Data showed the U.S. job market appeared to be slowing, but not to the point where the Fed would see a pullback in its inflation target.

Data released by the U.S. Labor Department on Friday showed that U.S. nonfarm payrolls increased by 390,000 in May, but that was worse than the previous value of 428,000 in April and the smallest gain in 13 months since April 2021.

The combined values ​​for March and April were revised down slightly by 22,000. Total U.S. payrolls are now more than 820,000 below their pre-pandemic historical peak in February 2020, and if trends don’t change significantly, the difference could be smoothed out within a few months.

The non-farm unemployment rate was 3.6% in May, unchanged from the previous value in April, and the market had expected it to fall to 3.5%, the lowest since December 1969.

Some analysts said that although the slowdown in employment growth in May helped ease inflationary pressures, the labor market is still tight and will not change the prospect of further aggressive interest rate hikes by the Federal Reserve.

Sal Guatieri, senior economist at BMO Capital Markets, believes that the May report will bring mixed blessings to the Fed. The good news is that the unemployment rate is more stable, the labor force participation rate is more solid, and wage growth may be weak. The worry is that the US economy is still overheating. Cooling to the point where inflation could fall back toward the Fed’s target.

This means that while the slowdown in employment growth in May helped ease inflationary pressures, the rate hikes will not stop as long as the Fed does not see inflation falling back.

Investors are now all but certain that the Fed will raise rates by 50 basis points each later this month and at its July meeting, in line with the Fed’s previous hints.

The possibility of stopping rate hikes in September has also been largely ruled out by the market. However, investors are uncertain whether the Fed will choose to continue raising interest rates by 50 basis points or move to a more dovish 25 basis points at its September meeting.

September rate hike: 50bp or 25bp?

The key is the “wage-inflation” spiral. Some analysts said that if the unemployment rate continues to decline and companies push up wages to compete for talent, even a slight drop in inflation will not make much sense.

Historically, the United States fell into the nightmare of a “wage-inflation” spiral in the 1970s. Under the rigidity of real wages and high inflation expectations, wages and prices rose in a spiral, resulting in an increase in the cost of living-workers demanded higher wages-enterprises. Passing on costs – prices continue to rise – strengthens the vicious spiral transmission chain of inflation expectations.

The formation of the “wage-price” spiral not only means the de-anchoring of inflation expectations, but also the loss of the Fed’s control over inflation and the advent of stagflation. After Volcker took office as the chairman of the Federal Reserve, he raised interest rates sharply while controlling the level of banks’ reserves, allowing short-term interest rates to fluctuate greatly, breaking inflation expectations, and restoring the Fed’s prestige.

Therefore, as Wall Street has seen before , inflation-related data such as hourly wages may determine the Fed’s future policy decisions. If it exceeds market expectations by a large margin, it may drive the Fed to accelerate interest rate hikes in September.

Data on Friday showed that U.S. average hourly wages rose 0.3% month-on-month in May, slightly below expectations for a 0.4% increase, and a 5.2% year-on-year increase, still high but down from April’s 5.5% increase. The labor force participation rate was unchanged at 62.3%, slightly higher than the previous reading of 62.2%.

This means that the pressure on the “wage-inflation” spiral has eased. Some analysts said that as savings continue to decrease and the haze of the new crown pneumonia epidemic is dissipating, the labor force will return to the labor market in the next few months, the situation of labor difficulties may be alleviated, and the upward pressure on wages will be reduced.

As a result, Wall Street believes the Fed may slow the pace of rate hikes to a single 25 basis point in September .

It is worth mentioning that there are three non-farm payrolls reports released before the September Fed meeting. Fed officials have said before that they are now more focused on monthly inflation data.

Cleveland Fed President Mester said on Friday that convincing evidence that inflation is falling, including months of falling data, is needed to conclude that inflation has peaked. If inflation does not cool, it may support a 50 basis point rate hike in September.

The Fed’s No. 2 and Vice-Chairman, Brainard, made a public statement on Thursday that the Fed still has a lot of work to do to bring inflation down to its 2 percent target. It is too early to say that inflation has peaked. Fed policymakers will still rely on data. Inflation and economic data in the coming months will be crucial in determining the Fed’s actions in September.

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