• Last week, markets were focused on employment data, as investors look for signs of a cooling labor market. The results were mixed, but they were generally soft enough to boost market confidence that the Federal Reserve (Fed) will see slower gross domestic product growth and low-enough inflation to begin cutting rates at its September Federal Open Market Committee (FOMC) meeting. This week’s Fed meeting will provide some clues as to the collective outlook for the economy, inflation, and rate policy.

Mixed Signals in the Labor Market

  • Job openings declined 3.5% in April to the lowest level since February 2021. The openings-to-unemployed ratio fell to 1.24 from 1.34 in March, as openings in some of the previously difficult to fill services categories of health care, social assistance, and government education experienced the largest declines. With the quits rate steady at 2.2%, the Fed should welcome these developing signs of cooler wage growth.
  • After the May ADP employment report indicated weaker-than-expected job growth and weekly initial jobless claims ticked up a bit, there was an expectation building among market participants that the May nonfarm payrolls report should show more distinct signs of cooling. Headline jobs growth dashed those expectations with a surge of 272,000 jobs and only a small downward revision to the previous two months. Fitting the narrative that has held over the past year, job growth was more prevalent in the services sectors of health care, leisure and hospitality, and government employment, while goods sectors such as department stores and home furnishings and retail seeing job declines.
  • Offsetting this apparent continuing labor market strength was a surprising increase in the unemployment rate to 4.0% from 3.9% in April, as the household employment survey showed a 408,000 decline and the labor force participation rate declined to 62.5% in May from 62.7% in April. However, arguably the most watched component of the payrolls report is the average hourly earnings reading, which rose 0.4% for the month and is up 4.1% year over year and higher than the +3.9% estimate and the +4.0% reading in April. This level of wage growth may keep inflation sticky, but it should lead to continued healthy consumer spending growth. Of course, the key component to fostering an environment of noninflationary wage growth would be employee productivity. First quarter productivity growth was rather disappointing at 0.2%, which led to a 4.0% increase in unit labor costs from the unchanged measure in the fourth quarter of last year. Any advance in productivity in the second quarter, which would keep unit labor costs contained, would be welcomed by the Fed.

Services Spending Offsets Weakness in Manufacturing

  • Business spending continues to be rather bifurcated between the manufacturing and services sectors. The May ISM manufacturing survey disappointed to the downside at 48.7, a full point lower than the 49.7 estimate and below the 49.2 reading from April. The new-orders component revealed ongoing soft demand as companies appear hesitant to invest given both monetary policy constraints and the impact of inflation on their cost structure. While somewhat stale, construction spending declined 0.1% in April with private, nonresidential construction declining for the second month in a row. Public construction also saw a decline, but that sector is expected to begin to improve in the coming months due to higher government fiscal spending.
  • The May ISM services survey fully offset the manufacturing weakness with a 53.8 reading, notably better than the 50.8 estimate and the 49.4 reported in April. The new orders, employment, and business index components all rose nicely for the month and the prices index managed to decline in this strong economic environment. While this may have come across as somewhat of a goldilocks report, respondents continue to be worried about sticky inflation and high interest rates.

Global Central Banks Diverge From Fed

  • With the FOMC meeting one of the most eagerly anticipated events of the week, other global central banks are already moving away from restrictive monetary policies.
    • The Bank of Canada (BOC) cut its target policy rate by 25 basis points (bps) to 4.75%, citing weak economic growth and inflation coming down toward its 2% target. But the BOC warned against assuming this move was the beginning of a pronounced easing cycle, as average hourly earnings growth remains high at 5.0% year over year.
    • At its meeting last week, the European Central Bank (ECB) cut its key policy rate 25 bps to 4.25%. The move was expected, but one governor dissented. In what markets viewed as a rather hawkish cut, the ECB acknowledged that underlying inflation had eased and inflation expectations had declined, but inflation is still above target and is expected to remain so for some time. The central bank is not committed to any path for future rate cuts at this time. In her press conference, ECB President Christine Lagarde cited a 2.5-point decline in the inflation rate since 2023 as rationale for the policy rate cut, but she also said that domestic price pressures are strong and wage growth is elevated. She believes wages are on a declining path and rate cuts are justified by growing confidence inflation will decline in the months ahead.

Equities Set Another Record

  • Another week and the S&P 500 Index set another record high, led by the mega-cap tech companies. Where the equity market goes from here will be interesting as this week will see the following major events and potential catalysts for equities: 1) May Consumer Price Index and Producer Price Index releases on Wednesday and Thursday, which are important to the Fed and interest rates; 2) Apple’s Worldwide Developers Conference, starting on June 10, which may showcase enhanced AI capabilities for iPhones; and 3) Nvidia starts trading after splitting shares 10-1 to make its absolute price more accessible to smaller investors. Not to be lost in all these events is a Fed meeting and press conference on Wednesday. With all that, we can be thankful that the earnings calendar is very light. Oracle reports after Tuesday’s close, Broadcom on Wednesday, and Adobe on Thursday. S&P 500 earnings estimates continue to slowly grind higher, indicating the analyst community is growing more confident in double-digit gains in 2024 and 2025. The real test of those projections won’t be until second quarter earnings start, which is still a full month away.

Source: FactSet

Please read important disclosures here.