The May Employment Report Wasn't Bad, May CPI Next Hurdle

The stock market may continue to have difficulty climbing out of its hole this week, as it braces for Friday's May CPI.  The latter will be boosted by higher energy and food prices, although the Core is likely to slow from April's jump.  On a positive note, Fed officials will be in their "blackout' period before the June 14-15 FOMC meeting, so their hawkish comments will not hit the screens.  The market treated the May Employment Report as a negative.  But, this was probably a mistake.

The stock market's fear is that the Fed will decide it necessary to push the economy into recession to bring down inflation.  This fear has led to sharp reactions to official comments about possibly moving the funds rate above the neutral 2.5% level.  It also appears to have been behind the market's negative reaction to Friday's strong May Payroll gain.

But, this fear is mainly hypothetical and more of an issue for later this year.  The Fed is essentially locked into two 50 BP hikes to 2.0% at the June and July FOMC Meetings.  The May Employment Report is irrelevant with regard to what the Fed does at those meetings as well as after July (since there will be more Employment Reports to see).  Indeed, no one is certain how the economic landscape will change after these hikes.  If the economy slows sharply and Core inflation moderates, the Fed could decide to hike by 25 BPs in subsequent meetings.  If the Fed does downshift, it still could bring the funds rate back to neutral or higher.  But, the pace of tightening would not likely precipitate recession.

At this point, the Fed officials' threatening comments may be aimed at influencing market and business expectations in a way to achieve slower growth without actually hiking too much.  Fed officials probably just want companies to cut hiring plans, and news reports suggest such hiring restraint is happening. 

Despite the market's reaction, the May Employment Report contained a number of elements that should please Fed officials.  Job growth is slowing modestly, moving toward a "soft landing" rather than recession.  It shows the economy still has momentum that could withstand the already announced tightening.  And, even though the Employment gain was large, it was accommodated by a higher Labor Force Participation Rate that kept the Unemployment Rate steady at 3.6%.  So, the gain is not necessarily inflationary.  Indeed, the 0.3% m/m increase in Average Hourly Earnings (AHE) showed that wage inflation remains subdued despite the strong demand for labor.  The low print may not have been an aberration, since it matched the average pace seen since February.  Moreover, it is below the 0.4% m/m averages in 2018 and 2019, before the pandemic.

A sectoral breakdown of AHE reveals that the earlier post-pandemic period of high wage inflation largely resulted from huge increases in just a few industries as they re-opened.  These huge increases are now behind us.  There also has been a slight increase in the number of sectors with 0.3% or lower AHE.  Six of thirteen sectors had 0.3% m/m or lower increases in AHE in May as well as between February and May on average, compared to 5 on average from April 2021 through January 2022. It remains to be seen whether the moderation in AHE shows up in the broader measures of labor costs -- Compensation/Hour and Employment Cost Index, both due in the summer.

The subdued wage inflation could show up in the May CPI, although higher commodity prices are a driving force.  Consensus looks for +0.7% m/m Total and +0.5% Core.  The Total estimate looks reasonable as gasoline prices jumped this month.  It risks being a bit higher if food prices speed up sharply.  The Core estimate can't be ruled out, but a slightly lower print is conceivable, as well.  This would likely require significant slowdowns in airfares and new vehicle prices after their large increases in April.