved lower. However, if we expect inflation rates to gradually head back toward 2.0% levels, consumers should see positive real wage growth again too.

2. The next CPI inflation report remains front and center

The second and perhaps most critical datapoint that both the Fed and BoC will likely be watching are inflation rates.

Consumer price index (CPI) inflation has been stubbornly elevated, and this has been exacerbated by oil price uncertainty and trade and tariffs as well. However, perhaps the silver lining more recently has been that investors have not seen a re-acceleration in inflation in recent months.

We believe the next inflation reading is critical: Given the scrutiny around inflation trends, investors and the central banks will be closely watching the next set of CPI inflation reports for August. This should help determine if the recent steady inflation readings were an anomaly or perhaps the start of a trend.

In the U.S., CPI inflation will be released on Friday, September 11. Expectations are for headline CPI inflation to remain steady at 3.4% year-over-year. However, core CPI inflation is expected to tick lower, from 2.5% to 2.4% annually.

In Canada, the next CPI inflation reading will be on Monday, September 14. The forecast for now is that headline inflation may tick higher from 3.0% last month, and core may also move slightly up from 2.0% last month, driven by sticky services and shelter and rent inflation.

We also know that oil prices did climb higher toward the end of August, but averages for the month remained relatively steady, with WTI crude oil climbing from about $79 per barrel on average in July to about $82 in August.

3. Longer-term inflation expectations

The third set of data that the central banks are likely watching are inflation expectations. The Fed and BoC want to keep inflation expectations anchored because these can become self-fulfilling: If households and corporations believe inflation will return to around 2.0%, their behavior and pricing models may reflect this view. Similarly, if they believe inflation will head towards 4% or 5%, they may reflect this as well.

The central banks have a number of tools to monitor inflation expectations. In the U.S., these include survey-based measures (like the Philadelphia Fed survey of professional forecasters), household measures (like the University of Michigan consumer sentiment survey), and market-based metrics, including the five- and 10-year breakeven rates as well as the Fed's  five-year forward inflation expectation rate.

Perhaps the most objective of these and easiest to monitor are the market-based metrics, as they are timely, involve real capital and investors, and have a longer-term focus.

Overall, these market-based inflation expectations remain relatively well anchored and have not shown signs of meaningful re-acceleration despite inflation running above target. Measures such as 10-year TIPS breakeven inflation and longer-term forward inflation expectations remain in the low-to-mid-2% range, suggesting investors expect inflation to moderate over time rather than become entrenched at current levels. This should be encouraging for the Fed and BoC, as anchored expectations can help prevent temporary inflation shocks from becoming more persistent.

What do the Fed and BoC decisions mean for portfolios?

We expect that the Federal Reserve and Bank of Canada will have tough decisions to make in their upcoming meetings on whether to raise interest rates or hold them steady. They will likely have to weigh elevated inflation rates against potentially better recent trends in inflation and well-anchored inflation expectations.

For investors, however, we know that a good defense against higher inflation is to invest in assets that can outpace inflation rates over time. In our view, a diversified portfolio across market caps, regions, and sectors can set up investors for positive after-inflation rates of return. We continue to favour U.S. large-cap stocks, Canadian small-and-mid-cap stocks, and emerging market equities.

Also, keep in mind that even if the central banks decide to raise rates one or even two times, we don't believe this would derail the broader narrative. The U.S. and Canadian economies are growing at or above trend levels, and corporate earnings growth for both the S&P 500 and the Canadian TSX are on pace for over 25% this year. In this backdrop, we believe the economy would be able to absorb a mid-cycle adjustment in interest rates, especially if it helps bring credibility to the central bank and pushes inflation expectation lower.

Your financial advisor can help ensure that your portfolio is aligned with your personal investment goals and risk tolerances, to help ensure you are making progress toward financial fulfillment, regardless of inflation and interest rate risks.

Mona Mahajan
Investment Strategist

^{Source for all data in commentary: Bloomberg.}

Previous weeks' weekly market wraps

8/28: A Clearer Path into September

8/21: A roller-coaster week for rates: Separating opportunity from risk

8/14: Cooling inflation supports the case for Fed patience

8/7: Easing headwinds clear the way to new highs

7/31: Fed and tech earnings take center stage

7/24: Will the rise in oil prices force the Fed's hand?

7/17: Markets take a breather as earnings outlooks come to the forefront