Jobs Data Give Fed Options

Fed funds futures contracts were pricing in a mere 8% chance that the Fed will raise rates by 50 basis points in June. The odds of a quarter-point cut stand at 100%. Treasuries fell slightly on the data, with the yield on the 10-year Treasury rising to 4.73%. Stocks generally rose, with the Dow up 91 points to 10,287 and the Nasdaq up 31 points to 1,992.

If the consumer and producer price indexes for May are higher than expected, Hoffman and Harris said the chances of a larger rate hike in June could go up, but they still believe the Fed will take a gradualist approach. Harris noted that there continues to be "slack" in the labor market and that there are no signs of serious wage inflation.

While some investors might worry about the 0.3% rise in earnings last month and 2.2% year-over-year increase, Bill Cheney, chief economist at MFC Global Investment Management, said strong productivity will keep a lid on inflation.

"The Fed will be analyzing all inflation signals with increasing intensity, but for now I think they still believe that there's enough slack in the overall economy and labor market to preclude a serious outbreak of inflation," he said.

Despite more than 900,000 new jobs in the past three months, the economy has lost more than one million net jobs since before the recession and 3 million to 5 million new people have entered the work force over that time. What's more, the unemployment rate has barely budged over the past few months despite big payroll gains because more people have joined the labor force.

Investors have already priced in a quarter-point move in June but some economists had speculated prior to the employment report that a half point hike might be necessary to restrain inflation. An improvement in the job market can lead to higher wage growth, which is a large component of overall inflation.