July’s strong jobs report could prepare the Federal Reserve to dial back its bond-buying program

July’s strong jobs report puts the Federal Reserve on track to slow its bond purchases — if the spread of Covid-19 doesn’t hurt the economy and hiring later in the summer.

Hiring was the fastest pace in a year. The economy added 943,000 jobs in July, nearly 100,000 more than the Dow Jones consensus estimate. The unemployment rate also fell to 5.4%, beating the forecasted jobless rate of 5.7%. Employment in May and June was also revised higher by a total of 119,000 payrolls.

“This is a good number that gets the Fed primed and pumped to taper,” Grant Thornton chief economist Diane Swonk said.

Fed watchers expect the central bank to formally announce the wind down of its $120 billion monthly bond-buying program – which had been put in place to prop up the economy through the pandemic – at one of its next few meetings. Market pros also think the central bank will start the process of cutting back its asset purchases by the end of 2021 or early 2022.

The S&P 500 and the Dow Jones Industrial Average jumped, while Treasury yields moved higher. The 10-year yield edged up to 1.28% after hitting a low of 1.13% earlier in the week. Bond yields move opposite prices.

“There’s a lot to like about this number. It seems stocks like it. … The dollar and rates are up and that suggests investors think maybe numbers like these will get the Fed to do something eventually,” State Street Global Advisors chief investment strategist Michael Arone said.

The central bank has said it would like to see “substantial progress” toward its goals for the economy before it is ready to taper back its purchases of Treasurys and mortgage securities. Recently, Fed Chairman Jerome Powell said the Fed would like to see a few strong employment reports as proof the labor market is recovering.

Tapering back that program would be a first step toward ultimately raising interest rates, something the Fed has forecast for 2023. The gradual pullback of asset purchases is expected to take 10 months or longer.

“It’s going to depend heavily on Covid for the timing. I still think they’re going to do it by year end,” Swonk said. “This is a pre-Covid report, and these are the kinds of gains they wanted, with upward revisions as well.”

Some market pros have expected a strong jobs number could signal the Fed will make an announcement as early as September, and then follow through with reducing its purchases by late this year or early next year.

“It looks like you’re continuing to make your way toward substantial progress. It’s a good number,” NatWest Markets head of strategy John Briggs said. “I think it means for me that September is still on track for the Fed to talk about tapering. I think if you get another number like this in the September report, you’re going to have substantial progress.”

State Street’s Arone said with job gains averaging over 800,000 in the last several months, it will take about seven months for the labor market to recover its pandemic losses. “It aligns with many investors’ expectations” for the Fed to begin tapering, he said.

Swonk of Grant Thornton said the composition of the jobs gains showed some real progress for the economy, which is still down more than 5.7 million payrolls from its pre-pandemic level in February 2020.

“It was dominated by all the sectors we expected — education, leisure and hospitality. Movies are coming back. Everything that was hardest hit by the pandemic,” she said. “Also some encouraging signs by the mining industry which means we could get some relief on oil prices. Not only are we hiring workers but workers are also showing up. The participation rate is moving up. We lost a half a million off the roles of the long-term unemployed.”

Employment in leisure and hospitality rose by 380,000, but employment in that sector is still down 10.3% from its February 2020 level.

“Transportation numbers ticked up pretty healthily and manufacturing has been in a nice trend in the last few months. That suggests to me that some of the supply chain bottleneck challenges are starting to get some relief,” Arone said. The transit and ground passenger transportation sector added 19,000 workers and manufacturing gained 27,000.

The Fed has blamed supply chain congestion for some the sharp jump in inflation recently. The Fed has downplayed rising inflation as temporary.

But economists are especially watching wage inflation since it is stickier than other inflation.

In the jobs report, average hourly earnings increased by 0.4% for the month and were up 4% from a year ago, more than expected. Economists have been closely watching this number, as inflation has picked up across the board in recent months.