Jobs Data Give Fed Options

Analysts don't see May's strong employment report thwarting the Fed's plan to gradually raise interest rates.
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Updated from 11:37 a.m. EDT

U.S. job growth continued at a robust pace in May, but wasn't considered strong enough to provoke a 50-basis-point interest rate hike at the end of this month.

Nonfarm payrolls rose 248,000 last month, surpassing expectations for an increase of 225,000. The pace of growth has slowed from April and March, when a revised 346,000 and 353,000 jobs were created, respectively.

The unemployment rate held steady at 5.6%, in line with projections and average hourly earnings rose 0.3%, slightly above the 0.2% estimate.

Ethan Harris, senior economist at Lehman Brothers, said while the headline payroll number wasn't as impressive as it had been in the previous two months, the details of the employment report were very encouraging.

Job growth was widespread in May and manufacturing employment recorded its biggest gain in almost six years. Over the past three months, some 947,000 jobs have been created, the most since March to May 2000. Still, Harris believes the odds of a 50-basis-point rate increase this month are "very low."

"Three strong job numbers in a row don't make up for three years of bad job growth," he said. "The Fed has been saying we're going to be measured...these kind of verbal promises do matter. The Fed has kept to its word, but only for a limited time frame."

At its last meeting in early May, the central bank said it would remove policy accommodation "at a pace that is likely to be measured," signaling that it would raise rates but not in large increments.

Stuart Hoffman, chief economist at PNC Financial Services Group, said a half-point rate hike is unlikely after Friday's jobs data.

"It's pretty obvious it was a very good report; the jobless recovery has been left in the dust," he said. "But I don't think the fact that we've created more jobs than expected in May and over the past three months will get the Fed to be more aggressive than they've said they intend to be."

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.

Ian Shepherdson, chief economist at High Frequency Economics, said he is now looking for a 25-basis-point increase at the end of this month but he remains "agnostic" on whether the Fed will raise rates by half a point in August "not least because surveys suggest job gains may accelerate." The Institute for Supply Management index suggests that 100,000 manufacturing jobs are coming, he said. In May, factory employment increased by 32,000.

Employment in service-providing industries added 176,000 in May, led by a 64,000 increase in professional and business services jobs. Construction gained 37,000 jobs and goods-producing industries added 72,000.

The average workweek was unchanged at a seasonally-adjusted 33.8 hours. The manufacturing workweek rose by 0.4 hour to 41.1 hours. Hours worked at factories were the highest since October 2000.

Now that payrolls are finally increasing, economists are no longer hailing the Labor Department's household survey as the best measure of employment growth. The household survey, which is believed to capture the growth in small businesses and is used to compile the unemployment rate, found that employment rose by 196,000 in May.

Gerald Purgay, senior vice president at human resource consultancy firm DBM, said he is "cautiously optimistic" about the employment outlook but noted there are still forces holding the job market back, notably very strong productivity, continued outsourcing and industry consolidation. "It's still a difficult job market where the median time to find a job is about five months," he said.

DBM continues to advise clients to be flexible in seeking employment, which means being willing to change industries or accept a lower compensation package.

Despite impressive job gains over the past three months, a recent poll by the

Wall Street Journal

and NBC showed that President Bush's approval rating has fallen to 47%, a new low for his tenure, amid continued worries over high oil prices and the situation in Iraq. Over the past 40 years, a sub-50% reading at this juncture has tended to result in a loss for the incumbent president at the November election.