No “Groundhog Day” effect here – the May employment report was one to chew on. Slower job growth and steady unemployment late in the economic cycle would be consistent with reaching full employment, but not so much the softer wage growth and stagnant weekly hours. Beyond those two significant caveats, it’s the context and the risks that made this report such a headline-grabber, fueling expectations for the Federal Reserve to cut interest rates in the months ahead.
The Headline Numbers
- Nonfarm payrolls rose by a much-weaker-than-expected 75k. Downward revisions to the prior months brought the 3-month moving average to 151k.
- The unemployment rate held steady at 3.6%, as did labor force participation (62.8%). The U-6 “underemployment” rate declined to 7.1% from 7.3%.
- Wage growth slowed to 3.1% from 3.2% and average weekly hours were unchanged.
- The weakness in the cyclically sensitive goods-producing jobs was a worrying sign and a decent summary statistic: it suggests risk of a serious slowdown, but by no means guarantees a recession.
- Cross-currents of external shocks vs. cyclical trend:
- The markets are taking this report as further evidence that growth is at risk and the Fed must cut rates, but the reality is more complicated. It’s possible that wages are still being held back by widely-discussed factors such as globalization, technology transitions, and low labor bargaining power. Certainly, this raises the risk that we are heading into an outright slowdown, and markets have reason to focus on that risk, but it’s important to bear in mind alternative interpretations.
- For the optimistic case, the breadth of job gains was decent (diffusion index down, but still positive – 54.8 versus 59.9 prior) and the broad business services sector looked relatively healthy (in fact, its +33k was strongest among major sectoral categories). While manufacturing was weak, it didn’t show significant further deterioration as many of us feared.
- Another reason not to panic: economists have been expecting job growth to slow for months. To absorb new workers, the U.S. labor market needs job growth of only about +100k per month, which the 3-month moving average of 151k handily surpasses. The Fed’s forecast of higher unemployment by year end implies that it already expects job growth to fall modestly below that rate (but not so far that GDP growth drops off). Of course, the trick is that recent trade conflicts could undermine business confidence and lead to a much sharper slowdown.
- Less margin for error: There’s more than just sentiment behind slowdown fears. Even if the labor market and overall growth are downshifting for purely cyclical reasons, that suggests less capacity to absorb a negative shock. In that respect, it’s similar to the conditions in some financial markets – not on red alert, but limited margin for error. Those margins will be tested in the coming weeks, from the tariffs on Mexico to the FOMC meeting to the G-20 meeting. Also, the most recent headlines have yet to filter into the economic data, since the May employment survey was conducted around the time that China trade tensions escalated and before headlines about Mexico tariffs.
- Business confidence in focus: Job openings continued to grow in May (4.5%), per iCIMS Monthly Hiring Indicator. Employers could still get nervous and cancel those openings, but they haven’t yet. The June and July numbers will give us a better chance to evaluate employers’ resilience – comparing new job openings and other measures of business sentiment.
- A note on labor productivity: There have been some optimistic interpretations of recent upticks in labor productivity data, but labor productivity is fundamentally a question of GDP growth versus job growth. If GDP growth slows, as most expect, then productivity growth will too, unless job growth slows in line with GDP. Since the recent pop in GDP doesn’t seem to be long-lived, and the capital expenditures by firms don’t seem to have picked up too much, it’s not clear why we should expect labor productivity to sustain its recent gains and deliver us. For the moment, we have more reason to expect GDP to slow than productivity gains to persist, let alone accelerate.
- Fed communication tools are outdated, just when they need them:
- The Fed is signaling it has the US economy’s back and thus, indirectly, Trump’s. Their job is to support the economy, come Hell or high water. Yet the Fed is in an awkward position because of how quickly external events are moving and because of the current dot plot’s inability to convey risk scenarios. Indeed, the dot plot was designed in an environment of commitment strategies – forward guidance, “patience,” etc. Now that we are in an environment of regime shifts and multi-modal distributions, the Fed finds its communication toolkit badly outdated.
- After "dovish hikes," now we may get "hawkish cuts” if the Fed doesn’t hike as much as markets expect. Will the Fed and markets see convergence or confrontation (even if inadvertent)? It will be very hard for them to stick this landing.