NFP Breakdown June Employment: Cooling, Still Hot

Summary

In June, there was a rise in nonfarm payrolls by 209K, which fell slightly below the Bloomberg consensus for the first time in 15 months. Additionally, revisions made to job growth in the previous two months revealed that employment growth has not been as strong as initially thought. Although government hiring remained strong with an increase of 60K, private sector employment only saw a gain of 149K, marking the smallest increase since 2020. The unemployment rate remained steady at 3.6% and has not changed since the FOMC's rate hike in March 2022. Yesterdays employment report offered additional evidence that the labour market is slowly coming into better balance as job growth slows and labour supply steadily expands. That said, job growth of +200K is still quite strong even if it is directionally slower than the scorching pace seen over the past year. A stronger-than-expected reading on average hourly earnings, as well as upward revisions to wage growth in earlier months, suggests the Federal Reserve is not out of the woods yet in its fight to tame elevated inflation. I expect a 25 bps rate hike from the FOMC at its upcoming meeting on July 25-26th.

Back to Earth for Payroll Gains

Nonfarm payrolls have seemed to defy the gravity weighing down other gauges of the labour market over the past year. However, the June employment report suggests this dynamic has run its course. Nonfarm payrolls increased by 209K in June—a respectable gain in its own right—but below the Bloomberg consensus for the first time in 15 months. Revisions also pointed to recent job growth flying a little closer to Earth. Payroll gains for April and May were revised down by a combined 110K, bringing the three-month average pace of job growth down to 244K. Job growth also narrowed a bit over the month with the diffusion index of industries adding jobs dipping to 58.0 from 61.2 in May. Government hiring was once again robust (+60K), but the 149K increase in private sector employment was the smallest gain since 2020. While the construction and manufacturing sectors posted solid gains, goods-adjacent services like retail, wholesaling and transportation & warehousing all saw employment slip over the month. Temporary employment also fell in June (-13K) in another sign that demand for workers is beginning to wane at the margin.

After a sharp divergence between establishment-based payrolls and the household measure of employment in May, the two aligned more closely in June. Household employment rose by 273K, which outpaced another modest rise in the labour force (+133K) and helped drive the unemployment rate back down to 3.6%. The unemployment rate has remained within the narrow range of 3.4-3.7% since March of last year when FOMC began its most aggressive tightening campaign since the early 1980s.

The labour force participation rate held steady in June at 62.6%, its fourth consecutive month at this level. A steady labour force participation rate is in some ways encouraging given that the aging population should put steady downward pressure on this measure over time, all else equal. The labour force participation rate for workers ages 25-54 ticked higher in June and is now at its highest point in more than 20 years (chart). After a sluggish start to the recovery, labour supply has expanded steadily over the past couple of years and should help bring labour supply and demand into better balance over time.

Wages Still Flying

There had been signs of cooling wage growth in the recent monthly employment reports, but today's release partially dashed this disinflationary trend. The previous report showed average hourly earnings increasing at a 4.0% annualized rate over the three months ending in May, not too far off the ~3.5% pace that would be consistent with the FOMC's 2% inflation goal.

Faster wage growth in June and upward revisions to the prior months pushed the three-month annualized rate up to 4.7%, above the year-ago rate of 4.4%. The Employment Cost Index report, to be released on July 28th, will provide a more comprehensive look at labour cost pressures in the second quarter. But based on what I know now, a tight labour market is keeping wage growth about a percentage point above what would be consistent with the FOMC's inflation target.

On balance, the labour market continues to cool, but only at a gradual pace. Through first half of the year, businesses added an average of 278K jobs per month, continuing a step down from 354K in the second half of 2022 and 445K in the first half of last year. That said, the directional slowdown has come off a scorching hot base, and +200K is still a very solid pace of job growth. Accordingly, the unemployment rate is no longer declining on trend, but it has yet to break higher. Jobless claims have inched higher, but they remain historically low along with the JOLTS measure of layoffs.

The surprisingly resilient labour market has helped to keep the U.S. economy expanding at a moderate pace despite continued fears about a recession.

However, even amid more forthcoming labour supply and gradually cooling labour demand, the weight of the evidence still suggests that the labour market remains too tight to be consistent with 2% inflation. The directional progress towards a more balanced labour market is encouraging and helps explain why the FOMC has slowed the pace of its rate hikes, but last Friday data, point to another 25 bps rate hike at the upcoming FOMC meeting on July 25-26th.