NEW YORK—The U.S. economy created 173,000 jobs in August and the unemployment rate dropped to 5.1 percent, increasing pressure on the Federal Reserve as it meets later this month to decide whether it's finally time to raise interest rates for the first time in nearly a decade.

It's a highly delicate time for the Fed following weeks of market turmoil and central bank officials giving mixed signals on whether they might make a move this month, a decision with profound economic and political ramifications.


But even the jobs report — which was slightly weaker than expected but showed wages rising and joblessness falling to the lowest level in seven years — may not give the Fed or markets more clarity. It was not weak enough to force the Fed to wait, or good enough to make a September rate hike an easy call.

“The Fed itself clearly doesn’t know what to do in September,” said Megan Greene, chief economist at Manulife and John Hancock Asset Management. “I think they were surprised by all this market volatility and that volatility isn’t going anywhere. I think they should wait. It would be total madness to raise rates when there is no inflation, there is still slack in the labor market and there are all these risks from outside the U.S.”

The problem for Yellen and the Fed is that unemployment is close to dropping below 5 percent and economic growth is close to 3 percent, both signals that it could be past time to move beyond an emergency policy of below zero rates or risk allowing inflation to take hold. A report out Thursday on non-manufacturing activity — which makes up the bulk of the economy — showed continued strength, suggesting solid underlying growth.

And once inflation bites, especially in a slow-growing economy, it can take heroic efforts to beat back, as President Jimmy Carter learned the hard way in the late 1970s when Paul Volcker moved aggressively to boost rates, leading to severe recession but breaking the back of runaway inflation.

Hawkish analysts say if the Fed balks again in September, it will be flirting with economic disaster.

“If they keep waiting they become the kid on the diving board who won’t jump and eventually people think they will never jump,” said Bob Eisenbeis, chief monetary economist at Cumberland Advisors. “It becomes a credibility issue. A single rate hike now would send a signal that the Fed feels good about the state of the U.S. economy. Why play this game of chicken on inflation, particularly with huge amounts of excess reserves in the banking system? That’s like playing with matches alongside a tank of gasoline.”

Some analysts have little sympathy for the Fed’s current predicament, saying the central bank could easily have begun a very modest rate hiking campaign last year or the year before, removing the decision from the cauldron of a presidential campaign cycle.

“I have never seen a case where a central bank anywhere spent two years debating whether to raise rates by a quarter point and not reaching a decision,” said Allan Meltzer, a Fed historian and professor at the Carnegie Mellon Tepper School of Business. “They knew there was an election coming. They put themselves inside this box, and they did it for no good reason. They could easily have done this a year or even two years ago.”

A very soft jobs number on Friday would have made it much easier for Yellen and the central bank to put off a rate hike until at least December.

But a strong figure well above 200,000 would have increased pressure to ignore recent market gyrations and take the first step toward ending an emergency policy that began with the financial crisis of 2008 and 2009.

The problem is the number was largely inconclusive. The August figure often comes in low and later gets revised higher, so the 173,000 jobs created could easily get bumped up to 200,000 or more. “You would have to get a figure well below expectations, in the range of 125,000 or so, or much stronger, in the range of about 300,000, for the Fed to change its view of where the economy is going,” said Steven Ricchiuto, chief economist at Mizuho Securities USA.

The August report was mainly positive with earnings up 0.3 percent and the June and July figures revised up by a total of 44,000. But the labor force shrank by 41,000 in August, helping explain some of the drop in joblessness. This mixed picture will only make the Fed's call more difficult.

"So far, unemployment falling much faster than the Fed has expected has not triggered a rate hike, but the room for maneuver is now very small," Pantheon Macroeconomics's Ian Shepherdson said in a note to clients on Friday.

Other analysts also noted the dilemma the August report presents for the central bank.

"With something for everybody in the report, this places the Fed in a complex uncertainty jam," said Mohamed A. El-Erian, chief economic adviser at Allianz. "On its own, this report is unlikely to prove decisive for Fed decision makers. It is not strong enough to suggest that the US economy can easily withstand the adverse impact of weaker global growth and financial market volatility; and it is not weak enough to signal a red light for a September rate hike."

Whatever the Fed decides could seal the fate of the U.S. economy and drastically alter the political playing field for the 2016 elections. Make a false move and raise rates too soon or too clumsily and already volatile markets could crash and the economy could slip into recession, making life miserable for Hillary Clinton and other Democrats seeking to hold the White House.

But wait too long and inflation could spike and spin beyond the central bank’s ability to control. Not since the 1992 election has the Fed loomed so large as a major political player. Former President George H.W. Bush blamed his loss to Bill Clinton that year in large part on then-Fed Chairman Alan Greenspan waiting too long to cut rates.

“I think that if the interest rates had been lowered more dramatically that I would have been reelected president because the recovery that we were in would have been more visible,” Bush said about the 1992 election. “I reappointed him, and he disappointed me."

The question now is whether the Fed raises rates too fast and “disappoints” Hillary Clinton and the Democrats.

The Fed prides itself on its independence and avoidance of making any decisions based on political factors. But outside observers say the central bank cannot avoid such pressures.

These people say that intense scrutiny from Republicans of the Fed’s actions during and after the financial crisis mean it is very unlikely that the central bank would launch another round of asset purchases — so-called quantitative easing — even if the situation seemed to demand it.

And they say the Fed will want to launch any interest rate hiking campaign well before the general election next November so as not to be seen tilting the electoral balance one way or the other.

“The Fed does not talk about politics at all, they studiously avoid it,” said Charles Geisst, an economic historian at Manhattan College. “But with the GOP all over them for disclosure on asset purchases I can’t see them doing any more of that. And they will want to raise rates well before the election so they aren’t accused of playing politics.”

At the moment, Wall Street is highly uncertain about what the Fed will do.

After the Chinese market began to collapse last month and the government in Beijing moved to devalue the nation’s currency, New York Fed Chief William Dudley said a September rate hike looked “less compelling.” That led traders to believe a rate hike would not arrive until December at the earliest.

But just days later, Fed Vice Chairman Stanley Fischer said at a major conference in Jackson Hole, Wyoming, that there was “good reason to believe” that inflation was about to move higher, which many market participants took as a sign that a September hike remained a very real possibility.

Since then, U.S. markets have gone on a roller coaster ride with the Dow tanking one day on bad news out of China only to bounce back strong the following day. The question now is whether Yellen, the first Democratic nominee to run the Fed since Volcker, views the market volatility as a transitory problem largely unrelated to the strength of the U.S. economy or a strong reason to hold off on hiking rates.

If there is anything close to consensus on Wall Street right now, it is that Yellen and the Fed ultimately decide to do nothing at the September meeting and wait for more data and signals that the current market gyrations are temporary.

“I think they do nothing and punt,” Ricchuito said. “And market volatility adds to the argument for why they should punt. There’s little risk to waiting and lots of risk if you move prematurely. One stupid mistake and you are fighting deflation. Why take the risk?”

