Ouch! Jobs Report Miss Sends Rate Hike Odds Down, Raises Questions

Talk about a letdown.

Friday’s monthly jobs report was a big whiff, raising questions about the health of the economy and causing investors to re-think odds of a summer interest rate hike.

The U.S. economy created just 38,000 jobs in May, the government said Friday in its monthly payrolls report, well below expectations for around 160,000 and the lowest figure since September 2010. Perhaps most concerning of all, there were job losses in construction and manufacturing, two sectors that often give strong clues about the overall health of the economy. This drop in construction and manufacturing jobs, combined with the weak overall number and downward revisions to previous jobs reports, raise some questions about what’s actually underlying the economy, and seem to contradict other recent data that pointed to a healthier consumer.

Before Friday, there was a lot of hawkish talk coming out of the Federal Reserve about possible rate hikes. But this jobs report may give the Fed new perspective. Odds of a rate hike fell sharply after the jobs report, to 6% in June, back at levels last seen around a month ago, according to CME futures. Chances of a July rate hike, which had climbed above 60% last week, fell to 37%. There may be a chance to get a read on the Fed’s reaction to this report later today, as Fed Governor Lael Brainard is scheduled to speak this afternoon.

Monthly employment growth has now slipped to an average of just 116,000 per month when Friday’s sluggish growth and downward revisions to the March and April reports are factored in. That’s quite a slowdown from the 229,000 monthly average in 2015. There were losses in mining, manufacturing, construction and information jobs in May, though the information industry’s number should be taken with a grain of salt because it reflected striking workers at Verizon Communications Inc VZ. There were job gains in health care and in professional and business services. Employment in other major industries and the government was little changed. The unemployment rate fell to 4.7%, but civilian labor force participation also fell slightly. When fewer people participate in the economy, the unemployment rate can fall, but not necessarily because more people have jobs.

The disappointing jobs report comes after a month of data suggesting, for the most part, that the U.S. economy is improving, though not dramatically. The housing market appears strong, auto sales, though somewhat disappointing for May, remain at relatively high levels, and consumer spending has rebounded. The Fed typically takes these and numerous other factors into account when determining interest rates. Fed officials also closely watch inflation, and the Fed’s favored inflation gauge, personal consumption expenditures, was at 1.6% in April, below the Fed’s 2% target rate. Core inflation has been below 2% since 2012, and some Fed officials have recently cautioned that there’s risk in raising rates if inflation hasn’t perked up.

Wage growth is one metric that often factors into inflation, Friday’s jobs report showed hourly wages rising just 5 cents after a 9-cent rise in April. In sum, average hourly earnings have risen 2.5% over the last year. If anyone is looking for a silver lining in the jobs report, the wage growth might represent that. It’s not huge, but it’s a trend in the right direction. And the U6, which measures “underemployment,” held steady at 9.7%.

The jobs report takes center stage Friday, but it’s not the only data hitting the market. Reports on international trade and factory orders are also scheduled, along with the Institute for Supply Management’s services-sector index. And the weekly U.S. oil rig count Friday afternoon could provide hints about whether U.S. producers are responding to higher crude prices. Oil rig counts recently hit record lows, but seem to have stabilized slightly over the last two weeks

Though the S&P 500 index (SPX) closed a little above the 2100 mark on Thursday, its highest close since November, it remains below its April intraday high and continues to see a drift-type trading, seeming to lack a huge commitment either up or down. The key to Friday’s trade is whether the index can close convincingly above 2100 and challenge the April high of 2111, as well as the all-time high just above 2134 set in May 2015. As of Thursday’s close, the index remained about where it was a year ago. Stock futures fell after the jobs report, and Treasuries rose, with the yield on U.S. 10-year Treasury notes slipping under 1.75%.

Q2 Earnings Forecast: Down Again: It’s not too soon to start thinking about Q2 earnings, with the start of earnings season just over a month away. And from early indications, it’s looking like another down quarter. Aggregate Q2 S&P 500 Index earnings per share are forecast to fall 5%, according to S&P Capital, with the energy sector expected to post the biggest year-over-year losses at nearly 78%. That’s actually an improvement from energy’s forecast Q1 EPS loss of 106%. Other sectors S&P Capital expects to post Q2 EPS losses include consumer staples, financials, information technology, materials, and telecommunication services. Looking for a positive sector in regards to Q2 earnings? Consumer discretionary and industrials are forecast to post strong EPS gains of 9.7% and 8.2%, respectively, S&P Capital said. But if aggregate S&P 500 earnings fall in Q2, it would be the fourth-consecutive quarter of year-over-year EPS declines.

The Elusive 2100 Mark: There’s been a lot of focus lately on the psychological 2100 level, which the S&P 500 index (SPX) has traded above now and then this year, including on Thursday, but as Argus Research pointed out in a report this week, the SPX actually first touched 2100 in February 2015, more than 15 months ago. “For a year and a half, stocks have largely gone nowhere,” Argus said. But the research firm is encouraged by some recent economic data, including durable goods orders and consumer spending. These data, as well as expectations for improving gross domestic product (GDP), support a Fed rate hike, Argus said, adding that the markets can stomach a hike as long as economic data continues to support rising consumer prosperity and industrial recovery from recent currency, commodity, and energy price shocks.

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