Conflicting Jobs Data Creates Challenges for the Fed

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

Equities posted strong gains last week as mixed employment reports were largely shrugged off by investors. The seemingly contradictory jobs data from the Bureau of Labor Statistics (BLS) showed robust hiring in May but also an uptick in the unemployment rate and a decline in the labor participation rate. While the conflicting employment data grabbed most of the attention, other economic news also created a blurred picture of an economy in which pockets of strength and weakness are scattered throughout.

We’ve highlighted the discrepancies between the BLS’s Nonfarm payroll data and the so-called Household report in the past and last week’s reports further widened the gap between the two measures. The Nonfarm payroll report showed that 272,000 new positions were added in May—well above April’s gain of 165,000 and Wall Street forecasts of 180,000. The pace of gains eclipsed the 12-month average of 230,000 new positions added. May gains were driven by additions in the health care, government, and leisure and hospitality sectors. In a potentially positive sign for the economy, 229,000 of the new jobs were created in the private sector. However, the BLS’s other jobs report, the Household survey, showed the unemployment rate at 4 percent, up from April’s 3.9 percent. The labor participation rate declined to 62.5 percent, down 0.2 percent from the prior month. While the participation rate declined, the number of available workers grew and accounted for the rise in the unemployment rate. In total, the Household report showed a net loss of 408,000 jobs. For further context, the latest unemployment rate is up from a cycle low of 3.4 percent.

Additionally, the economy is inching toward triggering the so-called Sahm rule (regular readers of our commentaries may recall this rule, developed by former Federal Reserve Economist Claudia Sahm). According to the rule, since 1960, every time the three-month moving average unemployment rate rose by 0.5 percent or more from the previous low, a recession followed. The three-month average low for unemployment is 3.7 percent, and the current rate is now 0.37 percent higher than the low, meaning a 0.1 percent increase would put the rise essentially at the threshold. Digging deeper, the latest data shows that 21 states have already seen unemployment rise to levels eclipsing the Sahm rule.

On a year-over-year (not seasonally adjusted) basis, the Nonfarm measure shows payrolls grew by 1.8 percent, with approximately 2.8 million new positions added. In contrast, the Household survey puts the total number of jobs gained in the past year at just 340,000 total, or approximately 28,000 per month. Further, since November 2023, the Household report has shown 783,000 net job losses. Theories on possible causes for the discrepancies vary from flaws in the estimates used to calculate figures based on forecasts for the numbers of businesses opening and closing to the shortcomings of the reports in picking up the effects of immigration on the job market. While we are not advocating that one of the reports is more accurate than the other, we do believe the strong Nonfarm number of new positions is overstated. The BLS’s own numbers seem to support our view. Seasonally adjusted revisions by the Bureau show that since 2023, 13 of the last 16 months of job gain estimates have been revised lower. And while we have been making this point for several months, we are not alone.

A recent analysis by Bloomberg Economics also highlights the disconnect between the two BLS reports. In a report released last week, the research unit estimates that the Nonfarm payroll data may have overestimated job gains by 730,000 last year. The researchers argue that the same factors are in play this year and that average monthly job gains number fewer than 100,000 each month, far less than the 242,000 three-month average that has been reported through April.

While the debate about which payroll report is more accurate may seem like a dry academic exercise best suited for college lecture halls, it has real-world implications. That’s because the Federal Reserve is closely monitoring the employment market due to its relationship to wage growth, which historically filters into price pressures. The lagging nature of the job market as it relates to economic strength has historically made it difficult for the Fed to achieve a soft landing after a rate hiking cycle has taken place. The conflicting signals given off by the BLS reports only add to the challenge.

Unfortunately, pertaining to inflation, there is one area of the employment picture for which various sources of input are in agreement—that’s wages. The latest data from the BLS shows average hourly earnings for all employees in the private sector grew by 0.4 percent in May and are up 4.1 percent year over year. For production and nonsupervisory employees, wages were up 0.5 percent in May. Over the past 12 months, average hourly earnings for the group have increased by 4.2 percent. It’s worth noting that the current pace of wage growth is still above the 3 to 3.5 percent range the Fed believes is necessary for inflation to fall sustainably to its goal of 2 percent. And a review of shorter-term measures shows that we remain stuck in the lower 4 percent area.

The BLS data is consistent with other surveys we follow that show wage pressures remain high even in sectors that have seen demand for workers weaken. As such, we believe the Federal Open Markets Committee will be unwilling to significantly adjust interest rates until wages come down to the 3-3.5 percent range or the employment market deteriorates significantly. Unfortunately, given the conflicting data from the BLS, the Fed may not be able to clearly assess the job market until it begins to contract for an extended period. If so, that could be a tipping point for the economy and ultimately lead to a short, mild recession.

Wall Street wrap

While the employment reports garnered the most headlines, other data out last week showed a mixed economy still feeling the effects of higher costs.

Manufacturing prices continue to rise as sector contracts: The latest data from the Institute for Supply Management (ISM) shows prices in the manufacturing sector continued to climb even as activity slipped further into contraction territory. The latest headline reading of 48.7 is down 0.5 from April’s reading. The latest reading marks the 18th time in the past 19 months that the reading has been in contractionary territory. A reading of 50 or above signals expansion. Readings for new orders came in at 45.4, down 3.7 points from April. Order backlogs slid further into contraction territory, with the May reading declining to 42.4—down from April’s 45.4 level.

Despite weakening in the manufacturing industry, materials prices continued to rise, albeit at a somewhat slower pace. The latest reading for input prices was 57, down from April’s reading of 60.9. In total, 12 of the 18 industries in the survey reported paying higher prices, with five of the six largest industries reporting higher costs. The latest reading marks the fifth consecutive month of rising prices, suggesting that inflation pressures may continue to be at risk of reigniting and broadening within the goods side of the economy. Goods prices have been the driving force in the disinflationary process as price increases shifted to the services sector. With input prices continuing to climb, we may see inflation on this side of the economy perk up, which could put additional upward pressure on inflation overall.

The employment index rose 2.5 points in May from the prior month and inched into expansionary territory at 51.1.

Growth in the services sector rebounds: Meanwhile, ISM data for the services side of the economy showed that the sector rebounded in May with a headline reading for the sector coming in at 53.8, up from 49.4 in March. New orders edged higher to 54.1, up from April’s reading of 52.2. The employment index remained in contractionary territory, but the pace of easing slowed with May’s reading of 47.1, up from April’s 45.9. The latest reading of the employment index marks the fifth time in the past six months that this measure has shown contraction. Given that services is the largest segment of the economy, this bears further watching, as it may signal potential weakening of the employment picture.

On the inflation front, the prices paid index in the survey remained high at 58.1 but eased some from April’s level of 59.2. The number of industries that reported paying higher prices came in at 14 of 18.

The declining employment readings in services and rising prices for both sides of the economy highlight the Fed’s challenge in making rate cut decisions should the readings signal a rise in unemployment at a time when inflation is moving higher.

Job openings continue to decline: The BLS Job Openings and Labor Turnover Survey released last week shows the number of job openings in April came in at 8.1 million, compared to 8.4 million in March and down 1.8 million year over year. For additional context, the post-COVID series high for this measure was 12.2 million in March of 2022. The so-called “quits” rate, which is viewed as a proxy for the level of confidence employees feel about the job market, held steady at 2.2 percent, marking the sixth consecutive month at that level (last month’s rate was revised up to 2.2 percent).

Jobless claims rise: Weekly initial jobless claims were 229,000, up 8,000 from last week’s upwardly revised level. The four-week rolling average of new jobless claims came in at 222,250 down 750 from the previous week’s average.

Continuing claims (those people remaining on unemployment benefits) stand at 1.792 million, up 2,000 from the previous week’s revised total. The four-week moving average for continuing claims came in at 1.788 million, up 2,750 from the previous week.

While weekly claims have stayed relatively low by historic averages, it’s worth noting that hiring announcements this year through the end of May are at the lowest level since 2014, according to data from Challenger, Gray and Christmas Outplacement Services. During the first five months of this year, 50,883 new hires were announced, compared to 101,833 during the same period in 2023 and 612,686 in 2022. Meanwhile, job cut announcements remain elevated, with 385,859 announced during the first five months of this year, similar to last year’s pace but well ahead of 2022, when just 100,694 cuts were announced through May of that year. The current level joins 2023 and 2020 as seeing the most layoff announcements since 2009.

The week ahead

Tuesday: The National Federation of Independent Businesses Small Business Optimism Index readings for May will be out prior to the opening bell. Recent readings have indicated that price pressures and the state of the labor market continue to be chief concerns among small businesses, with many firms raising wages. We will watch for signs that suggest these challenges are easing.

Wednesday: The focus for the day will be on the Federal Reserve as it releases its statement following its monthly meeting. This meeting will also include updated economic and interest rate forecasts from members of the Federal Reserve Open Markets Committee. We expect the Fed will hold rates steady, and we will be listening for forward guidance on the path and timing of rate changes going forward. We will also be listening to comments on the current state of the employment picture and wages.

The Consumer Price Index report from the BLS will be the big report for the week. Recent data has shown the disinflationary process has stalled and may be reversing; we will be dissecting the data to see if the recent trend of increasing prices is continuing.

Thursday: The latest readings from the Bureau of Labor Supply on its Producer Price Index will offer a front-line view of changes in costs for buyers of finished goods. It can provide insights into the direction of input costs faced by businesses and can indicate how prices may move at the consumer level in the future.

Initial and continuing jobless claims, which rose last week, will be out before the market opens. We’ll continue to monitor this report for signs of changes in the strength of the employment picture.

Friday: The University of Michigan will release its preliminary report on June consumer sentiment and inflation expectations. We will be watching to see if recent news of higher inflation and forecasts of higher rates for longer has affected consumers’ expectations.

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