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The May jobs report on Friday continued to reflect a robust job market, but with hints that the best days of the labor market are behind us for now. Despite the overall good news of the economy adding 390,000 jobs in May, this was the slowest pace of growth in a year, and we have yet to recover all the jobs lost during the covid lockdowns. Separately, job openings remain at an elevated level but shrank for the first time this year. Initial claims for unemployment benefits, while still low, have begun to inch higher.
Frankly, despite its mandate for full employment, the Federal Reserve (Fed) would welcome some slack in the job market to help in the battle against raging inflation. The markets are still pricing in 199 basis points (1.99%) of rate hikes from the Fed over the next eighteen months. Half of those increases will likely come 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 path will depend more on inflation levels and the economy’s health. May consumer inflation (CPI) readings are released this week. While the headline year-over-year rate could decline versus last month, the increase is almost sure to be above 8%. These inflation levels leave the Fed with a Hobson’s choice regarding rate hikes at the next two meetings at a minimum.
As further evidence beyond the labor market that the economy remains a distance away from recession, the May Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI) has historically been a reliable real-time indicator of recession. The May manufacturing component was reported last week at 56.1, and the U.S. has never begun a recession at that level. An ISM PMI reading below 50 is typically a good rule of thumb that the recession warning lights are flashing red.
Despite the inflationary challenges to the consumer, households have accumulated significant savings that can be used to supplement income to support consumption. Lower-income families, in particular, feel the pinch from the increase in food and fuel prices, though, and are forced to forego spending on other items due to the price increases. As continued proof of the growing pressure, gasoline prices hit a new high again last week.
After being down 19% from the peak, the S&P 500 has rebounded to almost 14% below the peak. In the last twelve recessions, stocks have declined by 24%. The markets have priced in an economic slowdown but not yet a recession. Given the current data, this is reasonable since a recession is not likely until late-2022 or 2023.
History would indicate low odds of the Federal Reserve avoiding recession once they begin to raise rates. The need to battle high inflation would suggest a higher probability than usual that an economic downturn will result from this tightening cycle. Markets may have moved a little too early to price in an impending recession but still reflect an economic slowdown. Investors focus on quality companies that can survive the probable economic downturn on the horizon and thrive in its wake.