With the US debt ceiling issue now in the rear-view mirror, market focus has shifted squarely to the upcoming Federal Open Market Committee meeting on June 14, and whether the Federal Reserve will pause or raise interest rates by another 25 basis points.
At the May meeting, Fed chairman Jerome Powell indicated that the central bank had likely done enough to warrant a pause in June to allow more time to assess incoming data, after an unprecedented 500bp in rate hikes in a little over a year and amid uncertainty over the impact of tighter lending standards at midsized banks.
Despite a consensus at the start of the year that the US would enter a recession in 2023, the economic data has proved remarkably resilient as we approach the halfway point, complicating the Fed’s decision making.
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On Friday, the May employment data once again confounded expectations with a blowout 339,000 new jobs added, and upwards revisions to the March and April figures as well.
The US labour market appears to be showing little sign of softening, barring the increase in the unemployment rate from 3.4 per cent to 3.7 per cent last month. Job openings increased again in April and initial jobless claims also tracked lower in May.
At first glance, these strong labour market indicators are at odds with widespread reports of redundancies at technology companies that have hit the headlines in the past few months.
However the detailed non-farm payrolls data show that the number of jobs in the information sector, which would cover most of the tech jobs, fell by 9,000 in May.
Another 2,000 jobs were lost in manufacturing, which is also consistent with recent survey data showing weakness in the manufacturing sector.
This has been more than offset by strength in the services sector, which is also reflected with the May payrolls data – the bulk of new jobs last month was in services, particularly health care and social assistance, professional and business services, and transportation and warehousing.
The tight labour market has undoubtedly been a key factor in supporting overall household consumption spending in the US, even in the face of higher borrowing costs and elevated inflation.
Inflation-adjusted personal spending growth is still above 2 per cent year-on-year and, notwithstanding the rise in credit card debt, consumer balance sheets are still healthy.
San Francisco Fed researchers estimate there is still about $500 billion of excess savings held by US households, which could continue to support consumer spending through to the end of this year.
Against this backdrop, it is perhaps unsurprising that inflation has proved stickier than expected.
While the headline Consumer Price Index has indeed slowed to 4.9 per cent in April from 6.4 per cent at the start of the year – and the peak of more than 9 per cent in June 2022 – this has largely been due to slower food (and other goods) inflation and lower energy prices compared with a year ago.
However, core inflation, which excludes volatile food and energy prices, remains relatively high at 5.5 per cent, almost unchanged since January.
Housing costs, in particular, have continued to rise at a sustained pace so far this year, and transport services inflation remains in the double digits.
While the Fed’s preferred inflation benchmark (the core Personal Consumption Expenditure deflator) is slightly lower at 4.7 per cent, this has also barely budged since January and remains well above the 2 per cent target.
There is then a case to be made for the Fed to raise rates again at the June meeting, and the market is now pricing a 30 per cent probability of a 25-basis-point hike this month.
However, the weakness in the household survey, which indicated 310,000 jobs lost last month and a rise in the unemployment rate to 3.7 per cent, will likely give the Fed enough reason to pause, particularly if the May inflation data shows a further moderation in both headline and core inflation, as is expected.
Khatija Haque is chief economist and head of research at Emirates NBD
