Fed Suggests Pause in Rate Hikes, While Employment and Economic Activity Remain Broadly Resilient

Key Takeaways:

• The Federal Open Market Committee (FOMC) raised the federal funds rate by 25 basis points to a target range of 5-5.25 percent at its May 2-3 meeting. With the federal funds rate now above 5 for the first time since 2007, the FOMC statement reads, “In determining the extent to which additional policy firming may be appropriate…the Committee will take into account the cumulative tightening of monetary policy.” In its previous statement, the FOMC had noted “some additional policy firming may be appropriate.”
• Nonfarm payroll employment increased by 253,000 in April, though February and March were revised downward by a combined 149,000 jobs, according to the Bureau of Labor Statistics (BLS). Professional and business service employment rose by 43,000. The unemployment rate ticked down one-tenth to 3.4 percent, while the labor force participation rate was unchanged at 62.6 percent (though prime-age participation was up two-tenths to 83.8, exceeding its pre-pandemic peak). Average hourly earnings rose 0.5 percent over the month and 4.4 percent over the year, a small acceleration for both compared to March.
• The Job Openings and Labor Turnover Survey (JOLTS) showed job openings declined by 384,000 in March, according to the BLS. Over the past three months ending in March, job openings have declined by 1.6 million. The quits rate ticked down one-tenth to 2.5 percent, while layoffs rose by 248,000 to 1.8 million.
• Nonfarm business productivity declined at a 2.7 percent annualized rate in 2023 Q1, according to the BLS. Unit labor costs rose 6.3 percent annualized after a slowdown to an annualized rate of 3.3 percent in 2022 Q4.
• The ISM Manufacturing Index increased 0.8 points to 47.1 in April, recovering part of its 1.4-point decline in March but remaining in contractionary territory for the sixth straight month. The new orders index rose 1.4 points to 45.7 and the production index was up 1.1 points to 48.9. Breaking with recent trend, the non-seasonally adjusted prices paid index jumped 4.0 points to 53.2.
• The ISM Services Index rose 0.7 points to 51.9 in April. The business activity index was down 3.4 points, but this was more than offset by a 3.9-point gain in the new orders index. The prices paid index (seasonally adjusted for services) was up one-tenth to 59.6.
• Light vehicle sales jumped 7.7 percent to a seasonally adjusted annualized rate of 16.2 million, the highest sales figure since May 2021, according to Autodata.
• Factory orders rose 0.9 percent in March, according to the Census Bureau, though this was due almost entirely to a surge in aircraft orders. Excluding transportation, factory orders were down 0.7 percent.
• The real goods U.S. trade deficit narrowed by $4.6 billion to $99.4 billion in March as real exports jumped 3.5 percent, according to the Census Bureau. Real imports were up 0.3 percent.
• Private residential construction spending declined 0.2 percent in March, according to the Census Bureau. The weakness was due entirely to single-family spending, which was down 0.8 percent. Spending on multifamily construction and improvements were up 0.4 percent and 0.3 percent, respectively.

Forecast Impact:

The labor market remained resilient in April, though with downward revisions to the prior two months, the three-month moving average of job gains is down to 222,000 (from 284,000 at end of 2022). Additionally, temporary help services, a generally leading indicator of broader labor market growth, is down 174,000 jobs since its peak, suggesting hiring in other areas may soon slow. This would be consistent with indicators from the JOLTS, such as near-2019 levels of layoffs in March and substantial declines in job openings. While the labor market is likely cooling (albeit slowly), we think it’s still strong enough to remain supportive of above-trend wage growth.

The FOMC statement suggested they are likely to pause further rate hikes. This is consistent with market expectations, though, at a minimum, we expect fewer cuts by the end of the year than current market pricing suggests. There may be some additional upside risk with rates as the economy does not appear to be slowing evenly, which could contribute to stickier inflationary pressures. The surge in light vehicle sales, for example, a typically rate-sensitive sector, is at odds with our forecast for generally weaker consumer demand. Additionally, while neither index supports robust growth, the slight rebounds in both the ISM Manufacturing and the ISM Services indices suggest the economy still has some resilience. Though manufacturing remains in a contraction, it seems to be a relatively slow one, and residential investment, as indicated by residential construction spending, may be leveling off. We believe these factors, combined with a stronger-than-expected trade report that indicates a strong base entering Q2, probably mean second quarter growth will be stronger than we had previously forecast.

Nathaniel Drake
Economic and Strategic Research Group
May 5, 2023

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