Strong Jobs Data and Cool Wage Growth Send Markets Higher

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

An end to the debt ceiling standoff and strong jobs data coupled with a decline in the pace of wage gains sent the markets higher last week as investors grew optimistic that the Fed may hold rates steady and avoid slowing the economy any further. The strong showing sent the S&P 500 to its highest close since August 17, 2022.

Over the past several months, stronger than expected jobs reports have typically been met with selling pressures as investors feared that further evidence of a tight labor market would lead the Federal Reserve to continue to raise rates and ultimately push the economy into recession. However, the Nonfarm payroll report for May released late last week by the Bureau of Labor Statistics (BLS) indicated that while hiring remained robust with 339,000 new positions added—well above Wall Street expectations of 190,000—wage growth came in lower than anticipated. Average hourly earnings for all employees rose a modest 0.3 percent for the month and are now up 4.3 percent year over year. The wage growth was below April’s rise of 0.4 percent and year over year growth of 4.4 percent. For further context, annualized wage gains reached a post-COVID peak of 5.9 percent in March 2022 and have moved lower since then despite continued labor market tightening. The average workweek declined by 0.1 percent in May, reducing the overall uptick in payroll costs employers faced. In a sign of potential labor market softening, the average workweek has now fallen to 34.3 hours, well off the 35 hours registered in January 2021 and back to pre-COVID levels.

Perhaps importantly as to whether the subdued wage growth can continue, the BLS’s other measure of employment, the Household report (which is used to calculate the unemployment rate) showed that 310,000 workers lost their jobs in May. The number of people laid off, along with 130,000 new entrants into the labor market, pushed the unemployment rate to 3.7 percent. The unemployment rate in April was 3.4 percent. The Household report began to weaken in March 2022 and, as we have noted in the past, has markedly diverged from the Nonfarm data for much of the past year. Since March 2022, the Household measure has shown 2.393 million workers added to payrolls, while the Nonfarm report has shown 4.681 million additions.

Certainly, the overall data suggests the labor market remains resilient; however, the degree of resiliency varies depending on which report is used as a measure. Further evidence of some weakness in the labor market shows up in the Conference Board labor differential, which has a correlation with the jobs data and showed weakness last month. The differential is a measure of the gap between the number of respondents who believe jobs are easy to land and those who report challenges finding work. The differential fell from 47.1 in March 2022 down to 31.5 in November, which is consistent with the weakening of the Household report. After rising back to 40.7 in February of this year, it fell to 36.9 by April and in last week’s Conference Board release fell to 31. We believe this data, along with falling wages, may provide room for the Fed to hold rates steady in June. However, all eyes will be on the data between now and the June 14th meeting—especially this week’s Institute of Supply Management (ISM) Services report and next week’s Consumer Price Index (CPI) reading.

Prior to the latest data, Federal Reserve Chair Jerome Powell had suggested that there may still be a path to avoiding a recession with relatively modest job losses if wages remain controlled and inflation expectations continue to be anchored. The markets appear to have renewed optimism that the rate hiking cycle of the past 15 months is over. While we believe enough progress has been made on the inflation front that the Fed should conclude its rate hiking efforts, we think they may pause on rates in June but not fully remove their bias toward higher rates until the employment market shows sustained signs of weakening. As a result, we remain doubtful that a much hoped for soft landing will materialize. Instead, the cumulative effect of 500 basis points of rate increases, along with tighter lending standards by banks and an ongoing reduction in liquidity in the economy, will lead to a mild, shallow recession. However, any such contraction, we believe, will put an end to lingering inflation pressures and give the Fed room to cut rates and spur economic growth as needed.

Wall Street Wrap

Last week’s Nonfarm payroll report grabbed the headlines but wasn’t the only report to suggest the market continues to endure despite further signs that portions of the economy continue to weaken.

More signs of a resilient job market: The Job Openings and Labor Turnover Survey from the Bureau of Labor Statistics showed the employment picture remains tight, with 358,000 openings added in April resulting in a total of 10.1 million unfilled positions. The latest reading marks a reversal from the prior two months, which saw a total decline of more than 1 million open jobs. However, in a sign of a declining worker confidence in job security and a cooling labor market, the quits rate which measures how many workers left their jobs voluntarily as a percent of total employment fell to 2.4 percent, which is the lowest since February 2021 and off last April’s level of 3 percent.

While job openings increased in April, weekly jobless claims inched higher last week with 232,000 new claims, up from the prior week’s 230,000. Continuing claims (those people remaining on unemployment benefits) remain elevated at 1.795 million.

More signs of weakness for manufacturers: The latest data from the ISM shows the manufacturing sector notched a seventh consecutive month in contractionary territory. The composite reading for the index came in at 46.9, down from April’s reading of 47.1 (readings below 50 signal contraction). New orders were down, coming in with a reading of 42.6, down 3.1 percent from April’s level of 45.7. The latest reading marks the ninth consecutive month of contractionary readings. Customer inventories inched higher, to 51.4 from the prior reading of 51.3. New orders minus customer inventories equates to negative 8.8 compared to negative 5.6 last month. The differential continues to be at a level that over the past 26 years has occurred only during periods of recession.

Prices also fell sharply, with a reading of 44.2, down from April’s 53.2. With customer inventories growing and orders falling, we believe manufacturers will struggle to raise prices in the coming months.

Despite the lackluster business environment, staffing demand rose to 51.4, up from the prior month’s reading of 50.2. In a statement accompanying the latest data, Tim Fiore, chair of the ISM, noted that respondents were equally split between hiring and shrinking headcount given the uncertainty of when economic growth will resume.

Long-term trend on home prices remains down: The latest S&P CoreLogic Case-Shiller Index shows home prices climbed 0.42 percent in March from the prior month, marking the second monthly increase in a row following a streak of seven consecutive months of declines. March’s reading shows home prices rose 0.7 percent year over year, down from February’s year-over-year gain of 2.1 percent. Prices began the year up 3.7 percent from January 2022, and annual gains continue to fall from the post-COVID peak of 20.8 percent registered in March of 2022. The survey’s 20-city composite indicates home prices declined 1.1 percent year over year, compared to February’s 0.4 percent year-over-year gain. The continued easing of home price appreciation is noteworthy given that shelter has a significant weight in the calculation of the CPI, with price movements taking 12 months or longer to begin to affect the CPI reading. With shelter costs having peaked in the first quarter of 2022, we expect this portion of the CPI calculation should fall significantly in the coming months.

The week ahead

Monday: The health of the services side of the economy will be in the spotlight as the ISM releases its latest Purchasing Managers Services Index for May. Recent readings have shown the services sector as a strong point in an uneven economy and a source of labor market strain.

Wednesday: The Federal Reserve will release its latest look at the financial condition of consumers through its Consumer Credit report. Consumers have begun to take on more credit card debt in recent months, but overall balance sheets have remained strong. We will be watching for changes in debt levels in light of recent data showing increased spending.

Thursday: Initial and continuing jobless claims will be announced before the market opens. Initial filings were up last week, and we will be watching to see if recent signs of some softening in the job market continue.

Final wholesale inventory numbers for April will be released after the market opens. Of interest will be any revisions to the direction of inventories from initial readings.

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