A third consecutive stronger-than-expected jobs report has shifted the Federal Reserve’s attention firmly toward inflation and strengthened the case among hawkish officials for interest rate increases later this year, removing any remaining pressure on the central bank to prioritize the labor market.
The U.S. economy added 172,000 jobs in May, nearly double the 88,000 economists had forecast. The unemployment rate held steady at 4.3%. Payrolls for March were revised up by 29,000 to 214,000, and April’s count was revised higher by 64,000 to 179,000.
Average monthly job growth over the past three months now stands at more than 188,000, a robust pace that gives the Fed little reason to consider rate cuts.
What the Report Means for Fed Policy
The May payroll number decisively removes one of the two key concerns that had previously made Fed officials hesitant to raise rates: the risk of a deteriorating labor market.
Stephen Brown, chief North America economist for Capital Economics, said the third consecutive payroll beat should further reduce concern within the Federal Open Market Committee about downside risks to employment, making it even harder for the Fed to justify looking past persistently elevated inflation.
“Providing the labor market does not suffer a dramatic summer jobs scare again, then it looks increasingly likely that the FOMC will enact a couple of insurance hikes later this year,” Brown said.
Investors responded to the report by pricing in a nearly 40% probability of a rate hike at the October meeting, moving up the anticipated timeline from December before the report was released.
Government bond yields also moved higher in anticipation that a tightening of monetary policy is becoming more likely.
Fed Hawks Are Growing More Vocal
Several Federal Reserve officials used the week’s events to make their inflation concerns explicit and to signal that patience with elevated prices is running thin.
Cleveland Fed president Beth Hammack said the jobs report reaffirms that the labor market is roughly in balance, and that her primary concern has shifted to inflation.
“Inflation is high, moving higher, and I believe persistently high inflation is the bigger concern,” Hammack wrote. She added that while holding rates steady is reasonable given current uncertainties, if recent trends continue, it may soon be appropriate to act.
Dallas Fed president Lorie Logan said inflation is taking too long to return to the Fed’s 2% target and expressed increasing concern that higher rates could be necessary later this year to fully restore price stability.
New York Fed president John Williams told reporters that inflation risks have increased significantly in light of the Middle East conflict and a resilient economy, while unemployment risks have edged lower.
Williams suggested the Fed should remove language from its policy statement that signals the next move will be a rate cut, acknowledging that the direction of future policy is no longer clearly pointed in one direction.
Three members of the FOMC, including Hammack and Logan, had already objected to retaining that forward guidance language at the last meeting, arguing that the Fed should signal its next move could be either a cut or a hike.
Leisure and Hospitality Leads the Gains
The composition of May’s job growth offered a slight shift from recent patterns.
After more than a year in which healthcare dominated monthly payroll gains, leisure and hospitality led May’s increase with 70,000 jobs added. Healthcare and social assistance also contributed, but for the first time in many months, it was not the primary driver.
Jerry Tempelman, a former senior analyst at the New York Fed, said the breadth of the May gains is notable.
“Employers appear to be looking past economic and financial uncertainties brought about by the ongoing conflict in the Middle East,” Tempelman said.
What Comes Next
The Federal Reserve will receive one more inflation reading before its June 17 meeting, when officials will decide whether to hold rates steady, adjust their policy guidance, or take more decisive action.
The combination of a robust labor market and inflation running at a three-year high gives the hawkish wing of the committee substantial ammunition to push for a rate hike signal or an outright increase, while the uncertainty surrounding the Iran war and its potential to slow economic growth provides the cautious majority with reason to wait.
The balance between those two forces will likely define monetary policy for the remainder of the year, with the outcome hinging heavily on whether the Iran conflict moves toward resolution or continues to generate inflation pressure with no clear end in sight.
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