Market backs off on hopes for interest rate cuts following strong jobs report

May’s surprising pace of job growth and wage rise added to the conviction that the Federal Reserve will stay on hold through this summer and possibly beyond.

The Bureau of Labor Statistics reported Friday that nonfarm payrolls increased by 272,000 for the month, considerably higher than the Wall Street consensus of 190,000 and well above April’s comparatively muted gain of 165,000. In addition, average hourly earnings rose 4.1% over the past 12 months, more than expected.

Beyond signaling a still-vibrant labor market, the data at the very least adds to the narrative that the Fed doesn’t have to rush to lower interest rates.

As inflation runs above the central bank’s 2% target, there’s scant evidence that higher rates are endangering broad metrics of economic growth.

“I’ve been a little flummoxed at the parlor game of when will the Fed start cutting,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “I’ve been more in the camp that neither of the components of the Fed’s dual mandate are pointing to the need to start cutting, and higher-for-longer means nothing could happen this year.”

The Fed’s “dual mandate” entails maintaining both full employment and stable prices.

Even with the unemployment rate rising to 4% in May, the labor market appears vibrant.

However, on the other side of the mandate, inflation is still running well above the Fed’s target. Most gauges have prices rising annually at about a 3% rate, down significantly from the peaks of mid-2022 but still running hot.

Pricing in fed funds futures pointed to almost no chance of a reduction at either the Federal Open Market Committee’s meeting next week or on July 30-31. From there, pricing indicates about a 50-50 chance of a September move, and only about a 46% probability that the Fed will follow up with a second cut before the end of the year, according to the CME Group’s FedWatch measure Friday afternoon.

All of those probabilities were down sharply from Thursday levels.

Investors, though, shouldn’t get too pessimistic, according to Rick Rieder, chief investment officer of global fixed income for money management giant BlackRock. He pointed to softness in demand for workers as shown by a report earlier this week indicating that job openings are continuing to decelerate.

Moreover, the household survey, which is used to calculate the unemployment rate, showed a decrease in employment of 408,000 and a continuing trend of part-time employment far outpacing full-time positions.

“And thus, the Federal Reserve’s mandate of price stability and full employment comes very much into balance,” Rieder wrote in a post-report analysis. “With these conditions, the Fed can lower the Fed Funds rate from very restrictive territory to merely restrictive positioning.”

“We believe the Committee can still start cutting the policy rate by 25 basis points at its September meeting, with a desire to get one more cut done this year, but inflation readings from here need to be supportive of this,” he added.

Similarly, Citigroup, long above consensus on Wall Street as the firm continued to expect aggressive rate cuts, said it now sees the Fed not moving until September but then continuing to cut rates from that point.

“The jobs report does not change our view that hiring demand, and the broader economy, is slowing and that this will ultimately provoke the Fed to react with a series of cuts beginning in the next few months,” Citigroup economist Andrew Hollenhorst wrote.