Weekly market wrap

All in a Day's Work: Three Quick Takes on the Latest Jobs Report

Last week closed the market's books on May and opened the curtain on the latest reading on the jobs market. The former was benign, with the TSX and S&P 500 logging small moves on the month¹. The latter, however, exhibited more movement, with the underpinnings of the labour market beginning to reveal a more mixed picture, including some signs of softening. The domestic May employment report will be released on June 9, so this piece will focus on the details of last week's U.S. employment report.

Context is important here, as the labour market is still in very healthy shape, with unemployment only slightly up from this year's low of 3.4%, a rate you'd have to go back to 1953 to beat^1,2. But Friday's release of the May U.S. employment figures signals to us that the jobs market will become a slightly softer wind at the economy's back as we advance. Here are three takeaways from the latest employment data:

1. The labour market's best days are behind it – May's U.S. payroll report shows that we're far from putting this stellar jobs market out to pasture, but we think the extreme tightness in employment conditions is set to loosen over the remainder of this year.
   • 339,000 new payrolls were added in May, nearly double consensus expectations and up from the prior month. This was the best month of hiring since January's 472,000 gain and a slight reacceleration over the last several months, even in the face of a slowing economic backdrop.

Job growth picked up in May, though we expect it to gradually slow this year.

• • The U.S. unemployment rate rose to 3.7%, the 16th consecutive month below 4%^1,2. This is the longest such streak since the 27-month stretch between 1967 and 1970, and the fourth-longest period below 4% in the post-war era^1,2. 
  • The strong monthly payroll gain appears at odds with the rise in the unemployment rate, a mixed trend that we view as confirmation that the labor market is at an inflection point, undergoing a transition from a two-year sprint toward a brisk walk as we advance.
  • We expect a more moderate increase in unemployment relative to historical recessionary rises in joblessness. Our call entering 2023 was that the unemployment rate would rise but remain below 5% this year. Excluding the 2020 pandemic experience, in the previous seven recessions since 1970, the unemployment rate rose by an average of 3.4%, with an average peak level of 8.3%^1,2.
  • Other gauges of employment conditions are signaling moderation ahead. Job openings, while still three million above pre-pandemic openings, have declined by nearly two million over the past year, including a decline of one million just in the last four months. Job postings are on a gradual downtrend as well, with employers tightening their belts in anticipation of slower demand. Meanwhile, initial jobless claims ticked higher last week, with new claims having now risen more than 25% from the lows last year¹.

2. Wage pain is the Fed's gain – A softening in the labour market does have a silver lining, in that slower wage growth will be a key driver of further declines in inflation over the remainder of the year. This in turn adds support to an approaching conclusion to the Fed's rate-hiking campaign, which has been a sturdy headwind to the financial markets since the beginning of 2022.
   • Workers have held the upper hand for the past few years, as tight labour conditions have driven above-average wage growth. Average hourly earnings have risen at a year-over-year rate of 4.9% in the last 24 months, compared with 2.7% over the previous 10 years¹.
   • U.S. wages grew at an annual pace of 4.3% in May¹. While still healthy, this was down from the previous month and now sits at the slowest pace since June 2021.
   • The rate of employees quitting their jobs has fallen recently, another signal of emerging softening in employment conditions. As turnover declines (less workers quitting to take a new job at a higher pay), we think this portends further moderation in wage growth. As reference, a 1% decline in the quit rate in 2007-2008 was accompanied by a 1% drop in the pace of wage gains. 

The rate of workers quitting their jobs is falling, signaling less availability and slower wage gains.

• • Although moderating wages is not exactly a trend worth rooting for, it is a necessary condition for relief on the inflation front. The decline in the pace of wage growth last month lends support to the case for the Fed to move to the sidelines and pause on rate hikes, though we'd admit that the ongoing strength in monthly payroll gains complicates the picture a bit. Nevertheless, we think the downward trend in wage growth will persist, reducing a lingering upward pressure point on consumer price inflation. 

Moderating wage growth ahead bodes well for further declines in inflation.

3. The consumer still has gas in the tank – While the broader economy is slowing, someone forgot to tell the consumer.  Household spending has remained robust this year despite weakness elsewhere, something we attribute squarely to the strength of the labour market. While we expect that strength to fade somewhat over the balance of the year, we think consumers remain well positioned to weather a slowdown with fewer bruises than a traditional recession.
   • U.S. job gains were generally broad-based in May, a favourable trend for consumers at large. Manufacturing was one area of weakness, which we believe is consistent with factory activity and ISM manufacturing surveys that have been flashing recessionary conditions for some time now.  Job growth in the leisure & hospitality sector was a solid 48,000, reflecting an ongoing consumer appetite for discretionary spending¹.  We suspect the summer travel season will further confirm that the consumer is not heading fully into hibernation.
   • We'd emphasize that while we expect employment conditions to soften ahead, we're starting from an extremely healthy position, which we think will limit the damage to household consumption, and thus the overall economy. This is highlighted by the fact that while the rate of job openings has fallen over the past year, the unemployment rate also declined during that time, an atypical relationship that underscores the unique strength of this labour market.

A check on the markets 

• Politics and payrolls drive gains last week – A late-week rally last week was sparked by the combination of a U.S. debt-ceiling resolution and a positive interpretation of the latest jobs report. In terms of the latter, we suspect the market found comfort in the fact that hiring growth continued at a strong clip while also being accompanied by a moderation in wage growth.  While this isn't a full goldilocks scenario, resiliency in payroll gains that happens at the same time as a sustained moderation in inflation is probably the closest thing to a soft landing for the economy as the markets could hope for. Small-caps outperformed handily on Friday, signaling a positive interpretation for the economic outlook. 

The unemployment rate remains historically low, which has traditionally been supportive of market returns.

• Spotlight moves from fiscal policy back to monetary policy - The small gain for the S&P 500 in May reflected, in our view, a market that was catching its breath and evaluating the terrain ahead. After moving generally sideways through April and May, the stock market is off to a strong start in June, bringing the year-to-date return for the S&P 500 above 12%¹. With U.S. lawmakers finding a debt-ceiling deal to avert the default cliff, all eyes will now move to the Bank of Canada's interest-rate announcement this week (which we think has an increased probability of a restart to rate hikes), and then the upcoming U.S. inflation report and the Fed's next rate announcement, which will both occur within the span of two days (June 13 and 14). The results will likely set the pace for the markets this summer. We suspect the path ahead will be less smooth than we've experienced over the last several weeks, but the case for broader-term optimism is not misplaced, in our view.

Craig Fehr, CFA
Investment Strategist

^{Sources: 1. Factset 2. Edward Jones}

Weekly market stats

^{Source: Factset. 06/02/2023. Bonds represented by the S&P Canada Agg index. Past performance does not guarantee future results. * Source: Morningstar, 06/05/2023.}

The Week Ahead

Important economic data coming out this week includes the Bank of Canada interest rate announcement and labor market data.