Slowdown in job market pushes Fed rate hike farther out

U.S. stocks bounced back on Friday after Wall Street decided a disappointing jobs report wasn't as bad as first thought, but would likely mean the Federal Reserve won't raise interest rates at its next meeting in June.

Given the economy has been growing at a less than 2 percent rate since the middle of last year, it would stand to reason that payrolls would not expand by 200,000 and more a month for months on end.

And they haven't. Nonfarm payrolls increased 160,000 in April, below the 200,000 gain expected and a decline from the revised 208,000 gain in March. February's result was also revised lower. The unemployment rate held steady at five percent.

Further negative aspects to the report had the labor force participation rate reversing its recent uptrend, slipping 0.2 percent to 62.8 percent. The bright spot was a 0.3 percent increase in hourly earnings, pushing the annual growth rate to 2.5 percent.

"Investors as a whole are very convinced that this modest growth we're seeing here in the U.S. is pretty dependable, said Scott Wren, senior global equity strategist, Wells Fargo Investment Institute. "Our fixed income team is looking for one rate hike this year; the highest probability for that has been December."

The report signaling a slowdown in the labor market comes after a spate of weak U.S. data, including soft consumer spending (as the savings rate rises), an underwhelming Q1 GDP growth report, and ongoing stalling in the manufacturing sector. The result, as shown below, has been a hook down in the Citigroup Economic Surprise Index which measures where the economic data is coming in relative to analyst expectations.

Philippa Dunne of the Liscio Report notes that the jobs report is just the latest evidence the labor market is slowing. The Federal Reserve's labor market conditions indicator (LMCI) -- a composite of 19 separate employment indicators -- has been negative for three consecutive months and "looks to have peaked for the cycle" suggesting we've already seen the best pace of job gains for this expansion and that things are likely to slow from here.

She adds that the LMCI tends to peak about nine months before the business cycle does. "If this trend is sustained, come autumn, it might not only be leaves that are falling," Dunne noted. "We've been cautious about joining the 'recession is coming!' brigade, and we'll stay that way for now. But let's just say this is mildly troubling news."

Friday's jobs report threw cold water on any notion the Fed would be increasing interest rates in June. Ethan Harris at Bank of America Merrill Lynch now expects another 0.25 percent rate hike in September followed by another in March; a shift from the previous call for a hike in June and December.

The change is based on a loss of momentum in the U.S. economy, a Fed engaged in "opportunistic reflation" targeting inflation above two percent, and uncertainty related to recent market volatility, the U.K. referendum on the European Union, and the upcoming U.S. presidential election.

The weak jobs numbers was, according to Harris, "the last of a string of softer indicators that has prompted us to change our forecast." But he remains hopeful, noting "the economy is still expanding, inflation is still accelerating and the Fed is still normalizing."