Another Expected Premium in US Private Employment... Fed's Interest Rate Dilemma Deepens (Comprehensive)

Indicators suggesting that the labor market remains resilient despite over a year of tightening by the U.S. Federal Reserve (Fed) were added on the 1st (local time). With opinions divided between additional rate hikes and a pause, the Fed's dilemma ahead of this month's Federal Open Market Committee (FOMC) regular meeting is expected to deepen. Investors' attention is focused on the employment report to be released the following day.

According to private employment data firm Automatic Data Processing (ADP) on the day, private sector employment in May increased by 278,000 compared to the previous month. Although this is a slowdown from the revised figure of 291,000 in the previous month, it far exceeded the market forecast of 170,000. By sector, leisure and hospitality saw an increase of as many as 208,000 jobs. The mining and construction sectors also increased by 94,000 and 64,000 jobs, respectively.

The weekly initial jobless claims released on the same day rose by 2,000 from the previous week but remained historically low. Last week's claims were 232,000, below Wall Street's forecast of 235,000.

These indicators suggest that the overall labor market remains strong despite the Fed's aggressive tightening. The Job Openings and Labor Turnover Survey (JOLTs) released the previous morning also showed that U.S. job openings in April reached 10.1 million, surpassing market expectations. Since the Fed has cited inflation and labor market overheating as reasons for additional tightening, if employment reports and other indicators released the following day also exceed expectations, the outlook for further Fed tightening is likely to strengthen again.

[Image source=Reuters Yonhap News]

Ahead of the FOMC regular meeting scheduled for June 13-14, the Fed has raised the U.S. benchmark interest rate to 5.0-5.25% through ten consecutive hikes since March last year. As a result, even within the Fed, opinions are divided between hawks (who prefer monetary tightening) concerned about persistent inflation and labor market overheating, and doves (who prefer monetary easing) who argue that it is time to pause rate hikes and assess the cumulative effects of policy amid recession concerns.

However, the market largely expects a pause. According to the CME FedWatch Tool, the federal funds futures market currently reflects about a 76% probability that the Fed will hold rates steady this month. In contrast, the probability of an additional 0.25 percentage point hike is around 23%. Patrick Harker, President of the Federal Reserve Bank of Philadelphia, hinted again on the day that a pause in June is possible. Holding voting rights at this year's FOMC, he stated that the Fed is close to a point where it can stop raising rates. The Wall Street Journal (WSJ) also reported that Fed officials might skip June and resume hikes later depending on economic data.

The key lies in the upcoming indicators. The Fed is expected to closely monitor data and deliberate until just before the FOMC. Harker, who stated a pause stance the previous day, added that the employment report released this Friday and the Consumer Price Index (CPI) announced on the first day of the June FOMC will be important, leaving open the possibility of further tightening depending on the data. Currently, Wall Street estimates that nonfarm payroll growth in the May employment report will slow to between 189,000 and 190,000 compared to the previous month. The consensus unemployment rate is 3.5%.

Han Tan, Chief Market Analyst at Exinity Group, said, "The May nonfarm payroll report and the U.S. CPI data will determine the Fed's next rate move." Vanguard's Chief Economist Joe Davis supported an additional rate hike, stating, "Tomorrow's employment report will highlight the challenges the Fed faces in its efforts to bring inflation back to target."

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