Wage Data Sparks Concerns of More Rate Hikes

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

Equity markets started the second half of the year on a down note as investors grew concerned that the Federal Reserve would resume rate hikes at its next meeting and could continue tightening to slow a seemingly still resilient economy. The dour mood on Wall Street started with the release of the minutes from the latest Federal Reserve Board meeting, which showed that all but two members of the Federal Reserve Board believed at least one more rate hike would be necessary before the current rate tightening cycle was complete and that two-thirds of Board members were calling for at least two more hikes. While initial reaction to the minutes was mildly negative, Wall Street pessimism gained traction as investors interpreted some of the details in a mixed bag of employment data as providing more reason for the Fed to remain hawkish. 
 

The Nonfarm payroll report for June released late last week showed some softening with 209,000 new hires, down from May’s level of 306,000 and short of consensus of 230,000. It’s important to note that both the May and April readings were revised down from initial estimates and, combined, came in at 110,000 fewer hires total in the preceding two months. Of the June new hires, 60,000 were for government jobs, leaving just 149,000 hired in the private sector. Overall, this is the smallest number of monthly new hires since December 2020. However, investors focused on the wage data that showed wage growth grew by 0.4 percent from the previous month and was now up 4.4 percent on a year-over-year basis. Total weekly hours worked also edged higher to 34.4 hours in June, up from May’s average of 34.3, adding modestly to the overall uptick in wage costs. The pace of wage growth was unchanged from May’s upwardly revised reading of 0.4 percent; however, it is important to remember that pace of hourly pay growth has fallen significantly from its post-COVID year-over-year peak of 5.9 percent in March 2022. 
 

The ADP National Employment Report also showed an overall tight employment picture with 497,000 jobs created, including 373,000 new hires in the services sector. Taken together with the wage data, the image of a still robust job market remains. However, other reports out last week painted a somewhat less rosy picture. 
The Job Openings and Labor Turnover Survey from the Bureau of Labor Services showed the number of job openings fell by 496,000 in May, resulting in 9.8 million unfilled positions. The so-called “quits” rate, which is viewed as a proxy for the level of confidence employees feel about the job market, came in at 2.6 percent, up modestly from May’s reading of 2.4 percent. Perhaps not surprisingly, the industries that saw the greatest increases in quits were on the services side of the economy, including health care, social assistance and construction. While the quits measure moved slightly higher, it remains near lows last seen in May 2021 and off from last April’s level of 3 percent. 
 

Additionally, initial claims for unemployment rose to 248,000, up 12,000 from the prior week. The four-week rolling average of new jobless claims came in at 253,250, down a modest 3,500 from the prior week’s estimate. Continuing claims (those people remaining on unemployment benefits) remain elevated at 1.72 million, a decrease of 13,000 from the last reading.
 

Our point in highlighting the inconsistency in the data is to demonstrate that while the overall numbers suggest the labor market remains resilient, the degree of resiliency varies depending on which report is used as a measure. Given the lagging nature of employment data, we believe the mixed picture could signal that the job market could cool more rapidly than currently expected by the Fed and may coincide with a short, mild recession.
 

While we are skeptical of the need for further rate hikes given our belief that enough progress has been made in unwinding COVID-induced inflation, we think the Fed will be inclined to raise rates until signs of a weakening employment picture are sustained and too great to ignore. The Fed is intently focused on wage growth and sees it as the last support needed to fall to prevent a return to the wage/inflation spiral that took place from 1966–1982. While in our view, a return to those times is unlikely, we believe the Fed’s fear of such a scenario makes it likely that it will maintain a bias toward higher rates until it sees wage growth fall meaningfully below 4 percent. As a result, we believe the rally the markets enjoyed during the first half of the year may have gotten ahead of itself. We believe the threat of an approaching recession may slow the market’s upward trajectory. However, should a recession arrive in the coming months, we believe it will be mild, and the continued momentum in the disinflationary process will leave ample room for the Fed to cut rates as necessary to spur growth.

Wall Street Wrap

While the latest employment readings painted a mixed picture of the resiliency of the job market, other economic releases out last week suggest the economy remains on uneven footing.

Manufacturing continues to contract: The latest data from the Institute of Supply Management (ISM) shows the manufacturing sector has now been in contraction territory for eight consecutive months with a reading of 46, down 0.9 from May’s reading (readings below 50 signal contraction). Weakness was widespread with only one of the six largest manufacturing industries—transportation—showing growth. The latest reading marks the lowest level since May 2020, when it was at 43.5. New orders remained in contraction territory at 45.6; however, this marked an improvement from the prior month’s reading of 42.6. Importantly, as it pertains to inflation, price pressures have evaporated as reflected in the contractionary reading of 41.8, which is the second lowest level recorded in the post-COVID period and less than half of the 87.1 recorded in March 2022.

Notably, staffing contracted; the latest employment reading came in at 48.2, 3.3 points lower than May’s level. In a statement accompanying the latest data, Tim Fiore, chair of the ISM, noted, “Labor management sentiment at panelists’ companies indicate a slowdown in hiring, with layoffs slightly more prevalent.”

While the report continued to paint a gloomy picture for manufacturing, inventory levels for both manufacturers and customers contracted and remain low, which could result in a quick recovery for the sector should demand ramp back up.

Services sector shows continued strength: ISM data for the services side of the economy showed continued expansion, with the latest headline reading for the sector coming in at 53.9, up from May’s level of 50.3 (readings above 50 signal expansion). New orders rose to 55.5, up 2.6 points from the prior month’s level. Additionally, supply chains continue to keep pace with demand, with the latest survey showing delivery times shrank in June. It’s worth noting that the six-month average reading for supplier delivery times reflects the fastest supplier delivery performance since June 2009.

The prices paid reading dropped to 54.1, down 2.1 percentage points from May. For further context, the measure reached an all-time high of 84.5 in December 2021 and began 2023 at 67.8. The ongoing decline is important because it has served as a leading indicator of so-called “super core” inflation (PCE services excluding housing). The ISM prices paid reading suggests, in our view, that the super core reading is likely to continue to unwind in the coming months. When looking at the Manufacturing and Services prices together and weighted by each group’s representation in the total economy, they suggest that inflation is set to continue to retreat toward the Fed’s stated target of 2 percent.

While prices suggest ongoing relief in core inflation, the employment picture remains tight, with that latest reading of 53.1 reflecting ongoing hiring in the industry.

The week ahead

Monday: The Federal Reserve will release its latest look at the financial condition of consumers through its Consumer Credit report. Consumers' debt levels have increased in recent months but have remained manageable. We will be watching for changes in debt levels in light of recent data showing increased spending.

Tuesday: The NFIB Small Business Optimism Index readings for June will be out before the opening bell. The report should provide insights about the state of the labor market for small companies and expectations related to price increases at the consumer level in the months ahead.

Wednesday: The Consumer Price Index report from the Bureau of Labor Statistics will be the big report for the week. Data continues to show progress in the disinflationary process, and we will be dissecting the data to see if the pace of disinflation has changed with a particular focus on the services side of the equation.

The Federal Reserve will release data from its Beige Book. The book will provide recent anecdotal insights into the nation’s economy and will highlight emerging regional economic trends.

Thursday: The latest readings from the U.S. Bureau of Labor Statistics on its Producer Prices Index will offer a front-line view of changes in costs for buyers of finished goods. It can provide insights into how easing input costs, such as raw materials and wages, are impacting the prices of goods bought by end consumers.

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 there are additional signs of softening in the labor market.

Friday: The University of Michigan will release its preliminary report on July consumer sentiment as well as inflation expectations. We will be watching the report for signs that respondents’ expectations in the coming year and, more importantly, five- to 10-year period continue to ease.

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