With uncertainty dominating the landscape, and on the back of a sharp rally in equity markets, the highly anticipated May non-farm payrolls report represents another piece in what is becoming an increasingly difficult puzzle to solve as investors gear up for the second half of the year. The report showed non-farm payrolls grew +139k for the month, above the consensus for +126k, but also well above the whisper numbers which had been moving lower after a dour ADP print earlier in the week.
Driving the print were continued gains in health care (+62k) as well as job adds in leisure and hospitality (+48k), social assistance (+16k), and financial activities (+13k). Not surprisingly, federal government job losses continue to mount, with payrolls down -22k in the month, but there were also losses in manufacturing (-8k) and temporary workers (-20k), a reflection of the still challenging tariff backdrop. In addition, revisions to March and April payrolls netted to a decrease of -95k versus the previously reported prints.
Looking deeper, however, there are contradictions in the underlying data indicative of the fluid economic backdrop. While the unemployment rate remained steady at 4.2%, the labor participation rate fell to 62.4% from 62.6% – an unwelcome sign for a Fed looking to support its maximum employment mandate. There was a decline of -696k in employed persons in the month and unemployed rose by +71k – the fourth straight month of gains in that category. Conversely, wage growth remains ahead of inflation, as average hourly earnings grew by +0.4% month-over-month, and +3.9% year-over-year. Hours worked were steady at 34.3, with manufacturing hours worked ticking up slightly.
While the better-than-expected payroll adds ease to some of the mounting concerns around the potential for a near-term sharp deterioration in the hiring environment, there are still a lot of unanswered questions as to the resiliency of the labor market. The recently released Fed Beige Book indicated that nine of the twelve districts were reporting a decline in economic activity and cited the increase in policy uncertainty as a challenge. The May ISM Services PMI also decelerated, falling to 49.9 from 51.6 in April. This drop was attributable to a decline in both business activity and new orders, and while employment was modestly higher, so were prices paid. We believe this is something to watch as we move into the summer and weigh the possibility of Fed policy shifts in the second half of the year.
As for the Fed, today’s release lowered the probability of a Fed rate cut in September to 75%. As a reminder, this probability spiked above 90% recently but is likely to fluctuate as additional hard economic data points are released, providing color and context to the primarily cautious narrative. The Fed would likely prefer to remain on hold at least for the next several months to gauge the broader impact of constantly shifting tariff implementation; there could also be an improvement in business confidence and activity based on the new tax bill that could provide some additional support to the labor market.
A risk on market reaction is dominating in the early U.S. sessions, with equities higher and yields modestly higher across the curve. Our view is that the Fed will continue to watch Congress and the White House closely to determine the potential inflationary pressures resulting from policies, as it is likely that changes in policy, particularly as it relates to the very significant legislation currently being negotiated in the Senate, will have a much greater impact on yields this year than the timing of the next 25 basis point cut.
In terms of positioning, we would look to near-term volatility, especially during the lull ahead of Q2 earnings season, as an opportunity to deploy cash and reallocate back to strategic long-term allocations. Given the re-emergence of the benefits of diversification, we are also encouraging revisiting concentrations at the asset class, sub-asset class, and individual company level, with an eye towards allocating to our higher conviction areas of opportunity.
