Market expectations of interest rate cuts ease following strong employment data

The unexpected pace of job and wage growth in May has strengthened confidence that the Federal Reserve will keep interest rates on hold through the summer and perhaps beyond.

The Bureau of Labor Statistics reported Friday that nonfarm payrolls rose by 272,000 this month, well above Wall Street’s consensus estimate of 190,000 and well above April’s more modest gain of 165,000. Additionally, average hourly earnings rose 4.1% over the past 12 months, also beating expectations.

The data not only suggests a still-active labor market, but also supports the view that the Fed is at least in no rush to cut interest rates.

With inflation running above the central bank’s 2% target, there is little evidence that rising interest rates are endangering broader measures of economic growth.

“I’m a little confused by the social game of when the Fed is going to start cutting rates,” said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. “My position is that neither element of the Fed’s dual mandate indicates a need to start cutting rates, and rates staying high means nothing is going to happen this year.”

The Federal Reserve’s “dual mission” includes maintaining both full employment and price stability.

The labor market appears to be booming, although the unemployment rate rose to 4% in May.

But inflation remains well above the Fed’s target, with most measures projecting price increases at about 3% annually, down significantly from the peak seen in mid-2022 but still high.

Futures traders reduced bets on a rate cut following the jobs report.

Pricing of federal funds futures suggests there is little chance of a rate cut when the Federal Open Market Committee meets next week, or at its meeting on July 30-31. From there, pricing suggests a 50-50 chance of a September rate cut and only about a 46% chance that the Fed will cut rates a second time before the end of the year, according to CME Group’s FedWatch indicator as of Friday afternoon.

All of these probabilities have fallen significantly from Thursday’s levels.

But investors shouldn’t get too pessimistic, according to Rick Rieder, chief investment officer for global fixed income at asset manager BlackRock Inc. He pointed to weak demand for workers, as shown by a report earlier this week that job openings continued to slow.

In addition, the household survey used to calculate the unemployment rate showed that the number of employed people fell by 408,000, continuing the trend of part-time employment significantly exceeding full-time employment.

“Thus, the Fed’s price stability and full employment mandates are very nicely balanced,” Rieder wrote in a post-report analysis. “In these circumstances, the Fed can reduce the federal funds rate from highly restrictive territory to a merely restrictive positioning.”

“The Committee believes it could begin to cut interest rates by 25 basis points at its September meeting and would like to achieve one further rate cut before the end of the year, but future inflation data must provide support for this,” he added.

Similarly, Citigroup, which continues to expect aggressive rate cuts, well above the Wall Street consensus, said it sees the Fed not moving until September but will continue to cut rates from that point onwards.

“The jobs report does not change our view that demand for jobs and the overall economy are slowing, which will ultimately prompt the Fed to respond with a series of rate cuts in the coming months,” Citigroup economist Andrew Hollenhorst wrote.