The U.S. Bureau of Labor Statistics reported yet another strong increase in monthly payroll jobs, even if it was a little below consensus and the previous two months were revised down a bit. The economy added 209,000 jobs in June, a little below the three-month (April to June) average of 244,000 and a step down from the first-quarter average of 312,000.

The strength of the jobs report makes a 25-basis point rate hike all but certain at the July meeting of the Federal Open Market Committee (FOMC), the Fed's rate-setting body.

Chart 1

Job gains grew 1.9% (annualized) on average in the last three months. This is above the 1.4% during the two years (2018 and 2019) leading up to the pandemic and well above the 0.7%-0.8% (or about 100,000 per month) deemed consistent with keeping unemployment rate stable at the trend growth of labor force.

At the current pace of monthly job gains, payroll employment will catch up to our pre-pandemic employment forecast next summer (see chart 2). That said, we expect payroll growth will continue to gradually slow toward equilibrium in the coming months.

Still, the jobs market is more or less back to trend. This is harder to achieve than just hitting the pre-shock peak, and not bad for a recovery from a shock that many feared would lead to massive permanent job losses.

Chart 2

The breadth of private sector hiring--as captured by the diffusion index, where 50% indicates an equal balance between industries with increasing and decreasing employment--narrowed to 58%, near the lowest level of this expansionary cycle. This reflects concentrated gains in education and health care, leisure and hospitality, professional and business services, construction, and (surprisingly) manufacturing.

The private sector added 149,000 jobs altogether in June, but it was the government sector's huge 60,000 jobs added--led by state and local governments--that put the overall net jobs gain over 200,000 (see chart 3). Private sector job growth has slowed materially in the last 12 months to 1.8% (annualized) per month, slightly above the 2018-2019 average of 1.5%.

We expect further slowing, consistent with our forecast of slowing GDP growth. Meanwhile, the government sector could potentially pick up slack in the coming months given the shortfall in state and local government jobs (still 220,000 below February 2020).

Chart 3

Share Of Employed Prime-Aged Workers Nears Its Historical High

The unemployment rate fell 0.1 percentage point to 3.6%, remaining near a 50-year low. And for good reason--both the number of people employed and the number of folks entering the labor force increased.

As the unemployment rate ticked down, the share of 25-54 year olds (prime-aged workers) with a job continued to rise, hitting 80.9% in June, its highest level in over 20 years (see chart 4). The historical high mark for this measure is 81.9% (in April 2000). This gauge of employment is the least affected by changing age-composition and work-preference issues when comparing across time.

We compare this with the high milestone attained in the 1991-2000 expansion, instead of comparing with the last two expansions, which were cut short by financial and health crises, respectively. Compared to the 2000 high, the U.S. economy is currently short nearly 1.3 million prime age workers. We believe the economy could get there in about a year if activity continues to grow at the current pace.

Chart 4

Labor Market Remains Too Tight For Policy Makers' Comfort

Despite signs of normalizing, the labor market remains too tight for comfort from a monetary policy perspective. Gauges of labor demand from last week, including job openings, quits, and unemployment insurance claims, show still-elevated labor demand relative to supply when compared with 2019.

This is true for every major sector except finance (see chart 5). While job openings have been trending down, they remain far above the supply of available workers, with the job opening to unemployment ratio (1.6x) still substantially above the pre-pandemic level (1.2x).

The elevated level of job openings and the uptick in quits may be pointing to additional upward pressure on wage growth at the margin in coming months.

Chart 5

While the number of job gains edged down over the month, average hourly earnings rose 0.4%. This matches May's upwardly revised gain and is up 4.4% over the past year and an even stronger 4.7% on a three-month annualized basis. Nominal wage growth, which seemed like it might be slowing, now looks like it's been moving largely sideways over the last six months (see chart 6).

Chart 6

Wage growth is currently well above than 3.5% pace consistent with 1.5% labor productivity growth (average of 1990-2022) and a 2% average inflation target. Other more comprehensive measures of wage growth, including the Atlanta Fed's wage tracker and the Employment Cost Index, continue to run well above average hourly earnings.

Furthermore, with June Consumer Price Index (CPI) inflation coming in at 3.0%, inflation-adjusted wages were up by approximately 1.4% over the last 12 months, the strongest since March 2021.

Other Hard Data Is Generally Performing Better Than Expected

Overall, nothing in the June jobs report will deter the Fed from hiking at the July 27-28 meeting. Especially considering the recent strength across other key hard data like housing starts, home sales, new orders of capital goods, and a rebound in auto sales (which retraced close to two-thirds of its monthly decline in May).

Key sentiment data also picked up in June. Gauges of new orders, employment, and business activity in the June ISM services index edged up, signaling continued demand for services ahead of the summer travel and holiday season. (To be sure, June data for the ISM manufacturing index showed the broadest contraction in factory activity since the early pandemic days of May 2020.)

Our preferred running estimate of quarterly GDP (the average of the Atlanta Fed's Nowcast and S&P Global Market Intelligence GDP tracker) for the second quarter is currently at about 1.9%, close to our forecast of 1.7% (see "Economic Outlook U.S. Q3 2023: A Sticky Slowdown Means Higher For Longer," June 26, 2023) and just about matching first-quarter growth.

From The Fed's Corner

The minutes from the FOMC's June meeting highlight broad support for further rate hikes. Although the Fed paused in June with no dissent, the decision to do so appears to have been brokered by Chairman Jerome Powell between those on the FOMC who wanted to raise rates and those who wanted to stop.

And although CPI inflation is now at 3.0%, sharply down from the peak of 9.1% last June, we do not expect Fed officials to declare victory anytime soon (see chart 7). Core price inflation, which strips out the volatile energy and food prices, remains elevated (4.8%) relative to productivity growth and the inflation target. Core services inflation excluding housing, the so-called "super core" measure preferred by Powell, slid to 4% y/y in June, as calculated by Bloomberg. It averaged 2.3% for the two years leading up to the pandemic.

Chart 7

For the Fed, the easy part of lowering annual inflation is over. Base effects mean that declines in year-over-year inflation for the rest of this year will be slower. That said, we do expect further easing to come as lower inflation for shelter is captured (with a lag) in the official data. Nevertheless, It is still Fed officials' worst fear that disinflation stops prematurely and inflation bounces back.

Uncertainty reigned throughout the June meeting minutes, which is no different than any other meeting minutes over the last year. Fed staff view either a mild recession or continued slow growth (a "soft landing") as the most likely scenario. Recession or no, we expect a drawn-out period of slow growth for the next couple of years.

Market pricing of Fed policy through the end of 2023 has been volatile in recent months, shifting from sharp cuts to hikes. As of July 12, one more rate hike is baked in before cuts begin in the first quarter of next year. In our June forecast update, we penciled in one rate hike in July, followed by a pause until rate cuts begin next June.

Further action beyond July will depend on how the data evolves. For now, we are comfortable with our expectation of no more rate hikes in this cycle after July, consistent with our forecast for below-potential growth, easing inflation, and a better balance in labor demand and supply. We believe this will be just enough to keep the Fed on the sidelines.