Financial News for the Week of June 2nd, 2023

With Congress passing a deal to suspend the debt limit and avoiding a default, all eyes were focused on this morning’s non-farm payrolls report. Hiring rose by a robust +339k, which came in well above the consensus forecast of 195k in major financial news. Looking forward, markets are now expecting the Fed will have to keep rates higher for longer to cool the economy and inflation.

Turning to the specifics of debt ceiling deal, Congress passed the Fiscal Responsibility Act of 2023 which will suspend the debt ceiling for two years and avert a default on U.S. debt (link). The deal caps discretionary spending for 2024-2025 and will have a modest effect on reducing the deficit over that time horizon. Moreover, the overall impact on the economy should be modest with the peak impact coming in 2024 and the possibility of shaving 0.1% off GDP growth.

The economic data out this week showed U.S. manufacturing activity continues to feel the pinch from higher rates and a pullback in demand. The ISM manufacturing index registered a 46.9 reading – well short of the 50 print indicating growth. This is now the seventh consecutive month of contraction for the sector and the outlook in the coming months is decidedly gloomy in financial news. New orders contracted again (at a faster pace than the month prior) and the backlogs in business that have helped keep factories humming cleared at their fastest pace since the Global Financial Crisis (Chart 1). There was a silver lining to the report as the transportation sector did report an expansion for the month of May – helping it continue its recovery amid ongoing tight supplies. Indeed, despite vehicle sales in May coming in slightly below expectations (15.1 million annualized vs. the 15.3 million annualized expected) the details of the report show that pent-up demand is still being cleared and the industry remains undersupplied.

The weakness in the manufacturing sector was expected and stands in stark contrast to what’s happening across the rest of labor market. Nonfarm payrolls grew by 339k position in May, blowing past expectations for a more modest expansion of 195k. The bulk of the growth came from the services side – adding 257k positions in May – though construction (+25k) and government (+56k) all chipped in with healthy gains. However, this blowout print was accompanied by a 440k increase in the number of unemployed in the household survey – lifting the unemployment rate 30 basis points to 3.7%. Excluding the lockdown phase of the pandemic, this is the steepest rise in the jobless rate since November 2010. However, take the rise with a grain of salt, as the concept adjusted household employment that excludes categories like agricultural and household workers and adds in multiple job holders to make it comparable to the payrolls numbers, showed a still healthy 394k gain (Chart 2).

With this backdrop markets are as bracing for the possibility of another Fed hike by mid-summer and a delayed start to rate cuts. The need for rates to remain in restrictive territory for longer is in line with our view that policy easing won’t come until 2024Q1.

 

Andrew Hencic, Senior Economist | 416-944-5307