By: Brent Schutte, CFA
Equities posted strong gains last week as mixed employment reports were largely shrugged off by investors. The seemingly contradictory jobs data from the Bureau of Labor Statistics (BLS) showed robust hiring in May but also an uptick in the unemployment rate and a decline in the labor participation rate. While the conflicting employment data grabbed most of the attention, other economic news also created a blurred picture of an economy in which pockets of strength and weakness are scattered throughout.
We’ve highlighted the discrepancies between the BLS’s Nonfarm payroll data and the so-called Household report in the past and last week’s reports further widened the gap between the two measures. The Nonfarm payroll report showed that 272,000 new positions were added in May—well above April’s gain of 165,000 and Wall Street forecasts of 180,000. The pace of gains eclipsed the 12-month average of 230,000 new positions added. May gains were driven by additions in the health care, government, and leisure and hospitality sectors. In a potentially positive sign for the economy, 229,000 of the new jobs were created in the private sector. However, the BLS’s other jobs report, the Household survey, showed the unemployment rate at 4 percent, up from April’s 3.9 percent. The labor participation rate declined to 62.5 percent, down 0.2 percent from the prior month. While the participation rate declined, the number of available workers grew and accounted for the rise in the unemployment rate. In total, the Household report showed a net loss of 408,000 jobs. For further context, the latest unemployment rate is up from a cycle low of 3.4 percent.
Additionally, the economy is inching toward triggering the so-called Sahm rule (regular readers of our commentaries may recall this rule, developed by former Federal Reserve Economist Claudia Sahm). According to the rule, since 1960, every time the three-month moving average unemployment rate rose by 0.5 percent or more from the previous low, a recession followed. The three-month average low for unemployment is 3.7 percent, and the current rate is now 0.37 percent higher than the low, meaning a 0.1 percent increase would put the rise essentially at the threshold. Digging deeper, the latest data shows that 21 states have already seen unemployment rise to levels eclipsing the Sahm rule.
On a year-over-year (not seasonally adjusted) basis, the Nonfarm measure shows payrolls grew by 1.8 percent, with approximately 2.8 million new positions added. In contrast, the Household survey puts the total number of jobs gained in the past year at just 340,000 total, or approximately 28,000 per month. Further, since November 2023, the Household report has shown 783,000 net job losses. Theories on possible causes for the discrepancies vary from flaws in the estimates used to calculate figures based on forecasts for the numbers of businesses opening and closing to the shortcomings of the reports in picking up the effects of immigration on the job market. While we are not advocating that one of the reports is more accurate than the other, we do believe the strong Nonfarm number of new positions is overstated. The BLS’s own numbers seem to support our view. Seasonally adjusted revisions by the Bureau show that since 2023, 13 of the last 16 months of job gain estimates have been revised lower. And while we have been making this point for several months, we are not alone.
A recent analysis by Bloomberg Economics also highlights the disconnect between the two BLS reports. In a report released last week, the research unit estimates that the Nonfarm payroll data may have overestimated job gains by 730,000 last year. The researchers argue that the same factors are in play this year and that average monthly job gains number fewer than 100,000 each month, far less than the 242,000 three-month average that has been reported through April.
While the debate about which payroll report is more accurate may seem like a dry academic exercise best suited for college lecture halls, it has real-world implications. That’s because the Federal Reserve is closely monitoring the employment market due to its relationship to wage growth, which historically filters into price pressures. The lagging nature of the job market as it relates to economic strength has historically made it difficult for the Fed to achieve a soft landing after a rate hiking cycle has taken place. The conflicting signals given off by the BLS reports only add to the challenge.
Unfortunately, pertaining to inflation, there is one area of the employment picture for which various sources of input are in agreement—that’s wages. The latest data from the BLS shows average hourly earnings for all employees in the private sector grew by 0.4 percent in May and are up 4.1 percent year over year. For production and nonsupervisory employees, wages were up 0.5 percent in May. Over the past 12 months, average hourly earnings for the group have increased by 4.2 percent. It’s worth noting that the current pace of wage growth is still above the 3 to 3.5 percent range the Fed believes is necessary for inflation to fall sustainably to its goal of 2 percent. And a review of shorter-term measures shows that we remain stuck in the lower 4 percent area.
The BLS data is consistent with other surveys we follow that show wage pressures remain high even in sectors that have seen demand for workers weaken. As such, we believe the Federal Open Markets Committee will be unwilling to significantly adjust interest rates until wages come down to the 3-3.5 percent range or the employment market deteriorates significantly. Unfortunately, given the conflicting data from the BLS, the Fed may not be able to clearly assess the job market until it begins to contract for an extended period. If so, that could be a tipping point for the economy and ultimately lead to a short, mild recession.
About the Author:
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
