The labor market is not buying into talk of a recession

The bears have been consistently early, and the latest U.S. payrolls data shows that continues to be the case. The Labor Department reported Friday that U.S. employers added 339,000 jobs in May, the most since January and a number entirely out of line with widespread predictions of an imminent recession. More than any recent statistic, this one should spur broad rethinking about the near-term prospects of the American economy.

Until recently, it appeared that the robust pace of payroll additions had been moderating — however slowly — under the weight of the Federal Reserve’s aggressive interest-rate increases in the past 13 months. But even that may no longer hold true. With the gangbusters payroll additions in May and the significant upward revisions to previous months’ data, the report showed that the labor market in aggregate isn’t even really cooling off anymore — let alone collapsing. The six-month moving average of monthly payroll gains rose for the first time since October 2022.

Meanwhile, the so-called diffusion index showed that 60.2% of industries added jobs, a proportion that’s historically inconsistent with a recession starting in the next six months. That means that the majority of economists projecting economic contractions in the third and forth quarters of this year may have to reconsider. The labor market is often considered a “lagging indicator,” but it’s rare — outside of the highly unusual COVID-19 experience — for it to abruptly stop with no forewarning.

For markets, the surprise strength has several implications. First, it means that concerns about consumer spending, company earnings and the broader economy may have been overstated in the near term. Economists have been projecting a weaker economy “just around the corner” all year, and stock market analysts have followed their lead in underestimating earnings. That’s why first-quarter earnings forecasts were about 6% too low and why the second quarter may bring surprising durability as well. Stocks may have limited upside potential after the year-to-date rally, but the near-term downside doesn’t look as daunting as alarmists led us to think.

Second, the bond market may be underestimating the prospect of slightly tighter Fed monetary policy in the months ahead. Barring a shockingly hot inflation report later this month, recent comments by Fed speakers suggest betterthan-even odds that policymakers will “skip” an interest-rate increase at their June 13-14 meeting and wait for further information. But with core personal consumption expenditure inflation still more than double the Fed’s target, there’s a sizable risk that they will surgically lift interest rates higher in the ensuing months. The strong labor market didn’t cause the inflation, but it will give policymakers license to do so.

The report, of course, wasn’t entirely sunshine and roses. The unemployment rate ticked higher to 3.7% from 3.4% amid a decline in self-employed workers captured in the household survey. Yet the rate was still remarkably low by the standards of the past 50 years, and the proportion of the “prime age” (25-54) working population that had a job was only 0.1 percentage point below its two-decade high.

Meanwhile, average weekly hours worked fell to 34.3 from 34.4, the lowest since April 2020 and perhaps the clearest sign that employers are subtly cutting back on labor expenses. Of course, proprietors’ post-pandemic habit of hoarding labor — following the extreme labor shortages of recent years — may serve to prevent a deeper downturn. Clearly, workers are better off losing an hour or two of wages than losing their job entirely.

All told, the data have to be a net positive, and it was perhaps little wonder that the S&P 500 Index jumped 1.1% to the highest since August 2022. For markets, the unwinding of near-term recession fears should more than offset the threat of surgical tightening of U.S. monetary policy. More important, U.S. workers continue to find that the future isn’t nearly as gloomy as previously thought.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.