When is the Next Hike?

Macro Markets

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Nonfarm payrolls increased by 339,000 jobs last month. It beat expectations considerably and is sitting above the 200K a month. As previously reported, data for April was revised to show payrolls rising by 294,000 jobs instead of 253,000. The market reacted mix with initially SPX up 0.5% and then sitting flat, only to reverse later with stocks moving up, which could be more a function of tech stocks and AI catalysts. The yield on the 10-year Treasury note rose and was last up 2.3 basis points from the close at 3.631%; The two-year U.S. Treasury yield was up 6.4 basis points from Thursday at 4.405%.

The increase in the unemployment rate from a 53-year low of 3.4% in April, reported by the Labor Department on Friday, was the largest since April 2020. Outside the COVID-19 pandemic, it was the biggest jump since 2010, reflecting a drop in household employment and a rise in the workforce. The gradual increase in the labor pool is easing pressure on businesses to raise wages.

Despite massive layoffs in the technology sector after companies over-hired during the pandemic and the drag from higher borrowing costs on housing and manufacturing, the services sector, including the leisure and hospitality category, is still catching up after businesses struggled to find workers over the last two years. Industries like healthcare and education also experienced accelerated retirements.

Reuters, 2023

For the Fed, however, policymakers will also be looking at the surge in the unemployment rate, which was the biggest one-month increase since April 2020. There were 440,000 more people out of a job in May, the largest monthly rise since the onset of the pandemic. Even though labor demand has remained resilient, it’s unclear how long that will last. With a credit crunch threatening to halt the expansion and more companies planning to let workers go, hiring and pay gains may slow substantially in the coming months.

The mixed nature of the report may validate Fed Chair Jerome Powell’s approach to pausing interest-rate hikes to assess the impact of five percentage points of hiking so far. Other officials have also voiced support for holding rates steady at this month’s meeting while leaving the door open to resume tightening in July, as price pressures remain robust and the threat of a US debt default has been avoided.

Inflation: CPI

The next CPI report on June 13 coincides with the start of the next Fed meeting to set rates. The Fed will want more reassurance that core inflation, which has been broadly flat over recent months, is coming down. Yes, headline inflation has come down, but once food and energy costs are stripped out, annual core inflation has remained in a 5% to 6% range since December 2022. The key to any move down in inflation will likely be shelter costs since these carry a high weight in the CPI index.

Shelter costs may hold the key to a meaningful drop in core inflation. These costs comprise around a third of the CPI index and over 40% once food and energy are stripped out. This means that shelter is sufficiently large within the CPI to bring down core inflation. So far, that hasn’t happened. Shelter costs are rising at an 8.1% annual rate, according to the CPI’s calculations.

If shelter costs were flat year-on-year rather than 8.1%, then April’s core CPI inflation would have virtually been at the Fed’s 2% target rather than the reported 5.5%. Of course, that change won’t happen overnight, but if the Fed sees shelter costs coming down, that could prompt the Fed to reconsider its current rate position.

The Fed appears to have moved to more of a wait-and-see position for interest rates based on stubborn inflation. Policymakers have hinted that rates could move higher if inflation does not come down, but for now, and at least for the June meeting, the Fed may hold rates steady. The Fed currently does not believe that inflation will come down fast enough. It will take data to change their mind.

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