Wage Gains Reinforce Inflation Fears, Fed’s Position on the Sideline

This morning, nonfarm payrolls rose by 272k in May, surpassing the 180k gain expected according to Bloomberg and marking the largest gain in two months. The three-month average, meanwhile, rose from 237k to 249k. April payrolls were revised down from a 175k gain to a 165k increase. With additional revisions to previous months, the?overall change in nonfarm payrolls (May data + net revisions) was 257k.

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In the details, private payrolls rose by 229k in May following a 158k gain in April.?Goods-producing payrolls, meanwhile, increased by 25k, thanks to a 21k gain in construction payrolls and an 8k rise in manufacturing payrolls.

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Private service producing payrolls rose by 204k in May following a 158k gain in April. Education and health payrolls led the gain in May, rising 86k in May, albeit much lower than the 106k gain the month prior. Leisure and hospitality payrolls climbed 42k following a 12k increase the month prior, and professional and business services payrolls rose 33k, despite a 14k drop in temporary help payrolls. Also, trade and transport payrolls rose 27k in May, due to a 13k rise in retail trade payrolls. Financial payrolls, meanwhile, increased by 10k, the most in ten months. On the weaker side, information payrolls were unchanged. Finally, government payrolls rose by 43k in May following a 7k gain in April.

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Household employment, on the other hand, dropped by 408k in May, the most since December. The labor force, meanwhile, declined by 250k following an 87k gain in April. Thus, the unemployment rate unexpectedly ticked up from 3.9% to 4.0% in May, the highest since January 2022. According to the median forecast, the unemployment rate was expected to remain at 3.9% for a second consecutive month.

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The labor force participation rate, meanwhile, unexpectedly ticked down from 62.7% to 62.5% in May, a three-month low. The participation rate was expected to remain at 62.7%.

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Also, average hourly earnings rose 0.4% in May, a tenth of a percentage point more than expected and following a 0.2% increase in April. Year-over-year, wages rose 4.1%, up from a 4.0% gain in April and a two-month high.

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Finally, the average workweek remained at 34.3 hours in May for the second consecutive month.

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Bottom Line: While arguably rebalancing at a gradual pace in the aftermath of the fastest backup in rates in four decades, the expected slowdown in demand and overall impact on the U.S. labor market remains muted. Again, momentum is slowing in many?key categories of economic activity, particularly as younger and lower-income consumers more heavily adjust spending; the readjustment, however, against the backdrop of elevated wages remains less than anticipated.

Going forward, the minimal rise in?the level of layoffs coupled with still-solid demand for new hires limits any certainty of improvement in price pressures or for more dampened conditions for headline growth. This in turn is undermining expectations for a near-term reduction in rates, let alone a necessity?for less restrictive policy. While investors still anticipate between one to two rate cuts by year-end, this is reduced from two cuts prior to this morning’s release and even further reduced from six to seven cuts expected at the start of the year.?

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As the market digests the latest stronger-than-executed read on the labor market, longer-dated yields are pushing higher. The 10-year rose 14bps to 4.43% in the immediate aftermath of the report. As of 9:30 a.m. ET, the 10-year is trading at 4.41%, still a one-week high.

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Looking out to next week, the focus shifts from the labor market to inflation and the Fed. The Committee is widely expected to leave rates unchanged in the current rate of 5.25-5.50% for the seventh consecutive meeting at its June 12th meeting Wednesday.

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In addition to an updated policy announcement, statement text, and press conference, this month the Committee will offer a long-awaited update to the Summary of Economic Projections. Indicating three rate cuts as of the March report, with inflation – and the broader economy failing to evolve as expected – the Committee is likely to materially revise down expectations for rate reductions with projections expectedly indicating a widening or growing divide between those hopeful of inflation resuming its previous disinflationary path and those underscoring rising risks – upside risks – to price pressures.?

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Of course with the Fed’s rate announcement largely expected to be steady – read: uneventful – arguably the more important release of the week comes with the May inflation reports with the CPI also on Wednesday and the PPI released on Thursday as the Committee continues to look for compounding evidence of a disinflationary trend.

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Following three hotter-than-expected reports since the start of the year, the CPI cooled – somewhat – in April. This month, the CPI is expected to rise 0.1% in May and 3.4% over the past 12 months, potentially matching the annual gain in April – so offering no further confidence for the Committee desperate to see meaningful improvement in cost pressures. The PPI, meanwhile, is expected to rise 0.1% in May and 2.5% year-over-year, potentially rising from the 2.1% annual rise in April.

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Excluding food and energy costs, however, the core CPI is expected to increase 0.3% and 3.5% year-over-year, potentially retreating, albeit one tenth of a percentage point from the 3.6% annual gain in April. The core PPI, meanwhile, is expected to rise 0.3% in May and 2.5% on an annual basis, potentially rising again – albeit a minimal one tenth of a percentage point this time in the wrong direction – from the 2.4% pace reported in April.

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While one data point in either direction is not enough to force a near-term adjustment in policy, any further lack of evidence of an improving inflationary picture adds credence to the argument the Fed may have stopped short of a sufficiently restrictive level. At some point, should inflation continue to fail to evolve as expected, the Fed may be forced to?not just delay rate cuts, but actively?re-engage in additional rate hikes. ?

Ahead of the Fed, backing up to Tuesday, the May NFIB Small Business Optimism Index will be released.

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Also on Wednesday, weekly mortgage applications will be released.

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And finally, on Friday, import and export price indices for May, and finally, the preliminary University of Michigan Consumer Sentiment Index for June will be released.

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-Lindsey Piegza, Ph.D., Chief Economist