The May jobs report released on Friday continued to reflect a robust labor market, but with signs that the labor market’s best days are behind us for now. Despite the overall good news of the economy adding 390,000 jobs in May, this is the slowest pace of growth in a year, and we have yet to recoup all of the jobs lost during the covid shutdowns. Separately, job vacancies remain at a high level but have fallen for the first time this year. Initial jobless claims, although still low, have started to increase slightly.
Frankly, despite its mandate for full employment, the Federal Reserve (Fed) would welcome a loosening of the labor market to help in the fight against runaway inflation. Markets are still pricing in 199 basis points (1.99%) of Fed rate hikes over the next 18 months. Half of these increases will likely occur over the next two months, with a 50 basis point (0.50%) increase in short-term interest rates in June and July. After July, the trajectory will depend more on inflation levels and the health of the economy. May consumer inflation (CPI) readings are released this week. While the overall year-over-year rate could be down from last month, the increase is almost certain to be more than 8%. These inflation levels leave the Fed with a choice of a Hobson on rate hikes in the next two meetings at a minimum.
As further evidence, beyond the labor market, that the economy remains far from recession, the Purchasing Managers Index (PMI) from the May Institute for Supply Management (ISM) has always been a reliable indicator in time reality of the recession. The May manufacturing component was reported last week at 56.1 and the US has never entered a recession at this level. An ISM PMI reading below 50 is usually a good rule of thumb for recession warning lights to flash red.
Despite the inflationary challenges facing consumers, households have accumulated significant savings that can be used to supplement their incomes to support consumption. Low-income families, in particular, are feeling the pinch of rising food and fuel prices, however, and are being forced to forgo other expenses due to rising prices. As continued evidence of the mounting pressure, gasoline prices again hit a new high last week.
After falling 19% from the peak, the S&P 500 rebounded nearly 14% below the peak. Over the past twelve recessions, stocks have fallen 24%. Markets have priced in an economic slowdown but not yet a recession. Given current data, this is reasonable as a recession is not likely before the end of 2022 or 2023.
History would indicate a slim chance of the Federal Reserve avoiding recession once it starts raising rates. The need to fight high inflation suggests a higher than usual likelihood that an economic slowdown will result from this tightening cycle. Markets may have moved a bit too early to gauge an impending recession, but they still reflect an economic slowdown. Investors are focusing on quality companies that can survive the likely economic downturn looming on the horizon and thrive in its wake.