Today’s labor market report was much weaker than expected, notwithstanding the warning from the ADP report earlier this week. We had previously moved up our expected timing of the first-rate cut to September on the apparent slowdown indicated by weaker spending data, softcore inflation, and tighter financial conditions. The labor market had been the one area for which the data had been unambiguously strong. Indeed, in commenting on recent speculation about rate cuts, FOMC participants have noted that the consistent strength in the labor market suggests the economy is in a “good place.” After this disappointing report, an earlier cut is now more plausible: Our base case is now that the FOMC will cut the funds rate in July. But we still see a June cut as quite unlikely. We now expect the second cut to be earlier as well, late this year rather than in 2020.
Nonfarm payrolls increased only 75K in May, and gains in previous months were revised down a total of 75K; so the level of payrolls in May was exactly what was reported for April in the last jobs report. Monthly job gains have now averaged 151K and 175K over the last three and six months, respectively. Those are not bad figures by any means, given that they are well above the rate seen as consistent with a stable unemployment rate. And we have been projecting a slowdown in that range. While this report represents a substantial disappointment relative to expectations, it still paints a picture of a healthy labor market in absolute terms. The U-3 unemployment rate remained at 3.6% in May, and the participation rate was unchanged at 62.8%. The broader U-6 rate declined two tenths, to 7.1%.
But monetary policy is forward-looking, and policymakers will be focused on the change in direction in the labor market. The pace of job gains has slowed substantially since 2018. This puts the jobs data more in line with the spending data, which have shown deceleration in final private demand over that period. Overheating remains a remote prospect—average hourly earnings posted a modest 0.2% increase in May, and the 12-
month change edged down a tenth to 3.1%. The FOMC’s focus remains overwhelmingly on sustaining the expansion. While we don’t think this one additional data point is enough to push the FOMC to cut in June, there will be a discussion about easing and a contingent already prepared to cut. If the run of weaker data continues until the July meeting, we expect that the Committee will be prepared to move, notwithstanding our bias toward seeing a higher probability of moves at meetings with updated macro and rate projections. The risk management case for an earlier cut is becoming overwhelming.